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March 19, 2019, 4:07 p.m. EDT

10-K: MICHAELS COMPANIES, INC.

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(EDGAR Online via COMTEX) -- ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

We report on the basis of a 52- or 53-week fiscal year, which ends on the Saturday closest to January 31. All references to fiscal year mean the year in which that fiscal year began. References to "fiscal 2018" relate to the 52 weeks ended February 2, 2019, references to "fiscal 2017" relate to the 53 weeks ended February 3, 2018 and references to "fiscal 2016" relate to the 52 weeks ended January 28, 2017.

Michaels Stores, Inc. ("MSI") is headquartered in Irving, Texas and was incorporated in the state of Delaware in 1983. In July 2013, MSI was reorganized into a holding company structure and The Michaels Companies, Inc. (the "Company") was incorporated in the state of Delaware in connection with the reorganization.

Fiscal 2018 Overview

With $5,271.9 million in net sales in fiscal 2018, we are the largest arts and crafts specialty retailer in North America (based on store count) providing materials, project ideas and education for creative activities, primarily under the Michaels retail brand. We also operate a wholesale business under the Darice brand name and a market-leading vertically-integrated custom framing business under the Artistree brand name. At February 2, 2019, we operated 1,258 Michaels stores.

Financial highlights for fiscal 2018 include the following:

� Net sales decreased to $5,271.9 million, a 1.7% decrease compared to last year, primarily due to the closure of substantially all of our Aaron Brothers stores and $78.6 million associated with the 53rd week in fiscal 2017.

� Comparable store sales increased 0.8%, or 0.9% at constant exchange rates.

� Our Michaels retail stores' private brand merchandise drove approximately 60% of net sales in fiscal 2018 compared to 58% of net sales in fiscal 2017.

� We recorded restructure charges totaling $104.2 million consisting of $41.7 million related to the closure of substantially all of our Aaron Brothers stores, $57.2 million related to the closure of all of our Pat Catan's stores and $5.3 million of employee-related charges as a result of certain organizational changes made to streamline our operations at our corporate support center.

� We reported operating income of $563.6 million, a decrease of 23.4% from the prior year and net income of $319.5 million, a decrease of 18.2% from the prior year. The decreases are primarily due to restructure charges recorded in fiscal 2018 and the 53rd week of operations in fiscal 2017.

� Adjusted EBITDA, a non-GAAP measure that is a required calculation in our debt agreements, decreased by 6.1%, from $888.5 million in fiscal 2017 to $834.6 million in fiscal 2018 (see "Management Discussion and Analysis of Financial Condition and Results of Operations - Non-GAAP Measures").

� We recognized approximately $40 million of cost savings in fiscal 2018 as a result of sourcing initiatives that began in fiscal 2016.

� We refinanced our amended term loan credit facility and entered into two interest rate swaps associated with that facility.

� In June 2018, we executed a $250 million accelerated share repurchase agreement ("ASR Agreement') for delivery of 12.4 million shares of our common stock.

� We repurchased 24.6 million shares under our share repurchase programs for an aggregate amount of $451.9 million, including shares repurchased under the ASR Agreement.

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In fiscal 2018, we made significant progress implementing our strategic initiatives, including:

� repositioning our Aaron Brothers brand as a store-within-a-store to provide custom framing services in all Michaels stores and rebranding Framerspointe.com to AaronBrothers.com;

� creating flexible merchandising space in an additional 238 stores to highlight new product and present stronger, more cohesive seasonal product statements to customers;

� strengthening our omnichannel offering with improvements to the Michaels app and the expansion of our buy online, pick up in store and ship-from-store programs;

� supporting the growth of our e-commerce business by retro-fitting our DFW distribution center to support e-commerce fulfillment, allowing us to maintain greater control over, and lower our costs associated with, our e-commerce order fulfillment process;

� launching a new promotional tool to manage discounts more effectively through the use of targeted offers and serialized coupons;

� customizing our digital communications to customers by using new data analytics capabilities to drive customer insights; and

� generating meaningful cost savings through our ongoing Fuel for Growth and sourcing efforts.

Fiscal 2019 Outlook

In fiscal 2019, we intend to continue to expand our industry leadership through innovation and strategic initiatives such as:

� enhancing our digital platforms and tools to deliver a more seamless, omnichannel customer experience;

� expanding our e-commerce businesses and diversifying our fulfillment processes to drive increased profitability;

� leveraging new data analytical capabilities to help us identify actionable customer insights, create more effective customer communications and enhance our assortment;

� continuing to leverage our size and scale to curate our assortment, both in-store and online, to offer customers more newness, more exclusives and trend-right product; and

� generating meaningful cost savings through our ongoing Fuel for Growth efforts and product sourcing.

Comparable Store Sales

Comparable store sales represents the change in net sales for stores open the same number of months in the comparable period of the previous year, including stores that were relocated or expanded during either period, as well as e-commerce sales. A store is deemed to become comparable in its 14th month of operation in order to eliminate grand opening sales distortions. A store temporarily closed more than two weeks is not considered comparable during the month it is closed. If a store is closed longer than two weeks but less than two months, it becomes comparable in the month in which it reopens, subject to a mid-month convention. A store closed longer than two months becomes comparable in its 14th month of operation after its reopening. Comparable store sales exclude the impact of the 53rd week in fiscal 2017. All Aaron Brothers stores have been excluded from comparable stores sales in fiscal 2018.

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Results of Operations

The following table sets forth the percentage relationship to net sales of line items in our consolidated statements of comprehensive income. This table should be read in conjunction with the following discussion and with our consolidated financial statements, including the related notes.







                                                                        Fiscal Year
                                                                2018        2017        2016
          Net sales                                             100.0 %     100.0 %     100.0 %
          Cost of sales and occupancy expense                    61.6        60.3        61.0
          Gross profit                                           38.4        39.7        39.0
          Selling, general and administrative                    25.6        25.9        25.2
          Restructure charges                                     2.0           -           -
          Store pre-opening costs                                 0.1         0.1         0.1
          Operating income                                       10.7        13.7        13.8
          Interest expense                                        2.8         2.4         2.4
          Losses on early extinguishments of debt and
          refinancing costs                                         -           -         0.1
          Other (income) expense, net                               -           -           -
          Income before income taxes                              7.9        11.3        11.2
          Income taxes                                            1.8         4.0         3.9
          Net income                                              6.1 %       7.3 %       7.3 %
        


Fiscal 2018 Compared to Fiscal 2017

Net Sales. Net sales decreased $90.0 million in fiscal 2018, or 1.7%, compared to fiscal 2017. The decrease in net sales was due to a $95.3 million decrease related to the closure of substantially all of our Aaron Brothers stores, a $78.6 million decrease associated with the 53rd week in fiscal 2017 and a $4.6 million decrease in wholesale revenue. The decrease was partially offset by a $49.4 million increase related to 20 additional Michaels stores opened (net of closures) since February 3, 2018 and a $37.9 million increase in comparable store sales. Comparable store sales increased 0.8%, or 0.9% at constant exchange rates, compared to fiscal 2017 due to an increase in average ticket, partially offset by a decrease in customer transactions.

Gross Profit. Gross profit was 38.4% of net sales in fiscal 2018 compared to 39.7% in fiscal 2017. The 130 basis point decrease was primarily due to higher distribution related costs, a change in sales mix, occupancy cost deleverage due to the 53rd week in the prior year and an increase in shrink. The decrease was partially offset by benefits from our ongoing sourcing initiatives.

Selling, General and Administrative. Selling, general and administrative ("SG&A") was 25.6% of net sales in fiscal 2018 compared to 25.9% in fiscal 2017. SG&A decreased $39.0 million to $1,351.4 million in fiscal 2018. The decrease was primarily due to a $34.7 million decrease related to the Aaron Brothers store closures in fiscal 2018 and a $15.5 million decrease in payroll related expenses primarily due to the 53rd week in fiscal 2017. The decrease was partially offset by a $7.4 million increase associated with operating 20 additional Michaels stores (net of closures).

Restructure Charges. We recorded restructure charges totaling $104.2 million in fiscal 2018 consisting of $41.7 million related to the closure of substantially all of our Aaron Brothers stores, $57.2 million related to the closure of all of our Pat Catan's stores and $5.3 million of employee-related charges as a result of certain organizational changes made to streamline our operations at our corporate support center.

Interest Expense. Interest expense increased $18.0 million to $147.1 million in fiscal 2018 compared to fiscal 2017. The increase was primarily due to $13.2 million as a result of a higher interest rate on our amended and restated term loan credit facility and $4.6 million related to settlement payments associated with our interest rate swaps.

Losses on Early Extinguishments of Debt and Refinancing Costs. We recorded a loss on the early extinguishment of debt of $1.8 million in fiscal 2018 related to the refinancing of our amended and restated term loan credit facility.

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Income Taxes. The effective tax rate was 23.4% for fiscal 2018 compared to 35.5% for fiscal 2017. The effective tax rate for fiscal 2018 was lower than the same period in the prior year due to benefits recognized related to the Tax Cuts and Jobs Act of 2017 (the "Tax Act"), including a decrease in the federal statutory rate from 35% to 21%.

Fiscal 2017 Compared to Fiscal 2016

Net Sales. Net sales increased $164.7 million in fiscal 2017, or 3.2%, compared to fiscal 2016. The increase in net sales was due to $78.6 million associated with the 53rd week in fiscal 2017, a $49.9 million increase related to 15 additional Michaels stores opened (net of closures) since January 28, 2017 and a $47.8 million increase in comparable store sales. Comparable store sales increased 0.9% compared to fiscal 2016, or 0.7% at constant exchange rates, due to an increase in average ticket and an increase in customer transactions. Wholesale revenue decreased $11.3 million primarily due to the timing differences between new customer acquisitions and the expected decline in sales from legacy customers as a result of the Lamrite acquisition in fiscal 2016.

Gross Profit. Gross profit was 39.7% of net sales in fiscal 2017 compared to 39.0% in fiscal 2016. The 70 basis point increase was primarily due to our sourcing initiatives that began in fiscal 2016, occupancy cost leverage as a result of the 53rd week in fiscal 2017 and $4.0 million of non-recurring purchase accounting adjustments related to inventory recorded in the prior year. The increase was partially offset by an increase in shrink and distribution related costs.

Selling, General and Administrative. SG&A was 25.9% of net sales in fiscal 2017 compared to 25.2% in fiscal 2016. SG&A increased $82.3 million to $1,390.4 million in fiscal 2017. The increase was due to a $37.6 million increase in incentive-based compensation, a $23.5 million increase in payroll related expenses primarily due to the 53rd week in fiscal 2017, $9.9 million of higher healthcare costs, a $5.3 million increase in marketing expenses and $3.5 million of expenses primarily associated with operating 15 additional Michaels stores (net of closures). The increase was partially offset by $7.4 million of Lamrite integration costs recorded in the prior year.

Interest Expense. Interest expense increased $2.8 million to $129.1 million in fiscal 2017 compared to fiscal 2016. The increase was primarily due to $4.4 million in additional interest related to the 53rd week in fiscal 2017 and a higher interest rate on our term loan credit facility. The increase was partially offset by $1.1 million of interest savings due to the refinancing of our term loan credit facility in the third quarter of fiscal 2016 and $0.4 million in interest savings related to the refinancing of the senior secured asset-based revolving credit facility in the second quarter of fiscal 2016.

Losses on Early Extinguishments of Debt and Refinancing Costs. We recorded a loss on the early extinguishment of debt of $7.3 million during fiscal 2016, consisting of $6.9 million related to the amendment of our term loan credit facility and $0.4 million related to the refinancing of our senior secured asset-based revolving credit facility.

Income Taxes. The effective tax rate for fiscal 2017 was 35.5% compared to 35.0% in the prior year. The effective tax rate for fiscal 2017 was higher than the prior year due to an $8.5 million charge as a result of the enactment of the Tax Act. The charge consists of adjustments totaling $14.6 million related to repatriation taxes for accumulated earnings of foreign subsidiaries and the revaluation of net deferred tax assets, partially offset by a $6.1 million benefit due to a decrease in the federal statutory tax rate from 35% to 21%. In addition, we realized tax benefits associated with our direct sourcing initiatives that began in the second half of fiscal 2016 and $3.2 million of excess tax benefits in fiscal 2017 associated with the adoption of a new accounting standard related to share-based compensation.

Liquidity and Capital Resources

We require cash principally for day-to-day operations, to finance capital investments, purchase inventory, service our outstanding debt and for seasonal working capital needs. We expect that our available cash, cash flow generated from operating activities and funds available under our Amended Revolving Credit Facility (as defined below) will be sufficient to fund planned capital expenditures, working capital requirements, debt repayments, debt service requirements and anticipated growth for the foreseeable future. Our ability to satisfy our liquidity needs and continue to refinance or reduce debt could be adversely affected by the occurrence of any of the events described under "Item 1A. Risk Factors" or our failure to meet our debt covenants as described below. Our Amended Revolving Credit Facility provides senior secured financing of up to $850.0 million, subject to a borrowing base. As of February 2, 2019, the borrowing base was $850.0 million, of which we had no outstanding borrowings, $107.3 million of outstanding standby letters of credit and $742.7 million of unused borrowing capacity. Our cash and cash equivalents totaled $245.9 million at February 2, 2019.

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In September 2018, the Board of Directors authorized a new share repurchase program for the Company to purchase $500.0 million of the Company's common stock on the open market or through accelerated share repurchase transactions. The share repurchase program does not have an expiration date, and the timing and number of repurchase transactions under the program will depend on market conditions, corporate considerations, debt agreements and regulatory requirements. Shares repurchased under the program are held as treasury shares until retired. In June 2018, the Company entered into an ASR Agreement with JPMorgan Chase Bank, N.A. ("JPMorgan"). Under the ASR Agreement, we paid JPMorgan a purchase price of $250.0 million for delivery of 12.4 million shares of our common stock. The total number of shares repurchased was based upon a volume weighted average price of our stock over a predetermined period. The ASR agreement was completed on August 30, 2018. During the year ended February 2, 2019, we repurchased 24.6 million shares under our share repurchase programs for an aggregate amount of $451.9 million, inclusive of the ASR Agreement. As of February 2, 2019, we had $398.4 million of availability remaining under our current share repurchase program.

We had total outstanding debt of $2,717.5 million at February 2, 2019, of which $2,207.5 million was subject to variable interest rates and $510.0 million was subject to fixed interest rates. In April 2018, we executed two interest rate swaps with an aggregate notional value of $1.0 billion associated with our outstanding Amended Term Loan Credit Facility (as defined below). The swaps replaced the one-month LIBOR with a fixed interest rate of 2.7765%.

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

We intend to use excess operating cash flows to invest in growth opportunities, repurchase outstanding shares and repay portions of our indebtedness, depending on prevailing market conditions, liquidity requirements, contractual restrictions and other factors. As such, we and our subsidiaries, affiliates and significant shareholders may, from time to time, seek to retire or purchase our outstanding debt (including publicly issued debt) through cash purchases and/or exchanges, in open market purchases, privately negotiated transactions, by tender offer or otherwise. If we use our excess cash flows to repay our debt, it will reduce the amount of excess cash available for additional capital expenditures.

Cash Flow from Operating Activities

Cash flows provided by operating activities were $444.3 million in fiscal 2018, a decrease of $79.4 million from fiscal 2017. The decrease was primarily due to lower operating income in fiscal 2018, including the impact of the 53rd week in the prior year, investments in inventory associated with our wholesale business and increased duties. The decrease was partially offset by a reduction in cash paid for taxes.

Inventory decreased 1.3% to $1,108.7 million at February 2, 2019, from $1,123.3 million at February 3, 2018. The decrease was primarily due to the Aaron Brothers and Pat Catan's store closures in fiscal 2018. The decrease was partially offset by additional inventory associated with the operation of 20 additional Michaels stores (net of closures) since February 3, 2018 and investments in inventory associated with our wholesale business. Average inventory per Michaels store (inclusive of distribution centers, in-transit and inventory for the Company's e�commerce site) increased 2.7% to $832,000 at February 2, 2019, from $810,000 at February 3, 2018.

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        Cash Flow from Investing Activities
        The following table includes capital expenditures paid during the periods
        presented (in thousands):
                                                                              Fiscal Year
                                                                    2018         2017         2016
        New and relocated stores and stores not yet opened (1)    $  32,153    $  19,419    $  22,489
        Existing stores                                              39,524       35,940       47,290
        Information systems                                          54,794       47,894       27,584
        Corporate and other                                          18,916       24,577       17,099
                                                                  $ 145,387    $ 127,830    $ 114,462
        


We currently estimate that our capital expenditures will be approximately $135 million in fiscal 2019. We plan to invest in the infrastructure necessary to support the further development of our business, including investments in information technology related to our e-commerce business, enhancing our digital platforms and tools, and improving our data analytical capabilities to gain additional customer insights. In addition, we will continue to invest in new store openings and store remodels. In fiscal 2019, we plan to open approximately 37 new Michaels stores, including approximately 13 relocations, and up to 12 rebranded Pat Catan's stores.

Term Loan Credit Facility

On January 28, 2013, MSI entered into an amended and restated credit agreement maturing on January 28, 2020 (the "Credit Agreement") to amend various terms of MSI's then existing term loan credit agreement with Deutsche Bank AG New York Branch ("Deutsche Bank") and other lenders. The Credit Agreement, together with the related security, guarantee and other agreements, is referred to as the "Term Loan Credit Facility".

On July 2, 2014, MSI issued an additional $850.0 million of debt under the Term Loan Credit Facility maturing in 2020 ("Additional Term Loan"). The Additional Term Loan was issued at 99.5% of face value, resulting in an effective interest rate of 4.02%.

On September 28, 2016, MSI entered into an amendment with Deutsche Bank and other lenders to amend and restate our Term Loan Credit Facility. The amended and restated credit agreement, together with the related security, guarantee and other agreements, is referred to as the "Amended Term Loan Credit Facility".

On May 23, 2018, MSI entered into an amendment with JPMorgan, as successor administrative agent and successor collateral agent, and other lenders to amend and restate our Amended Term Loan Credit Facility. The amended and restated credit agreement, together with the related security, guarantee and other agreements, is referred to as the "Amended and Restated Term Loan Credit Facility". Borrowings under the Amended and Restated Term Loan Credit Facility bear interest at a rate per annum, at MSI's option, of either (a) a margin of 1.50% plus a base rate defined as the highest of (1) the prime rate of JPMorgan,

As of February 2, 2019, the Amended and Restated Term Loan Credit Facility provides for senior secured financing of $2,207.5 million. MSI has the right under the Amended and Restated Term Loan Credit Facility to request additional term loans (a) in the aggregate amount of up to $750.0 million or (b) at MSI's election, an amount of additional term loans if the consolidated secured debt ratio (as defined in the Amended and Restated Term Loan Credit Facility) is no more than 3.25 to 1.00 on a pro forma basis as of the last day of the most recently ended four quarter period, subject to certain adjustments. The lenders under the Amended and Restated Term Loan Credit Facility will not be under any obligation to provide any such additional term loans, and the incurrence of any such additional term loans is subject to customary conditions.

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There are no limitations on dividends and certain other restricted payments so long as (a) no event of default shall have occurred and be continuing and (b) immediately after giving pro forma effect to such restricted payment(s) and the application of proceeds therefrom, the consolidated total leverage ratio is less than or equal to 3.75 to 1.00.

MSI must offer to prepay outstanding term loans at 100% of the principal amount, plus any unpaid interest, with the proceeds of certain asset sales or casualty events under certain circumstances. MSI may voluntarily prepay outstanding loans under the Amended and Restated Term Loan Credit Facility at any time without premium or penalty other than customary breakage costs with respect to LIBOR loans.

MSI is required to make scheduled quarterly payments equal to 0.25% of the original principal amount of the term loans (subject to adjustments relating to the incurrence of additional term loans) for the first four years and two quarters of the Amended and Restated Term Loan Credit Facility, with the balance to be paid on January 28, 2023.

All obligations under the Amended and Restated Term Loan Credit Facility are unconditionally guaranteed, jointly and severally, by Michaels Funding, Inc. ("Holdings") and all of MSI's existing domestic material subsidiaries and are required to be guaranteed by certain of MSI's future domestic wholly-owned material subsidiaries ("the Subsidiary Guarantors"). All obligations under the Amended and Restated Term Loan Credit Facility, and the guarantees of those obligations, are secured, subject to certain exceptions, by substantially all of the assets of Holdings, MSI and the Subsidiary Guarantors, including:

� a first-priority pledge of MSI's capital stock and all of the capital stock held directly by MSI and the Subsidiary Guarantors (which pledge, in the case of any foreign subsidiary or foreign subsidiary holding company, is limited to 65% of the voting stock of such foreign subsidiary or foreign subsidiary holding company and 100% of the non-voting stock of such subsidiary);

� a first-priority security interest in, and mortgages on, substantially all other tangible and intangible assets of Holdings, MSI and each Subsidiary Guarantor, including substantially all of MSI's and the Subsidiary Guarantors . . .

Mar 19, 2019

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