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June 7, 2019, 2:48 p.m. EDT

10-Q: MICHAELS COMPANIES, INC.

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(EDGAR Online via COMTEX) -- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This discussion and analysis should be read in conjunction with the unaudited consolidated financial statements of the Company (and the related notes thereto included elsewhere in this quarterly report), the audited consolidated financial statements of the Company (and the related notes thereto) and the Management's Discussion and Analysis of Financial Condition and Results of Operations in the Company's Annual Report on Form 10-K for the fiscal year ended February 2, 2019

All of the "Company", "us", "we", "our", and similar expressions are references to The Michaels Companies, Inc. ("Michaels") and our consolidated wholly-owned subsidiaries, unless otherwise expressly stated or the context otherwise requires.

We report on the basis of a 52-week 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 2019" relate to the 52 weeks ending February 1, 2020 and references to "fiscal 2018" relate to the 52 weeks ended February 2, 2019. In addition, all references to "the first quarter of fiscal 2019" relate to the 13 weeks ended May 4, 2019 and all references to "the first quarter of fiscal 2018" relate to the 13 weeks ended May 5, 2018. Because of the seasonal nature of our business, the results of operations for the 13 weeks ended May 4, 2019 are not indicative of the results to be expected for the entire year.

Overview

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. As of May 4, 2019, we operated 1,260 Michaels stores.

Net sales for the first quarter of fiscal 2019 decreased 5.3% compared to the same period in the prior year. The decrease in net sales was due primarily to the closure of our Pat Catan's stores and substantially all of our Aaron Brothers stores in fiscal 2018 and a 2.9% decrease in comparable store sales. The decrease was partially offset by net sales related to 17 additional Michaels stores opened (net of closures) since the first quarter of fiscal 2018. Gross profit as a percent of net sales decreased 130 basis points to 38.2% during the first quarter of fiscal 2019 due primarily to higher distribution related costs, occupancy cost deleverage and a change in sales mix. Operating income as a percent of net sales increased to 8.5% for the first quarter of fiscal 2019 compared to 6.8% in the same period in the prior year. The increase was primarily due to the restructure charge of $47.5 million related to the closure of substantially all of our Aaron Brothers stores in the first quarter of fiscal 2018.

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.

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        Operating Information
        The following table sets forth certain operating data:
                                                                         13 Weeks Ended
                                                                       May 4,     May 5,
                                                                        2019       2018
            Michaels stores:
            Open at beginning of period                                  1,258      1,238
            New stores                                                       4          6
            Relocated stores opened                                          7          9
            Closed stores                                                  (2)        (1)
            Relocated stores closed                                        (7)        (9)
            Open at end of period                                        1,260      1,243
            Aaron Brothers stores:
            Open at beginning of period                                      -         97
            Closed stores                                                    -       (94)
            Open at end of period                                            -          3
            Pat Catan's stores:
            Open at beginning and end of period                              -         36
            Total store count at end of period                           1,260      1,282
            Other Operating Data:
            Average inventory per Michaels store (in thousands) (1)   $    822    $   814
            Comparable store sales                                       (2.9) %      0.4 %
            Comparable store sales, at constant currency                 (2.5) %        - %
        


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.







                                                             13 Weeks Ended
                                                            May 4,    May 5,
                                                             2019      2018
                      Net sales                               100.0 %  100.0 %
                      Cost of sales and occupancy expense      61.8     60.5
                      Gross profit                             38.2     39.5
                      Selling, general and administrative      29.3     28.4
                      Restructure charges                       0.3      4.1
                      Store pre-opening costs                   0.1      0.1
                      Operating income                          8.5      6.8
                      Interest expense                          3.4      3.0
                      Other expense (income), net               0.3    (0.1)
                      Income before income taxes                4.8      4.0
                      Income taxes                              1.3      1.7
                      Net income                                3.4 %    2.3 %
        


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13 Weeks Ended May 4, 2019 Compared to the 13 Weeks Ended May 5, 2018

Net Sales. Net sales decreased $61.8 million in the first quarter of fiscal 2019, or 5.3%, to $1,093.7 million compared to the first quarter of fiscal 2018. The decrease in net sales was due to a $38.7 million decrease related to the closure of our Pat Catan's stores and substantially all of our Aaron Brothers stores during fiscal 2018, a $31.3 million decrease in comparable store sales and a $2.7 million decrease in wholesale revenue. The decrease was partially offset by $11.2 million of net sales related to 17 additional Michaels stores opened (net of closures) since May 5, 2018. Comparable store sales decreased 2.9%, or 2.5% at constant exchange rates, compared to the first quarter of fiscal 2018 due to a decrease in customer transactions, partially offset by an increase in average ticket.

Gross Profit. Gross profit was 38.2% of net sales in the first quarter of fiscal 2019 compared to 39.5% in the first quarter of fiscal 2018. The 130 basis point decrease was primarily due to higher distribution related costs, occupancy cost deleverage and a change in sales mix. The decrease was partially offset by benefits from our ongoing sourcing initiatives and a decrease in promotional activity.

Selling, General and Administrative. Selling, general and administrative ("SG&A") was 29.3% of net sales in the first quarter of fiscal 2019 compared to 28.4% in the first quarter of fiscal 2018. SG&A decreased $8.0 million to $320.6 million in the first quarter of fiscal 2019. The decrease was due to an $11.0 million decrease related to the closure of our Pat Catan's stores and substantially all of our Aaron Brothers stores during fiscal 2018, a $5.3 million decrease in payroll-related costs and a $2.1 million decrease in marketing expenses. The decrease was partially offset by $5.6 million of CEO severance expense, $2.2 million associated with operating 17 additional Michaels stores (net of closures) and a $1.5 million increase in professional fees.

Restructure Charges. We recorded a restructure charge of $3.1 million in the first quarter of fiscal 2019 related to the closure of all of our Pat Catan's stores during the fourth quarter of fiscal 2018. We recorded a restructure charge of $47.5 million in the first quarter of fiscal 2018 primarily related to the closure of substantially all of our Aaron Brothers stores during the first quarter of fiscal 2018.

Interest Expense. Interest expense increased $2.8 million to $37.4 million in the first quarter of fiscal 2019 compared to the same period in the prior year. The increase was primarily due to $2.6 million as a result of a higher interest rate on our amended and restated term loan credit facility and $0.5 million related to settlement payments associated with our interest rate swaps.

Other Expense (Income), Net. Other expense (income), net increased $4.8 million in the first quarter of fiscal 2019 compared to the same period in the prior year. The increase was due to a $5.0 million charge related to the write-off of an investment in a liquidated business.

Income Taxes. The effective tax rate was 27.9% for the first quarter of fiscal 2019 compared to 41.6% for the first quarter of fiscal 2018. The effective tax rate for the first quarter of fiscal 2019 was lower than the same period in the prior year due primarily to an $8.1 million charge in the first quarter of 2018 related to repatriation taxes for accumulated earnings of our foreign subsidiaries associated with the enactment of the Tax Cuts and Jobs Act of 2017. The decrease was partially offset by $1.8 million of tax expense recorded in the first quarter of fiscal 2019 primarily related to the vesting of restricted shares.

Liquidity and Capital Resources

We require cash principally for day-to-day operations, to finance capital investments (including possible acquisitions), 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 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" of our Annual Report on Form 10-K for the fiscal year ended February 2, 2019 or our failure to meet our debt covenants. Our amended revolving credit facility provides senior secured financing of up to $850 million, subject to

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a borrowing base. As of May 4, 2019, the borrowing base was $784.3 million, of which we had $107.2 million of outstanding standby letters of credit and $677.1 million of unused borrowing capacity. Our cash and cash equivalents totaled $246.7 million at May 4, 2019.

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. As of May 4, 2019, we had $398.4 million of availability remaining under our current share repurchase program.

We had total outstanding debt of $2,711.2 million at May 4, 2019, of which $2,201.2 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 and restated term loan credit facility. 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 (including possible acquisitions), 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 $33.8 million in the first quarter of fiscal 2019 compared to $32.5 million in the first quarter of fiscal 2018. The increase in cash provided by operating activities was primarily due to additional collections of outstanding receivables, partially offset by the timing of vendor payments.

Inventory at the end of the first quarter of fiscal 2019 decreased $19.8 million, or 1.8%, to $1,101.7 million, compared to $1,121.6 million at the end of the first quarter of fiscal 2018. The decrease in inventory was primarily related to the Pat Catan's store closures in fiscal 2018. The decrease was partially offset by additional inventory associated with the operation of 17 additional Michaels stores (net of closures) since the first quarter of fiscal 2018 and lower than expected sales. Average inventory per Michaels store (inclusive of distribution centers, in-transit and inventory for the Company's e-commerce site) increased 1.0% to $822,000 at May 4, 2019 from $814,000 at May 5, 2018.

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Cash Flow from Investing Activities

The following table includes capital expenditures paid during the periods presented (in thousands):







                                                                            13 Weeks Ended
                                                                          May 4,      May 5,
                                                                           2019        2018
         New and relocated stores including stores not yet opened (1)    $  5,006    $  6,440
         Existing stores                                                    7,499       7,713
         Information systems                                                8,928      10,617
         Corporate and other                                                3,668       3,054
                                                                         $ 25,101    $ 27,824
        


Non-GAAP Measures

The following table sets forth certain non-GAAP measures used by the Company to manage our performance and measure compliance with certain debt covenants. The Company defines "EBITDA" as net income before interest, income taxes, depreciation and amortization. The Company defines "Adjusted EBITDA" as EBITDA adjusted for certain defined amounts in accordance with the Company's amended and restated term loan credit facility and amended revolving credit facility (together the "Senior Secured Credit Facilities").

The Company has presented EBITDA and Adjusted EBITDA to provide investors with additional information to evaluate our operating performance and our ability to service our debt. Adjusted EBITDA is a required calculation under the Company's Senior Secured Credit Facilities that is used in the calculations of fixed charge coverage and leverage ratios, which, under certain circumstances determine mandatory repayments or maintenance covenants and may restrict the Company's ability to make certain payments (characterized as restricted payments), investments (including acquisitions) and debt repayments.

As EBITDA and Adjusted EBITDA are not measures of liquidity calculated in accordance with U.S. generally accepted accounting principles ("GAAP"), these measures should not be considered in isolation of, or as substitutes for, net cash provided by operating activities as an indicator of liquidity. Our computation of EBITDA and Adjusted EBITDA may differ from similarly titled measures used by other companies.

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The following table shows a reconciliation of EBITDA and Adjusted EBITDA to net income and net cash provided by operating activities (in thousands):







                                                                 13 Weeks Ended
                                                               May 4,       May 5,
                                                                2019         2018
                 Net cash provided by operating activities   $   33,798   $   32,503
                 Amortization of operating lease assets        (81,371)            -
                 Depreciation and amortization                 (31,489)     (29,458)
                 Share-based compensation                       (7,251)      (6,969)
                 Debt issuance costs amortization               (1,237)      (1,274)
                 Loss on write-off of investment                (5,036)            -
                 Accretion of long-term debt, net                   130          126
                 Restructure charges                            (3,087)     (47,498)
                 Deferred income taxes                            (140)      (2,580)
                 Changes in assets and liabilities              133,374       82,035
                 Net income                                      37,691       26,885
                 Interest expense                                37,359       34,594
                 Income taxes                                    14,575       19,157
                 Depreciation and amortization                   31,489       29,458
                 Interest income                                  (811)      (1,406)
                 EBITDA                                         120,303      108,688
                 Adjustments:
                 Share-based compensation                         7,251        6,969
                 Restructure charges                              3,087       47,498
                 Severance costs                                  8,111          902
                 Store pre-opening costs                          1,226        1,505
                 Store remodel costs                                 66          515
                 Foreign currency transaction gains                (74)        (570)
                 Store closing costs                              (821)        1,062
                 Other (1)                                          964          725
                 Adjusted EBITDA                             $  140,113   $  167,294
        


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Disclosure Regarding Forward-Looking Information

The above discussion, as well as other portions of this Quarterly Report on Form 10-Q, contains forward-looking statements that reflect our plans, estimates and beliefs. Statements regarding sufficiency of capital resources and planned uses of excess cash flow as well as any other statements contained herein (including, but not limited to, statements to the effect that Michaels or its management "anticipates", "plans", "estimates", "expects", "believes", "intends" 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 Annual Report. Such forward-looking statements are based upon management's current knowledge and assumptions about future events and involve risks and uncertainties that could cause actual results, performance or achievements to be materially different from anticipated results, prospects, performance or achievements expressed or implied by such forward-looking statements. Most of these factors are outside of our control and are difficult to predict. Such risks and uncertainties include, but are not limited to the following:

� risks related to the effect of economic uncertainty;

� risks related to our substantial indebtedness;

� restrictions in our debt agreements that limit our flexibility in operating our business;

� changes in customer demand could materially adversely affect our sales, results of operations and cash flow;

� competition, including internet-based competition, could negatively impact our business;

� a weak fourth quarter would materially adversely affect our results of operations;

� unexpected or unfavorable consumer responses to our promotional or merchandising programs could materially adversely affect our sales, results of operations, cash flow and financial condition;

� evolving foreign trade policy (including tariffs imposed on certain foreign-made goods) may adversely affect our business;

� our reliance on foreign suppliers increases our risk of obtaining adequate, timely and cost-effective product supplies;

� our results may be adversely affected by serious disruptions or catastrophic events, including geo-political events and weather;

� our failure to adequately maintain security and prevent unauthorized access to electronic and other confidential information, which could result in an additional data breach, could materially adversely affect our financial condition and operating results;

� we may be subject to information technology system failures or network disruptions, or our information systems may prove inadequate, resulting in damage to our reputation, business operations and financial condition;

� our failure to increase comparable store sales and open new stores could impair our ability to improve our sales, profitability and cash flows;

� damage to the reputation of the Michaels brand or our private and exclusive brands could adversely affect our sales;

� risks associated with the suppliers from whom our products are sourced and transitioning to other qualified vendors could materially adversely affect our revenue and profit growth;

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� changes in regulations or enforcement, or our failure to comply with existing or future regulations, may adversely impact our business;

� significant increases in inflation or commodity prices such as petroleum, natural gas, electricity, steel, wood, and paper may adversely affect our costs, including cost of merchandise;

� improvements to our supply chain may not be fully successful;

� we are exposed to fluctuations in exchange rates between the U.S. and Canadian dollar, which is the functional currency of our Canadian subsidiaries;

� the Company's ability to execute its strategic initiatives could be impaired if it fails to identify a permanent Chief Executive Officer and retain its senior management team;

� any difficulty executing or integrating an acquisition, a business combination or a major business initiative could adversely affect our business or results of operations;

� our marketing programs, e-commerce initiatives and use of consumer information are governed by an evolving set of laws and enforcement trends and unfavorable changes in those laws or trends, or our failure to comply with existing or future laws, could substantially harm our business and results of operations;

� product recalls and/or product liability, as well as changes in product safety and other consumer protection laws, may adversely impact our operations, merchandise offerings, reputation, results of operation, cash flow, and financial condition;

� changes in estimates or projections used to assess fair value of intangible assets, goodwill and property and equipment may cause us to incur impairment charges that could adversely affect our results of operations;

� disruptions in the capital markets could increase our costs of doing business;

� our real estate leases generally obligate us for long periods, which subjects us to various financial risks;

� we have co-sourced certain of our information technology, accounts payable, payroll, accounting and human resources functions, and may co-source other administrative functions, which makes us more dependent upon third parties;

� failure to attract and retain quality sales, distribution center and other team members in appropriate numbers as well as experienced buying and management personnel could adversely affect our performance;

� affiliates of, or funds advised by, Bain Capital Private Equity, L.P. and The Blackstone Group L.P. own approximately 46% of the outstanding shares of our common stock and as a result will have the ability to strongly influence our decisions, and they may have interests that differ from those of other stockholders; and

� our holding company structure makes us, and certain of our direct and indirect subsidiaries, dependent on the operations of our, and their, subsidiaries to meet our financial obligations.

For more details on factors that may cause actual results to differ materially from such forward-looking statements see the Risk Factors section of our Annual Report. Except as required by applicable law, we disclaim any intention to, and undertake no obligation to, update or revise any forward-looking statement.

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Jun 07, 2019

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