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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10-K
(MARK ONE)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
FOR THE FISCAL YEAR ENDED JANUARY 30, 1999
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
FOR THE TRANSITION PERIOD FROM TO
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 or other jurisdiction of (I.R.S. employer
incorporation or organization) 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)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
TITLE OF EACH CLASS
Common Stock, Par Value $.10 Per Share
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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 BY CHECK MARK IF DISCLOSURE OF DELINQUENT FILERS PURSUANT TO ITEM
405 OF REGULATION S-K (229.405 OF THIS CHAPTER) IS NOT CONTAINED HEREIN, AND
WILL NOT BE CONTAINED, TO THE BEST OF REGISTRANT'S KNOWLEDGE, IN DEFINITIVE
PROXY OR INFORMATION STATEMENTS INCORPORATED BY REFERENCE IN PART III OF THIS
FORM 10-K OR ANY AMENDMENT TO THIS FORM 10-K. /X/
AS OF APRIL 14, 1999, THE AGGREGATE MARKET VALUE OF THE VOTING STOCK HELD BY
NON-AFFILIATES OF THE REGISTRANT WAS $681,414,773 BASED ON THE CLOSING PRICE OF
THE REGISTRANT'S COMMON STOCK ON SUCH DATE, $25.125, AS REPORTED ON THE NASDAQ
STOCK MARKET.
AS OF APRIL 14, 1999, 28,603,461 SHARES OF THE REGISTRANT'S COMMON STOCK
WERE OUTSTANDING.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Annual Meeting of Stockholders of
the Registrant to be held during 1999 are incorporated by reference into Part
III of this report.
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PART I
ITEM 1. BUSINESS.
GENERAL
UNLESS OTHERWISE NOTED, ALL NUMBERS CONTAINED IN THIS DOCUMENT ARE AS OF
JANUARY 30, 1999.
With approximately $1.6 billion in sales, Michaels Stores, Inc. (the
"Company") is the world's largest and only national retailer dedicated to
serving the arts, crafts, framing, floral and decorative items marketplace. The
Company's Michaels stores offer a wide selection of competitively priced items,
including picture framing materials and services, silk and dried flowers, hobby
and art supplies, creative crafts, and seasonal and holiday merchandise for the
hobbyist and do-it-yourself home decorator. The Company's primary customers are
women with above average median household incomes. While the average sale in the
Company's Michaels stores increased annually from approximately $12.00 in fiscal
1991 to $16.31 in fiscal 1997, the average sale decreased slightly in fiscal
1998 to $15.79.
In March 1995, the Company acquired Aaron Brothers, Inc. ("Aaron Brothers"),
a chain of specialty framing and art supply stores operating primarily on the
West Coast. The Company's Aaron Brothers stores offer professional custom
framing services, photo frames, a full line of ready-made frames, and a wide
selection of art supplies. During fiscal 1998, Aaron Brothers generated sales of
$81.8 million. The average sale in the Company's Aaron Brothers stores has
increased annually since the acquisition from approximately $23.94 in fiscal
1995 to approximately $31.45 in fiscal 1998.
The Company operates 496 Michaels stores and 78 Aaron Brothers stores in 46
states, Canada and Puerto Rico. The Company's Michaels stores average
approximately 16,900 square feet of selling space and offer an assortment of
approximately 40,000 stock keeping units ("SKUs") in a typical store during the
course of a year (including seasonal product). The Company's Aaron Brothers
stores average approximately 6,100 square feet of selling space and offer an
assortment of approximately 7,000 SKUs. For fiscal 1998, the average sales of
the Company's Michaels and Aaron Brothers stores open for the full fiscal year
were $3.1 million and $1.1 million, respectively.
The Company believes it is well positioned to continue to solidify its
position as the dominant nationwide specialty arts, crafts and decorative items
retailer and to increase its return on invested capital through its business
strategies of (i) offering a broad selection of products in an appealing store
environment that emphasizes superior customer service, (ii) effectively managing
its investment in inventory, and (iii) continuing to expand its nationwide
presence.
MERCHANDISING AND MARKETING
The Company's Michaels store merchandising strategy is to provide a broad
selection of products in an appealing store environment that emphasizes superior
customer service.
PRODUCT SELECTION
In general, each Michaels store offers products from a number of categories.
Most of the categories offer essentially the same type of merchandise throughout
the year, although the products may vary from season to season. The merchandise
offered by the major categories is as follows:
- General craft materials, including beads, bakeware, wood, doll making,
jewelry making, wall decor, rubber stamps, apparel crafts, books and
magazines, and plaster; needlecraft items, including stitchery supplies,
hand-knitting yarns, needles, canvas and related supplies for needlepoint,
embroidery and cross stitching, knitting, crochet, rug making kits, quilts
and afghans; ribbon and wedding accessories; and items for personalizing
home decor, including vases, containers, baskets, potpourri and gifts;
2
- Picture framing materials and services, including ready-made frames and
custom framing, mat boards, glass, backing materials and related supplies,
framed art and photo albums;
- Silk flowers, dried flowers and artificial plants sold separately or in
ready-made and custom floral arrangements, all accessories needed for
floral arranging and other floral items such as wreaths;
- Fine art materials, representing a number of major brand lines and
including items such as pastels, water colors, oil paints, acrylics,
easels, brushes, paper, canvas and materials for stenciling and memory
books;
- Hobby items, including wooden and plastic model kits and related supplies,
kids' crafts, plush toys and paint-by-number kits; party needs, including
paper party goods, balloons, candy, gift wrap, candy making and cake
decorating supplies; and candles.
In addition to the basic categories described above, the Michaels stores
regularly feature seasonal merchandise that complements the Company's core
merchandising strategy. Seasonal merchandise is ordered for several holiday
periods, including Valentine's Day, Easter, Mother's Day, Halloween and
Thanksgiving, in addition to the Christmas season. For example, seasonal
merchandise for the Christmas season includes artificial trees, wreaths,
candles, lights and ornaments.
During the Christmas selling season, a significant portion of floor and
shelf space in a typical Michaels store is devoted to Christmas crafts,
Christmas decorating and gift making merchandise. Because of the
project-oriented nature of these products, the peak Christmas selling season
extends from October through December. Accordingly, a fully developed seasonal
merchandising program, including inventory, merchandise layout and instructional
ideas, is implemented in each Michaels store beginning in July of each year.
This program requires additional inventory accumulation so that each store is
fully stocked during the peak season. Sales of all merchandise typically
increase during the Christmas selling season because of increased customer
traffic.
The following table shows Michaels' sales by department as a percent of
total sales for fiscal 1998, 1997 and 1996:
PERCENT OF SALES
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DEPARTMENT 1998 1997(1) 1996(1)
- -------------------------------------------------------------------- ----- ----------- -----------
General crafts...................................................... 29% 29% 31%
Picture framing..................................................... 18 18 17
Silk and dried floral............................................... 18 18 18
Fine art materials.................................................. 16 15 14
Hobby, party and candles............................................ 11 11 9
Seasonal............................................................ 8 9 11
--- --- ---
Total............................................................. 100% 100% 100%
--- --- ---
--- --- ---
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(1) 1997 and 1996 are restated to conform to the 1998 departmental categories.
The Michaels merchandising strategy is developed centrally and implemented
at the store level through the use of "planograms" which provide store managers
with detailed descriptions and illustrations with respect to store layout and
merchandise presentation. Planograms are also used to cluster various products
that can be combined to create individual projects.
Aaron Brothers stores offer professional custom framing services, photo
frames, a full line of ready-made frames, and a wide selection of art supplies.
The Company's merchandising strategy for its Aaron Brothers stores is to provide
guaranteed everyday low priced custom framing services and selection, with a
five-business day delivery guarantee. In addition, Aaron Brothers strives to
provide a fashion forward merchandise selection in an appealing environment with
superior customer service.
3
CUSTOMER SERVICE
The Company believes that customer service is critically important to its
merchandising strategy. Many of the craft supplies sold in Michaels stores can
be assembled into unique end products with an appropriate amount of guidance and
direction. Accordingly, Michaels has displays in every store in an effort to
stimulate new project ideas, and supplies project sheets with detailed
instructions on how to assemble the product. In addition, many Michaels sales
associates are craft enthusiasts who are able to help customers with ideas and
instructions. The Company periodically offers demonstrations and inexpensive
classes in its stores as a means of promoting new craft ideas and expanding its
customer base.
ADVERTISING
The Company focuses on circular and newspaper advertising. The Company has
found full-color circular advertising, primarily as an insert to newspapers, to
be the most effective medium of advertising. Such circulars advertise numerous
products in order to emphasize the wide selection of products available at
Michaels stores. The Company believes that its ability to advertise through
circulars and newspapers throughout the year in each of its markets provides the
Company with an advantage over its smaller competitors.
PURCHASING, DISTRIBUTION AND INVENTORY MANAGEMENT
To enhance its competitive positioning the Company is actively pursuing
improvements throughout its supply chain. These improvements are intended to
minimize the investment in inventory necessary to support the Company's sales
growth objectives, maximize its stores' in-stock position, and improve the
cost-effectiveness of the delivery of goods from its vendors to its stores.
PURCHASING AND DISTRIBUTION
The Company's purchasing strategy is to negotiate centrally with its vendors
in order to take advantage of volume purchasing discounts and improve control
over product mix and inventory. Approximately 51% of Michaels store stock is
shipped directly from the Michaels distribution centers, with the remaining 49%
being shipped directly from vendors. District managers are responsible for
monitoring store purchases to further manage the stores' merchandise needs. In
1998, the Company's top ten vendors accounted for approximately 21% of total
purchases with no single vendor accounting for more than 4.5% of total
purchases.
The Company believes that its distribution capabilities will allow it to
maintain a high in-stock position in its stores while balancing its overall
inventory position. The Company believes its distribution network is a
competitive advantage and it intends to increase the flow of goods through its
distribution centers and thereby reduce its supply chain costs and more
effectively manage its investment in inventories. The Company currently operates
four distribution centers that supply the Michaels stores with certain
merchandise, including substantially all seasonal and promotional items. The
Company's distribution centers are located in Texas, California, Kentucky and
Florida. Michaels stores receive deliveries from the distribution centers
generally once a week through an internal distribution network using contract
carriers.
Substantially all of the products sold in Michaels stores are manufactured
in the United States, the Far East and Mexico. Goods manufactured in the Far
East generally require long lead times and are ordered four to six months in
advance of delivery. Such products are either imported directly by the Company
or acquired from distributors based in the Unites States. In all cases,
purchases are denominated in U.S. dollars (or Canadian dollars for purchases of
certain items delivered directly to stores in Canada).
Aaron Brothers purchases all of its merchandise centrally. Aaron Brothers
operates a distribution center located in the City of Commerce, California that
currently serves all of its stores. Approximately 61% of their store stock is
shipped directly from the Aaron Brothers distribution center, with the
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remaining 39% being shipped directly from vendors. Aaron Bothers systematically
replenishes each of its stores on a weekly basis.
INVENTORY MANAGEMENT
The Company's primary objectives for inventory management are maximizing the
efficiency of the flow of product to the stores, improving store in-stock
position, improving store labor efficiency, and optimizing overall investment in
inventory. The Company manages its inventory in several ways, including weekly
tracking of inventory status; the use of planograms to control the merchandise
assortment; the use of store level radio frequency ordering based on store
specific rate of sale for each SKU; and the review of item-level sales
information in order to track the sell-through of seasonal and promotional items
and to plan its assortments. The data that the Company is obtaining from its
point-of-sale ("POS") system is an integral component in the inventory
management process. In addition, inventories are verified through physical cycle
counts conducted throughout the year in all stores on a rotating systematic
schedule.
STORE OPERATIONS
The Company's 496 Michaels stores average approximately 16,900 square feet
of selling space. The Company's 78 Aaron Brothers stores average approximately
6,100 square feet of selling space. Net sales for fiscal 1998 averaged
approximately $3.1 million per store for Michaels stores open the entire fiscal
year and $186 per square foot of selling space, and averaged approximately $1.1
million per store for Aaron Brothers stores open the entire fiscal year and $176
per square foot of selling space. Store sites are selected based upon meeting
certain economic, demographic and traffic criteria or for clustering stores in
markets where certain operating efficiencies can be achieved. The Michaels and
Aaron Brothers stores currently in operation are located primarily in strip
shopping centers in areas with easy access and ample parking.
Typically, a Michaels store is managed by a store manager and one to three
assistant store managers, depending on the sales volume of the store. Michaels'
field organization is headed by an executive vice president and is divided into
four geographic zones. Each zone has its own vice president, loss prevention
manager, human resources manager, and nine to eleven district managers. There
are a total of 39 districts. Typically, an Aaron Brothers store is managed by a
store manager and one to two assistant store managers, depending on the sales
volume of the store. Aaron Brothers' field organization is headed by a vice
president and is divided into four districts, each with a district manager and
an operations manager/trainer. The Company believes this organizational
structure enhances the communication among the individual stores and between the
stores and corporate headquarters.
STORE EXPANSION
Having achieved its objective of becoming the largest and only national
retailer in arts, crafts and decorative items, the Company recognized that it
had the critical mass to achieve improved operating efficiencies that could
result in higher returns on capital. On August 23, 1995, the Company announced a
shift in focus from sales growth to realizing higher returns on capital. As a
result, the Company moderated its internal store growth rate, opening 9 new
Michaels stores and 3 new Aaron Brothers stores in fiscal 1997. In fiscal 1998,
the Company returned to an accelerated new store opening program, opening 50
Michaels stores and relocating 14 stores. Aaron Brothers opened 5 stores and
relocated 5 stores. In fiscal 1999, the Company plans to open approximately 70
Michaels stores and relocate and/or expand up to 25 stores. Aaron Brothers plans
to open 15 stores and relocate 5 stores in fiscal 1999.
The Company's expansion strategy is to give priority to adding stores in
existing markets in order to enhance economies of scale associated with
advertising, distribution, field supervision, and other regional expenses.
Management believes that few of its existing markets are saturated and that
there are attractive new markets available to the Company. The anticipated
opening of Michaels and Aaron Brothers stores in 1999 and the rate at which
stores are opened thereafter will depend upon a number of factors, including
5
the success of existing Michaels and Aaron Brothers stores, the availability and
the cost of capital for expansion, the availability of suitable store sites, and
the ability to hire and train qualified managers. The Company intends to
continue to review acquisition opportunities in existing and new markets. The
Company has no arrangements or understandings pending with respect to any
acquisitions, other than the acquisition of leases for 16 stores formerly
operated by MJDesigns, Inc. in the mid-Atlantic states in March 1999.
Michaels has developed a standardized procedure that allows for the
efficient opening of new stores and their integration into the Company's
information and distribution systems. Michaels develops the floor plan and
inventory layout and organizes the advertising and promotions in connection with
the opening of each new store. In addition, Michaels maintains a qualified store
opening staff to provide new store personnel with in-store training.
Accordingly, Michaels generally opens new stores during the period from February
through October because new store personnel require significant in-store
training prior to entering the Christmas selling season.
Costs for opening stores at particular locations depend upon the type of
building and general cost levels in the area. In fiscal 1998, the average net
cost to the company of opening a new Michaels store was approximately $630,000,
which included leasehold improvements, furniture, fixtures and equipment, and
pre-opening expenses. The initial inventory investment (net of accounts payable)
associated with each new Michaels store averages approximately $570,000 at cost
depending on the store size, operating format and the time of year in which the
store is opened. The initial inventory investment in new Michaels stores is
offset, in part, by extended vendor terms and allowances.
INVESTMENT IN INFORMATION TECHNOLOGY
The Company is committed to utilizing technology to increase operating
efficiencies and to improve its ability to satisfy the needs of its customers.
The Company utilizes world-class technology in the form of the latest massively
parallel computer systems and private networks to communicate with stores and
distribution centers. With the installation of the POS system, which includes
bar code scanning, came the ability to better understand the demands of the
customer, emerging merchandise trends, and inventory replenishment requirements.
During the past year, the Company completed installation of new networked
computer systems in every store to handle communications, price management,
enhanced radio frequency terminal applications for inventory management, faster
credit authorization and gift certificate processing. A new, standardized,
warehouse management system running on the latest IBM RS/6000 computers and
utilizing radio frequency terminals with bar code scanning technology was
installed in all distribution centers. The Company is installing industry
leading merchandise information systems software that will be closely integrated
with store systems, including POS and warehouse management systems, to provide
greatly enhanced inventory management capabilities. The Company believes that
information is a competitive tool and intends to be the craft industry leader in
the effective and efficient utilization of this resource.
The Company's project to ensure that all application systems and
infrastructure are Year 2000 ready continues on schedule and on budget. An
experienced consulting firm with a worldwide practice in Year 2000 remediation
was engaged to provide objective project management and technical expertise, and
to provide an objective assessment of progress. The project includes an
assessment of the ability of outside vendors of merchandise and services to
supply the Company's needs and cooperative testing of all communications. The
Year 2000 project is the Company's highest priority initiative and status is
reported regularly to management and the Board of Directors.
COMPETITION
Michaels is the largest and only national retailer dedicated to serving the
arts and crafts marketplace. Michaels competes primarily with regional and local
arts and crafts merchants, and mass merchandisers that typically dedicate a
portion of their selling space to a limited selection of arts, crafts, picture
framing
6
and seasonal products. The Company believes that its Michaels stores compete
based on price, quality and variety of merchandise assortment, and customer
service. Michaels believes the combination of its broad selection of products,
emphasis on customer service, loyal customer base, information received from its
POS system, distribution capabilities allowing it to maintain high in-stock
positions, and capacity to advertise frequently in all of its markets provides
the Company with a competitive advantage.
The U.S. arts, crafts and decorative items retailing industry was estimated
by trade publications to be approximately $10 billion in 1997. The industry is
highly fragmented, and Michaels is the only national arts
and crafts retailer. Management believes that there are only a few competitors
with arts and crafts sales that exceed $200 million annually and that the
Company's arts and crafts sales are more than twice as large as its largest
direct competitor. The Company believes that its significant size relative to
its competitors provides it with several advantages including (i) purchasing
power, (ii) critical mass to support a cost efficient nationwide distribution
network, and (iii) the financial resources to support an annual advertising
expenditure of approximately $66 million and significant ongoing capital
investments in information technology.
Michaels' primary competitors include Hobby Lobby, a chain based in Oklahoma
City which operates approximately 176 stores primarily in the midwestern United
States, and A.C. Moore Arts & Crafts, Inc., a chain which operates approximately
37 stores in the mid-Atlantic and Northeast regions. The Company also competes
with Jo-Ann etc. (operated by Jo-Ann Stores, Inc.), MJDesigns, Inc. and Garden
Ridge Corporation.
Aaron Brothers' competition is composed primarily of local independent
custom frame shops and mass merchandisers. Aaron Brothers believes it remains
competitive due to its five business day delivery guarantee on custom frame
orders, its pricing structure, its fashion forward merchandising assortments and
its customer service.
SERVICE AND TRADE MARKS
The name "Michaels" and the Michaels logo are both federally registered
service marks held by an affiliate of the Company. The name "Aaron Brothers" and
the Aaron Brothers logo are federally registered trademarks.
EMPLOYEES
As of April 3, 1999, approximately 22,200 persons were employed by the
Company, approximately 14,200 of whom were employed on a part-time basis. The
number of part-time employees is substantially increased during the Christmas
selling season. Of the Company's full-time employees, approximately 1,900 are
engaged in various executive, operating, training and administrative functions
in the Company's corporate offices and distribution centers, and the remainder
are engaged in store operations.
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EXECUTIVE OFFICERS OF THE REGISTRANT
NAME AGE POSITION
- --------------------------------- --------- -----------------------------------------------------------------------
Sam Wyly......................... 64 Chairman of the Board of Directors
Charles J. Wyly, Jr.............. 65 Vice Chairman of the Board of Directors
R. Michael Rouleau............... 60 President and Chief Executive Officer
Bryan M. DeCordova............... 42 Executive Vice President-Chief Financial Officer
Lawrence H. Fine................. 45 Executive Vice President-General Merchandise Manager
Duane Hiemenz.................... 45 Executive Vice President-Store Operations
Douglas B. Sullivan.............. 48 Executive Vice President-Development
James F. Tucker.................. 54 Executive Vice President-Chief Information Officer
David A. Gary.................... 51 Senior Vice President-Logistics and Distribution
James C. Neustadt................ 51 Senior Vice President-Advertising and Marketing
H. Kevin Rutherford.............. 40 Senior Vice President-Human Resources
Mr. Sam Wyly has served as Chairman of the Board of the Company since 1984.
Mr. Wyly is an entrepreneur who has created and managed several public and
private companies. In the 1960's, he founded University Computing Company, which
became one of the first computer utility networks and one of the first software
products companies. His data transmission company, Datran, was one of the
pioneering telecommunications ventures that contributed to the breakup of the
telephone monopoly. He is a founder and currently serves as Chairman and a
director of Sterling Software, Inc., a worldwide supplier of software products.
He is also Chairman of the Executive Committee and a director of Sterling
Commerce, Inc., a provider of business-to-business electronic commerce software
to 80 of America's 100 largest corporations, and Chairman and a director of
Scottish Annuity & Life Holdings, Ltd., a variable life insurance and
reinsurance company. He is a founding partner of Maverick Capital, Ltd., a
manager of equity hedge funds. Mr. Wyly is the father of Evan A. Wyly and Kelly
Elliott who also serve as directors.
Mr. Charles J. Wyly, Jr. became a director of the Company in October 1984
and Vice Chairman in 1985. He co-founded Sterling Software, Inc. in 1981 and
since such time has served as a director and since 1984 Vice Chairman. Mr. Wyly
is a director of Scottish Annuity & Life Holdings, Ltd. Mr. Wyly served from
1964 to 1975 as an officer and director, including serving as President from
1969 to 1973, of University Computing Company, which became one of the first
computer utility networks and one of the first software products companies. Mr.
Wyly and his brother, Sam Wyly, founded Earth Resources Company, an oil refining
and silver mining company, and Charles J. Wyly, Jr. served as Chairman of the
Board from 1968 to 1980. Mr. Wyly served as Vice Chairman of the Bonanza
Steakhouse chain from 1967 to 1989 and has served as a director of Sterling
Commerce, Inc. since December 1995. Charles J. Wyly, Jr. is the father-in-law of
Donald R. Miller, Jr., a director and Vice President-Market Development of the
Company.
Mr. Rouleau became President of the Company in April 1997 and has been Chief
Executive Officer since April 1996. Prior to joining the Company, Mr. Rouleau
had served as Executive Vice President of Store Operations for Lowe's Companies,
Inc. ("Lowe's") since May 1992 and in addition as President of Lowe's Contractor
Yard Division since February 1995. Prior to joining Lowe's, Mr. Rouleau was a
co-founder and President of Office Warehouse which subsequently merged into
Office Max.
Mr. DeCordova became Executive Vice President-Chief Financial Officer in
March 1997. Prior to joining the Company, he served as Vice President of
Finance, Treasurer and Chief Financial Officer for Duckwall-ALCO Stores, Inc.
since 1990.
Mr. Fine became Executive Vice President-General Merchandise Manager in
December 1996. Before joining the Company, he was Senior Vice President of
Merchandising for Party City since 1995. Prior to Party City, he held a variety
of merchandising positions with the Jamesway Corporation for nearly 16 years.
8
Mr. Heimenz became Executive Vice President-Store Operations in August 1996
after joining the Company as a Zone Vice President in July 1996. Prior to
joining Michaels, Mr. Hiemenz had served with Lowe's for nine years, most
recently as a Regional Vice President.
Mr. Sullivan became Executive Vice President-Development in April 1997. He
joined Michaels in 1988 and has served in a variety of capacities, including
overseeing the Company's store operations, distribution, store opening, real
estate, legal and personnel functions. Prior to his joining the Company, Mr.
Sullivan had served with Family Dollar Stores, Inc. for 11 years, most recently
as Vice President-Real Estate.
Mr. Tucker became Executive Vice President-Chief Information Officer in June
1997. Before joining the Company, Mr. Tucker held the position of Senior Vice
President and Chief Information Officer for Shopko Stores, Inc. since 1994.
Prior to 1994, Mr. Tucker held the position of Vice President-Management
Information Services for Trans World Music Corp.
Mr. Gary joined the Company as Senior Vice President-Logistics and
Distribution in November 1997. For the previous two years he had served with
Kay-Bee Toys, Inc. as Vice President of Distribution and Logistics. Prior to
Kay-Bee Toys, Inc., Mr. Gary was Vice President of Distribution and Logistics
for Silo, Inc.
Mr. Neustadt joined the Company as Senior Vice President-Advertising and
Marketing in June 1998. Before joining the Company, Mr. Neustadt was Vice
President-Advertising for Lowe's since 1994. Prior to Lowe's, he held a variety
of advertising and marketing positions with Montgomery Ward, Handy Andy and
Payless Cashways Inc.
Mr. Rutherford became Senior Vice President-Human Resources in March 1998.
Prior to joining the Company, Mr. Rutherford was Vice President-Corporate Human
Resources for Borders Group Inc. since February 1997. From 1994 through February
1997, he served as Vice President-Human Resources for Walden Book Company. From
1992 through 1994, Mr. Rutherford was Vice President-Human Resources for
Footaction USA.
ITEM 2. PROPERTIES.
The Company's Michaels stores generally are situated in high visibility
shopping centers located on well-traveled roads. Almost all stores are located
in leased premises with lease terms generally ranging from five to ten years.
The base rental rates generally range from $85,000 to $250,000 per year. Rental
expense for stores open for the full 12-month period of fiscal 1998 averaged
$173,000. The leases are generally renewable, with increases in lease rental
rates. A majority of the existing leases contain provisions pursuant to which
the lessor has provided leasehold improvements to prepare for opening.
The Company's Aaron Brothers stores are generally located in high visibility
strip shopping centers in trade areas having a high density of population and
above average discretionary income. Almost all stores are located in leased
premises with lease terms generally ranging from five to ten years with options
to renew at increased rates. Rental expense for stores open for the full
12-month period of fiscal 1998 averaged $105,000.
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The following table indicates the number of the Company's stores located in
each state or province as of April 14, 1999:
NUMBER OF
STATE STORES
- -------------------------------------------- -------------
Alabama..................................... 7
Alaska...................................... 2
Alberta..................................... 2
Arizona..................................... 21*
Arkansas.................................... 3
British Columbia............................ 1
California.................................. 152*
Colorado.................................... 10
Connecticut................................. 3
Delaware.................................... 1
Florida..................................... 28
Georgia..................................... 18
Idaho....................................... 2
Illinois.................................... 24
Indiana..................................... 10
Iowa........................................ 6
Kansas...................................... 4
Kentucky.................................... 4
Louisiana................................... 4
Maine....................................... 2
Maryland.................................... 7
Massachusetts............................... 12
Michigan.................................... 18
Minnesota................................... 11
Mississippi................................. 3
Missouri.................................... 10
NUMBER OF
STATE STORES
- -------------------------------------------- -------------
Montana..................................... 2
Nebraska.................................... 1
Nevada...................................... 10*
New Hampshire............................... 3
New Jersey.................................. 9
New Mexico.................................. 2
New York.................................... 12
North Carolina.............................. 16
North Dakota................................ 1
Ohio........................................ 24
Oklahoma.................................... 7
Ontario..................................... 16
Oregon...................................... 13*
Pennsylvania................................ 12
Puerto Rico................................. 3
Rhode Island................................ 2
South Carolina.............................. 5
South Dakota................................ 1
Tennessee................................... 11
Texas....................................... 38
Utah........................................ 5
Virginia.................................... 11
Washington.................................. 16
West Virginia............................... 2
Wisconsin................................... 7
---
Total..................................... 594
- ------------------------
* Of the store counts indicated in Arizona, California, Nevada and Oregon,
Aaron Brothers accounts for 5, 69, 4 and 2 stores, respectively.
Michaels leases a 426,000 square foot building at the Alliance Airport in
Tarrant County, Texas, a 450,000 square foot building in Lancaster, California,
a 350,000 square foot building in Lexington, Kentucky, and a 500,000 square foot
building in Jacksonville, Florida for use as distribution centers. Aaron
Brothers leases a 126,000 square foot building in City of Commerce, California
for use as a distribution center and office facility. The Company also leases a
136,000 square foot building for the corporate headquarters in Irving, Texas.
ITEM 3. LEGAL PROCEEDINGS.
A lawsuit was commenced against the Company and several other parties on
September 19, 1994 on behalf of a former employee, Naomi Snyder, her child, and
her husband. The complaint alleged that the former employee and her then-unborn
child were exposed to excessive levels of carbon monoxide in one of the
Company's stores resulting in severe and permanent injuries to the child.
Plaintiffs' Statement of Damages sought $11 million. A settlement agreement was
reached by the parties and the Company's
10
portion of the settlement amount was fully covered by insurance. The lawsuit was
dismissed with prejudice on January 4, 1999.
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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The Company did not submit any matter to a vote of security holders during
the fourth quarter of the fiscal year covered by this report.
11
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS.
The Company's Common Stock is quoted through The Nasdaq Stock Market under
the ticker symbol "MIKE."
The following table sets forth the high and low sale prices of the Company's
Common Stock for each quarterly period within the two most recent fiscal years.
FISCAL 1998 HIGH LOW
- -------------------------------------------------- -------- --------
First............................................. $ 39 59/64 $ 28 5/8
Second............................................ 38 1/4 27 1/2
Third............................................. 33 5/8 16 3/4
Fourth............................................ 22 3/4 15 1/2
FISCAL 1997 HIGH LOW
- -------------------------------------------------- -------- --------
First............................................. $ 20 1/8 $ 11 5/8
Second............................................ 23 3/8 17 3/4
Third............................................. 34 5/8 20 3/4
Fourth............................................ 37 23 1/8
On April 14, 1999, the last reported sale price of the Common Stock on The
Nasdaq Stock Market was $25.125 and as of such date there were approximately 699
holders of record of the Common Stock.
The Company's present plan is to retain earnings for the foreseeable future
for use in the Company's business and the financing of its growth. The Company
did not pay any dividends on its Common Stock during fiscal 1997 and 1998.
12
ITEM 6. SELECTED FINANCIAL DATA.
FISCAL YEAR
----------------------------------------------------------------
1998 1997 1996(1) 1995 1994
---------- ---------- ---------- ---------- --------
(IN THOUSANDS EXCEPT PER SHARE AND STORE DATA)
RESULTS OF OPERATIONS:
Net sales....................................... $1,573,965 $1,456,524 $1,378,277 $1,294,886 $994,563
Operating income (loss)......................... 89,112 68,942 (20,987)(2) (15,046)(3) 64,036
Net income (loss)............................... 43,601 30,077 (31,233) (20,417) 35,647
Earnings (loss) per common
share......................................... 1.43 1.05 (1.35) (0.96) 1.67
BALANCE SHEET DATA:
Cash and investments............................ $ 96,124 $ 162,283 $ 59,069 $ 2,870 $ 16,909
Merchandise inventories......................... 501,239 385,580 351,208 366,102 375,096
Total current assets............................ 621,928 573,183 437,543 416,292 418,532
Total assets.................................... 962,650 908,494 784,435 739,780 686,026
Working capital................................. 391,227 358,691 239,812 228,983 232,442
Long-term debt.................................. 230,896 234,889 238,608 187,748 138,082
Total liabilities............................... 481,671 466,583 451,633 403,827 330,109
Stockholders' equity............................ 480,979 441,911 332,802 335,953 355,917
OTHER FINANCIAL DATA:
Cash flow from operating activities............. $ 6,038 $ 77,907 $ 29,749 $ 9,248 $(38,267)
EBITDA(4)....................................... 143,253 117,589 21,694 12,930 87,800
STORES OPEN AT END OF PERIOD:
Michaels........................................ 496 452 453 442 380
Aaron Brothers.................................. 78 74 72 68 n/a
- ------------------------
(1) Fiscal 1996 was a 53-week fiscal year; all other years were 52-week fiscal
years.
(2) Includes effect of an unusual pre-tax charge of $41.2 million for costs
associated with a sale to liquidate merchandise that was eliminated
following store resets, markdowns on discontinued furniture and other home
decor merchandise, and reserves for the closure of four stores and the
write-down of leasehold improvements in three stores.
(3) Includes effect of an unusual pre-tax charge of $64.4 million for costs
primarily associated with an inventory reduction program.
(4) EBITDA is calculated as income before income taxes plus interest,
depreciation and amortization. EBITDA is presented because it is a widely
accepted financial indicator of a company's ability to incur and service
debt. EBITDA should not be considered by an investor as an alternative to
net income, as an indicator of the operating performance of the Company or
as an alternative to cash flow as a measure of liquidity.
13
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
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 AVAILABILITY OF ACCEPTABLE REAL ESTATE LOCATIONS FOR NEW STORES,
DIFFICULTIES WITH RESPECT TO NEW INFORMATION SYSTEM TECHNOLOGIES AND OUR ABILITY
TO ADDRESS THE YEAR 2000 ISSUE, SUPPLY CONSTRAINTS OR DIFFICULTIES, THE RESULTS
OF FINANCING EFFORTS AND OTHER RISKS DETAILED IN OUR SECURITIES AND EXCHANGE
COMMISSION FILINGS.
GENERAL
In fiscal years 1996, 1997 and 1998, we added 13, 9 and 50 Michaels stores,
respectively, and closed 2, 10 and 6, respectively. During 1996 and 1998, a
substantial portion of our sales increases came from stores added during or
after the prior comparable period and therefore are not included in same-store
sales comparisons. During these periods, sales from these newer stores accounted
for approximately 90% and 89%, respectively, of aggregate sales growth
increases.
During 1996 we focused on implementing initiatives to improve our
merchandising and store operations, which included completing the installation
of the point-of-sale ("POS") system, redefining the merchandise strategy,
liquidating merchandise which did not support our focus toward return on
capital, resetting and standardizing the stores, and improving store staffing
effectiveness. These changes allowed us to focus on an expanded arts and crafts
assortment as our core line of business.
In 1997 we moderated our expansion plans and focused on same-store sales
growth, return on investment, productivity enhancements and improving cash flow.
We increased the number of basic merchandise SKUs centrally purchased and
available for store replenishment from our distribution centers, and we have
continued this process into 1999 with a goal of having approximately 20,000 SKUs
available by year-end. We believe that shifting more SKUs for inventory
replenishment to the distribution centers will result in an increase in
inventory turns in future years.
In 1998 we continued our focus on growing same-store sales, implemented
information system enhancements in merchandising and distribution, and returned
to an accelerated new store-opening program. In addition, we positioned the
Company for significant operating improvements in future years by putting new
inventory management tools in place.
Initiatives for 1999 include focusing on four cornerstones essential to our
operational turnaround for top line growth: 1) an enhanced version of our store
prototype; 2) effective distribution centers; 3) continued information system
enhancements; and 4) disciplined inventory management and control to ensure we
improve store in-stock positions while reducing store inventories.
14
RESULTS OF OPERATIONS
The following table sets forth the percentage relationship to net sales of
each line item of our Consolidated Statements of Operations. This table should
be read in conjunction with the following discussion and with our Consolidated
Financial Statements, including the related notes.
FISCAL YEAR
-------------------------------------
1998 1997 1996
----------- ----------- -----------
NET SALES............................................................... 100.0% 100.0% 100.0%
Cost of sales and occupancy expense..................................... 66.8 67.9 72.8
----- ----- -----
GROSS MARGIN............................................................ 33.2 32.1 27.2
Selling, general and administrative expense............................. 27.0 27.2 28.5
Store pre-opening costs................................................. 0.5 0.2 0.2
----- ----- -----
OPERATING INCOME (LOSS)................................................. 5.7 4.7 (1.5)
Interest expense........................................................ 1.4 1.6 1.5
Other (income) and expense, net......................................... (0.2) (0.2) (0.0)
----- ----- -----
INCOME (LOSS) BEFORE INCOME TAXES....................................... 4.5 3.3 (3.0)
Provision (benefit) for income taxes.................................... 1.7 1.2 (0.7)
----- ----- -----
NET INCOME (LOSS)....................................................... 2.8% 2.1% (2.3)%
----- ----- -----
----- ----- -----
FISCAL 1998 COMPARED TO FISCAL 1997
Net sales in the fiscal year ended January 30, 1999 ("1998") increased
$117.4 million, or 8%, over the fiscal year ended January 31, 1998 ("1997"). The
results for 1998 included sales from 50 Michaels and 5 Aaron Brothers stores
that were opened during the year, more than offsetting lost sales from 6
Michaels and 1 Aaron Brothers store closures. Same-store sales increased 1% in
1998. The improvement in same-store sales was due to a good performance in
memory books, wood, beads, candles, art, books and yarn, more than offsetting
the performance in apparel crafts, seasonal, needlecrafts and ribbon. Going
forward we expect to achieve same-store sales increases for 1999, taken as a
whole. Our ability to generate same-store sales increases is dependent, in part,
on our ability to continue to improve store in-stock positions on the
top-selling items, to properly allocate seasonal merchandise to the stores based
upon anticipated sales trends utilizing POS rate of sale information and the
success of our sales promotion efforts.
Cost of sales and occupancy expense, as a percentage of net sales, for 1998
was 66.8%, a decrease of 1.1% compared to 1997. This decrease was primarily
attributable to improvements in the initial markup and cost reductions in
merchandise purchases, partially offset by increased occupancy costs, as a
percentage of net sales, including higher rent reserves for store closures.
Selling, general and administrative expense, as a percentage of net sales,
decreased by 0.2% in 1998 compared to 1997. This decrease resulted from improved
expense leverage in corporate general and administrative expense, advertising
and depreciation.
Store pre-opening costs, as a percentage of net sales, increased by 0.3% in
1998 compared to 1997, as we opened or relocated 64 Michaels and 12 Aaron
Brothers stores compared to 23 Michaels and 4 Aaron Brothers stores in the prior
year.
Interest expense, as a percentage of net sales, was 1.4% for 1998, a
decrease of 0.2% compared to the prior year. This decrease was a result of
leveraging the fixed interest costs over a larger sales base.
15
FISCAL 1997 COMPARED TO FISCAL 1996
Net sales in 1997 increased $78.2 million, or 6%, over the fiscal year ended
February 1, 1997 ("1996"). The results for 1997 included sales from 9 Michaels
and 3 Aaron Brothers stores that were opened during the year, partially
offsetting lost sales from 10 Michaels and 1 Aaron Brothers store closures.
Same-store sales for comparable 52-week reporting periods increased 6% in 1997.
The improvement in same-store sales was due to a strong performance in the core
categories of general crafts, framing, art supplies and floral, which management
believes was the result of updated planograms and improved information from the
new POS item sales history database initiated during the summer of 1996.
Cost of sales and occupancy expense, as a percentage of net sales, for 1997
was 67.9%, a decrease of 4.9% compared to 1996. Cost of sales and occupancy
expense in 1996 included a $47.7 million charge for unusual costs and expenses
recorded in the third quarter of 1996 to cover losses on an extended sidewalk
sale, markdowns on discounted furniture and certain other home decor
merchandise, and reserves for the closure of 4 stores and the write-down of
leasehold improvements in 3 stores. Adjusting for the 1996 unusual items, cost
of sales and occupancy expense for 1997 decreased by 2.0% compared to the prior
year. This decrease was principally due to improved gross margins which
management attributes to decreased dependency on promotional advertising and
fewer seasonal clearance markdowns in the third and fourth quarters of 1997.
Selling, general and administrative expense, as a percentage of net sales,
decreased by 1.3% in 1997 compared to 1996. This decrease resulted from a
reduction in advertising costs of $8.3 million from 1996 levels and improved
expense leverage in store labor and all other categories of store operating
expenses with the exception of depreciation, which reflects the impact of
increased investment in the POS system. Additionally, in the third quarter of
1996 we recorded a $3.1 million charge associated with unusual costs and
expenses relating primarily to an extended sidewalk sale.
Interest expense, as a percentage of net sales, was 1.6% for 1997, a slight
increase of 0.1% compared to the prior year. This increase was primarily a
result of interest expense on the $125 million of Senior Notes issued in June
1996 which was, for the first time, outstanding for the full year in 1997.
For 1997 the effective tax rate increased to 38% from 24% in 1996 as we
returned to profitability. The 1996 effective tax rate was significantly lower
due to the loss in 1996 and our inability to fully carryback the tax losses to
prior years.
LIQUIDITY AND CAPITAL RESOURCES
We plan to spend approximately $83 million on capital expenditures during
fiscal 1999. We plan to open 70 Michaels and 15 Aaron Brothers stores for
approximately $42 million, of which 18 Michaels and 2 Aaron Brothers stores have
been opened as of April 14, 1999. In March 1999 we acquired leases for 16 stores
(included in the 70 Michaels stores noted above), formerly operated by
MJDesigns, Inc., for $4.5 million. We expect to spend approximately $9 million
on information systems, $22 million on store relocations and remodeling, and $5
million on various other projects.
We believe that our available cash, funds generated by operating activities,
funds available under a bank credit agreement, lease financing and proceeds from
the sale of stock should be sufficient to finance continuing operations and
sustain current growth plans. We believe that we can finance annual store
expansion at a rate of 15% from internally generated cash flow.
Our working capital needs are driven primarily by a seasonal buildup of
inventory to support higher sales in the third and fourth quarters, funding
required for growth in new stores and improvements in our information systems.
Net cash provided by operating activities for 1998 was $6.0 million as compared
to $77.9 million for 1997, decreasing primarily as a result of an increase in
merchandise inventories. Inventories per Michaels store increased 18% as a
result of increasing the number of items replenished by our distribution centers
from approximately 8,880 at year end 1997 to approximately 12,000 at year end
16
1998. Additional inventory was required for the opening of new stores in 1998
and 1999 and as the store in-stock position of top-selling merchandise in
existing stores was improved.
Capital expenditures during 1998 were $59.6 million (net of $18.4 million in
proceeds from sale/ leaseback transactions), incurred primarily for the opening,
relocation or expansion of stores, the relocation of a distribution center and
various enhancements to our information systems.
In October 1997 we began issuing Common Stock through our Dividend
Reinvestment and Stock Purchase Plan (the "Stock Purchase Plan"). The Stock
Purchase Plan provides owners of shares of Common Stock and other interested
investors with a convenient and economical method to purchase Common Stock. The
Stock Purchase Plan also provides us with a cost-efficient and flexible
mechanism to raise equity capital.
In October 1998 we repurchased 1,145,000 shares of our Common Stock for an
aggregate purchase price of $20.4 million and placed the shares in treasury.
At January 30, 1999, we had working capital of $391.2 million, compared to
$358.7 million at January 31, 1998. We currently have a bank credit agreement
providing for an unsecured revolving line of credit of $100 million, which may
be increased to $125 million under specific conditions. There were no borrowings
outstanding under the previous revolving line of credit at any time during 1997,
and in 1998 borrowings under the current bank credit agreement were outstanding
for 54 days during our peak season of seasonal inventory buildup.
SEASONALITY AND INFLATION
Our business is seasonal in nature with higher sales in the third and fourth
quarters. Historically, the fourth quarter, which includes the Christmas selling
season, has accounted for approximately 36% of our sales and (excluding 1995 and
1996) approximately 58% of our operating income.
We believe that the effects of inflation on 1998 results and the projected
effect on 1999 financial results will be nominal.
IMPACT OF THE YEAR 2000
We are highly dependent on our internal information systems for tracking
inventory and sales information and on our vendors' systems for assuring
accurate and timely deliveries of goods to our distribution centers and stores.
Because we have invested substantial amounts of money and effort in updating
internal systems in recent years, we believe such systems are already
substantially Year 2000 compliant.
We have implemented a comprehensive plan designed to make our operations
fully Year 2000 compliant, utilizing both internal and external resources. A
corporate project office has been established to oversee, monitor and coordinate
the Company-wide Year 2000 efforts. An experienced consulting firm has been
engaged to provide objective project management and technical expertise to
assist us in the completion of the project.
Our information systems include proprietary and third party application
systems and related hardware, software and data and telephone networks.
Approximately 70% of our application systems are presently believed to be Year
2000 compliant. Remediation or replacement of the majority of our remaining
systems is in process, with substantial completion anticipated by mid-1999. The
testing and certification stage for these areas is targeted to be largely
completed by the end of the third quarter 1999. We believe that we are on
schedule to complete Year 2000 compliance plans with respect to our information
systems.
17
We are currently assessing business equipment and systems, such as elevators
and security systems, which contain embedded computer technology. Based on our
preliminary assessment and assurances from third parties, we believe these
systems present little Year 2000 exposure or risk.
We have surveyed our "mission critical" merchandise and service vendors to
determine their Year 2000 status and are in the process of obtaining appropriate
assurances from these vendors. In addition, we are conducting more detailed
assessments of the progress of our electronic data interchange trading partners.
In 1998, our top ten vendors accounted for approximately 21% of total purchases,
with no single merchandise vendor accounting for more than 4.5% of total
purchases; thus, we do not believe any single vendor poses a significant risk.
We have completed the assessment phase with respect to vendors' systems.
We are developing contingency plans, such as alternative sourcing, and
identifying what actions would need to be taken if critical systems or service
providers are not Year 2000 compliant. We expect these plans to be finalized by
mid-1999. Currently, we do not expect that substantial increases in inventory
will be required as a contingency measure. We have begun, but not yet completed,
a comprehensive analysis of the operational problems and costs (including loss
of revenues) that would be reasonably likely to result from our failure or the
failure of certain third parties to complete efforts to achieve Year 2000
compliance on a timely basis. A contingency plan has not been developed for
dealing with the most reasonably likely worst-case scenario, and such scenario
has not yet been clearly identified. We currently plan to complete such analysis
and contingency plan by mid-1999.
Despite significant efforts to make our systems and facilities Year 2000
compliant, the ability of third party service providers, vendors and certain
other third parties, including governmental entities and utility companies, to
be Year 2000 compliant is beyond our control. Accordingly, we can give no
assurances that the systems of other parties on which our systems or operations
rely will be timely converted or compatible with our systems. The failure of
these entities to comply on a timely basis could have a material adverse effect.
At the present time, however, we do not expect Year 2000 issues to materially
affect our products, services, competitive position, or financial performance or
condition.
Total external non-capitalizable costs related to the Year 2000 effort
(exclusive of the costs of planned development of new systems) are estimated to
be approximately $2.5 million, of which approximately $1.2 million has been
incurred through January 1999. In addition, we have accelerated the planned
development of new information systems with improved business functionality to
replace systems that were not Year 2000 compliant. The cost of these new
information systems will approximate $4.0 million, of which approximately $1.4
million has been incurred prior to the date of this report. Our Year 2000 costs,
including the acceleration of development of new systems already planned, have
been, and are expected to be, funded with cash flow from operating activities.
We do not separately track internal direct costs associated with the utilization
of our officers and employees in Year 2000 compliance efforts. No significant
information system projects have been deferred because of the Year 2000 effort.
The foregoing statements as to cost and timetables relating to the Year 2000
effort are forward looking and are made in reliance on the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995. They are
based on our best estimates, which may be updated as additional information
becomes available. Forward looking statements are also based on assumptions
about many important factors, including the technical skills of employees and
independent contractors, the representations and preparedness of third parties,
the ability of vendors to deliver merchandise or perform services required by us
and the collateral effects of the Year 2000 issues on our business partners and
customers. While we believe our assumptions are reasonable, we caution that it
is impossible to predict the impact of certain factors that could cause actual
costs or timetables to differ materially from those expected.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company invests cash balances in excess of operating requirements
primarily in money market mutual funds and in short-term interest-bearing
securities, generally with maturities of 90 days or less. The
18
fair value of our cash and short-term investment portfolio at January 30, 1999,
approximated carrying value. The interest rates on our revolving line of credit
are repriced frequently, at market rates, which would result in carrying amounts
that approximate fair value. We had no borrowings outstanding under the line of
credit at January 30, 1999. We believe that the effect, if any, of possible
near-term changes in interest rates on our financial position, results of
operations and cash flows would not be material. The fair value of our Senior
Notes and Convertible Subordinated Notes ("Long-Term Debt") was estimated to be
$216.2 million at January 30, 1999 and was $5.7 million less than carrying
value. Generally, the fair value of our fixed interest rate Long-Term Debt will
increase as interest rates fall and decrease as interest rates rise. Market risk
was estimated as the potential increase in the fair value resulting from a
hypothetical 10% decrease in the interest rates used by the dealers to quote the
fair value of our Long-Term Debt at January 30, 1999, which would result in an
increase in fair value of approximately $10.2 million. (See Notes to
Consolidated Financial Statements, Note 3--Debt).
The table below presents principal cash flows and related weighted average
interest rates of our Long-Term Debt at January 30, 1999, by year of maturity
(dollars in thousands):
FISCAL YEAR
-----------------------------------------------------------------------------
1999 2000 2001 2002 2003 THEREAFTER
----------- ----------- ----------- ----------- ----------- ------------
Long-Term Debt retired......................... -- -- -- $ 96,940 -- $ 125,000
Weighted average interest rate................. 9.1% 9.1% 9.1% 9.1% 10.9% 10.9%
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The information called for by this item is included in "Item 14-Exhibits,
Financial Statement Schedules and Reports on Form 8-K."
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
There were no changes in or disagreements with accountants on accounting and
financial disclosure for the fiscal year ended January 30, 1999.
19
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information concerning the directors of the Company is set forth in the
Proxy Statement to be delivered to stockholders in connection with our Annual
Meeting of Stockholders to be held on June 17, 1999 (the "Proxy Statement")
under the heading "Proposal for Election of Directors," which information is
incorporated herein by reference. The name, age and position of each executive
officer of the Company is set forth under the heading "Executive Officers of the
Registrant" in Item 1 of this report, which information is incorporated herein
by reference.
ITEM. 11. EXECUTIVE COMPENSATION.
The information concerning executive compensation is set forth in the Proxy
Statement under the heading "Management Compensation," which information is
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information concerning security ownership of certain beneficial owners
and management is set forth in the Proxy Statement under the heading "Principal
Stockholders and Management Ownership," which information is incorporated herein
by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information concerning certain relationships and related transactions is
set forth in the Proxy Statement under the heading "Certain Transactions," which
information is incorporated herein by reference.
20
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
PAGE IN
REPORT
-----------
a) The following documents are filed as a part of this report:
(1) Financial Statements:
Report of Independent Auditors........................................................... 25
Consolidated Balance Sheets at January 30, 1999 and January 31, 1998..................... 26
Consolidated Statements of Operations for the fiscal years ended January 30, 1999,
January 31, 1998 and February 1, 1997.................................................. 27
Consolidated Statements of Cash Flows for the fiscal years ended January 30, 1999,
January 31, 1998 and February 1, 1997.................................................. 28
Consolidated Statements of Stockholders' Equity for the fiscal years ended January 30,
1999, January 31, 1998 and February 1, 1997............................................ 29
Notes to Consolidated Financial Statements for the fiscal years ended January 30, 1999,
January 31, 1998 and February 1, 1997.................................................. 30
Unaudited Supplemental Quarterly Financial Data for the fiscal years ended January 30,
1999 and January 31, 1998.............................................................. 40
(2) Financial Statement Schedules:
All schedules have been omitted because they are not applicable or the
required information is included in the financial statements or notes
thereto.
(3) Exhibits:
The Exhibits listed below and on the accompanying Index to Exhibits
immediately following the financial statement schedules are
incorporated herein, or incorporated by reference into this report.
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- ----------- -----------------------------------------------------------------------------------------
3.1 Bylaws of the Registrant, as amended and restated (previously filed as Exhibit 3.1 to
Form 10-K for the year ended January 30, 1994, filed by Registrant on April 28, 1994, SEC
File No. 000-11822).
3.2 Restated Certificate of Incorporation of the Registrant (previously filed as Exhibit 4.1
to Form S-8 (No. 33-54726), filed by Registrant on November 20, 1992.
3.3 Certificate of Amendment to the Restated Certificate of Incorporation of the Registrant
(Filed herewith).
4.1 Form of Common Stock Certificate (previously filed as Exhibit 4.1 to Form 10-K for the
year ended January 30, 1994, filed by Registrant on April 28, 1994, SEC File No.
000-11822).
4.2 Indenture, dated as of January 22, 1993, between Michaels Stores, Inc. and NationsBank of
Texas, N.A., as Trustee, including the form of 4 3/4%/6 3/4% Step-up Convertible
Subordinated Note included therein (previously filed as Exhibit 19.1 to Form 10-K for the
year ended January 31, 1993, filed by Registrant on April 29, 1993, SEC File No.
000-11822).
21
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- ----------- -----------------------------------------------------------------------------------------
4.3 Indenture, dated as of June 21, 1996, between Michaels Stores, Inc. and The Bank of New
York (previously filed as Exhibit 19.1 to Form 10-Q for the quarter ended July 28, 1996,
filed by Registrant on September 11, 1996, SEC File No. 000-11822).
10.1 Michaels Stores, Inc. Employees 401(k) Plan, as amended and restated, effective October
1, 1996 (previously filed as Exhibit 99.2 to Form 8-K, filed by Registrant on September
30, 1996, SEC File No. 000-11822).*
10.2 Michaels Stores, Inc. Employees 401(k) Trust, dated July 11, 1996 (previously filed as
Exhibit 99.3 to Form 8-K, filed by Registrant on September 30, 1996, SEC File No.
000-11822).
10.3 Form of Indemnity Agreement between Michaels Stores, Inc. and certain officers and
directors of the Registrant (previously filed as Exhibit 10.8 to Form 10-K for the year
ended January 31, 1993, filed by Registrant on April 29, 1993, SEC File No. 000-11822).
10.4 Form of Employment Agreement between Michaels Stores, Inc. and Sam Wyly (previously filed
as Exhibit 10.4 to Form 10-K for the year ended January 31, 1998, filed by Registrant on
May 1, 1998, SEC File No. 000-11822).*
10.5 Form of Employment Agreement between Michaels Stores, Inc. and Douglas B. Sullivan
(previously filed as Exhibit 10.5 to Form 10-K for the year ended January 31, 1998, filed
by Registrant on May 1, 1998, SEC File No. 000-11822).*
10.6 Michaels Stores, Inc. Amended and Restated Key Employee Stock Compensation Program
(previously filed as Exhibit 10.9 to Form 10-K for the year ended February 1, 1997, filed
by Registrant on May 2, 1997, SEC File No. 000-11822).*
10.7 Michaels Stores, Inc. Amended and Restated 1992 Non-Statutory Stock Option Plan
(previously filed as Exhibit 99.1 to Form S-8 (No. 333-21407), filed by Registrant on
February 7, 1997).*
10.8 Michaels Stores, Inc. Amended and Restated 1994 Non-Statutory Stock Option Plan
(previously filed as Exhibit 99.1 to Form S-8 (No. 333-21635), filed by Registrant on
February 12, 1997).*
10.9 Amended, Modified and Restated Master Lease Agreement, dated as of December 18, 1995,
between Jacksonville Funding Corporation as Lessor and Michaels Stores, Inc. as Lessee
(previously filed as Exhibit 10.17 to Form 10-K for the year ended January 28, 1996,
filed by Registrant on April 29, 1996, SEC File No. 000-11822).
10.10 Amendment No. 1 to Amended, Modified and Restated Master Lease Agreement, dated as of
April 22, 1996, between Jacksonville Funding Enterprises, LLC as Lessor and Michaels
Stores, Inc. as Lessee (previously filed as Exhibit 10.13 to Form 10-K for the year ended
January 31, 1998, filed by Registrant on May 1, 1998, SEC File No. 000-11822).
10.11 Amendment No. 2 to Amended, Modified and Restated Master Lease Agreement, dated as of
July 11, 1996, between Jacksonville Funding Enterprises, LLC as Lessor and Michaels
Stores, Inc. as Lessee (previously filed as Exhibit 10.14 to Form 10-K for the year ended
January 31, 1998, filed by Registrant on May 1, 1998, SEC File No. 000-11822).
22
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- ----------- -----------------------------------------------------------------------------------------
10.12 Amendment No. 3 to Amended, Modified and Restated Master Lease Agreement, dated as of
August 15, 1996, between Jacksonville Funding Enterprises, LLC as Lessor and Michaels
Stores, Inc. as Lessee (previously filed as Exhibit 10.15 to Form 10-K for the year ended
January 31, 1998, filed by Registrant on May 1, 1998, SEC File No. 000-11822).
10.13 Amendment No. 4 to Amended, Modified and Restated Master Lease Agreement and Waiver,
dated as of March 11, 1997, between Jacksonville Funding Corporation as Lessor and
Michaels Stores, Inc. as Lessee (previously filed as Exhibit 10.17 to Form 10-K for the
year ended February 1, 1997, filed by Registrant on May 2, 1997, SEC File No. 000-11822).
10.14 Consulting Agreement, dated as of October 1, 1996, between Michaels Stores, Inc. and
Michael C. French (previously filed as Exhibit 10.17 to Form 10-K for the year ended
January 31, 1998, filed by Registrant on May 1, 1998, SEC File No. 000-11822). *
10.15 Term Lease Master Agreement between IBM Credit Corporation as Lessor and Michaels Stores,
Inc. as Lessee (previously filed as Exhibit 10.18 to Form 10-K for the year ended
February 1, 1997, filed by Registrant on May 2, 1997, SEC File No. 000-11822).
10.16 Common Stock and Warrant Agreement, dated as of October 16, 1984, between Michaels
Stores, Inc. and Peoples Restaurants, Inc., including form of Warrant (previously filed
as Exhibit 4.2 to Form 10-K for the year ended January 31, 1993, filed by Registrant on
April 29, 1993, SEC File No. 000-11822).
10.17 First Amendment to Common Stock and Warrant Agreement, dated October 31, 1984, between
The First Dallas Group, Ltd. and Michaels Stores, Inc. (previously filed as Exhibit 4.3
to Form 10-K for the year ended January 31, 1993, filed by Registrant on April 29, 1993,
SEC File No. 000-11822).
10.18 Second Amendment to Common Stock and Warrant Agreement, dated November 28, 1984, between
First Dallas Investments-Michaels I, Ltd. and Michaels Stores, Inc. (previously filed as
Exhibit 4.4 to Form 10-K for the year ended January 31,1993, filed by Registrant on April
29, 1993, SEC File No. 000-11822).
10.19 Third Amendment to Common Stock and Warrant Agreement, dated February 27, 1985, between
First Dallas Investments-Michaels I, Ltd., The First Dallas Group, Ltd., Sam Wyly,
Charles J. Wyly, Jr. and Michaels Stores, Inc. (previously filed as Exhibit 10.23 to Form
S-1 (No. 33-09456), filed by Registrant on October 14, 1986).
10.20 Amendment to Common Stock and Warrant Agreement, dated as of September 1, 1992, between
Michaels Stores, Inc. and the other parties named therein (previously filed as Exhibit
4.8 to Form S-8 (No. 33-54726), filed by Registrant on November 20, 1992).
10.21 Bonus Plan for Officers and Employees (Filed herewith).*
10.22 Employment Agreement, effective as of April 29, 1997, between Michaels Stores, Inc. and
R. Michael Rouleau (previously filed as Exhibit 10.32 to Form 10-K for the year ended
February 1, 1997 filed by Registrant on May 2, 1997, SEC File No. 000-11822).*
23
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- ----------- -----------------------------------------------------------------------------------------
10.23 Michaels Stores, Inc. Stock Option Agreement, dated as of June 6, 1997, between Michaels
Stores, Inc. and R. Michael Rouleau (previously filed as Exhibit 99.1 to Form S-8 (No.
333-29417), filed by Registrant on June 17, 1997).*
10.24 Michaels Stores, Inc. 1997 Employees Stock Purchase Plan (previously filed as Exhibit
10.33 to Form 10-K for the year ended February 1, 1997, filed by Registrant on May 2,
1997, SEC File No. 000-11822).*
10.25 Michaels Stores, Inc. 1997 Stock Option Plan (previously filed as Exhibit 10.2 to Form
10-Q for quarter ended May 3, 1997, filed by Registrant on June 17, 1997, SEC File No.
000-11822).*
10.26 Revolving Credit Agreement, dated as of August 28, 1998, among Michaels Stores, Inc.,
BankBoston, N.A. and the other lenders named therein (previously filed as Exhibit 4 to
Form 10-Q for quarter ended August 1, 1998, filed by Registrant on September 15,1998, SEC
File No. 000-11822).*
10.27 Stock Purchase Agreement, dated as of March 29, 1996, between Michaels Stores, Inc. and
Quayle Limited (previously filed as Exhibit 4.7 to Form 10-K for the year ended January
28, 1996, filed by Registrant on April 29, 1996, SEC File No. 000-11822).
10.28 Stock Purchase Agreement, dated as of March 29, 1996, between Michaels Stores, Inc. and
Locke Limited (previously filed as Exhibit 4.8 to Form 10-K for the year ended January
28, 1996, filed by Registrant on April 29, 1996, SEC File No. 000-11822).
10.29 Stock Purchase Agreement, dated as of March 29, 1996, between Michaels Stores, Inc. and
Fugue Limited (previously filed as Exhibit 4.9 to Form 10-K for the year ended January
28, 1996, filed by Registrant on April 29, 1996, SEC File No. 000-11822).
10.30 Option Agreement, dated as of December 23, 1996, between Michaels Stores, Inc. and
Devotion Limited (previously filed as Exhibit 10.28 to Form 10-K for the year ended
February 1, 1997, filed by Registrant on May 2, 1997, SEC File No. 000-11822).
10.31 Option Agreement, dated as of December 23, 1996, between Michaels Stores, Inc. and
Elegance Limited (previously filed as Exhibit 10.29 to Form 10-K for the year ended
February 1, 1997, filed by Registrant on May 2, 1997, SEC File No. 000-11822).
21.1 Subsidiaries of Michaels Stores, Inc. (Filed herewith).
23.1 Consent of Ernst & Young LLP (Filed herewith).
27.1 Financial Data Schedule (Filed herewith).
- ------------------------
* Management contract or compensatory plan or arrangement required to
be filed as an exhibit to this form pursuant to Item 14(c).
b) No reports on Form 8-K were filed during the quarter ended January 30, 1999.
24
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Michaels Stores, Inc.
We have audited the accompanying consolidated balance sheets of Michaels
Stores, Inc. as of January 30, 1999 and January 31, 1998, and the related
consolidated statements of operations, cash flows, and stockholders' equity for
each of the three years in the period ended January 30, 1999. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Michaels Stores, Inc. at January 30, 1999 and January 31, 1998, and the
consolidated results of its operations and its cash flows for each of the three
years in the period ended January 30, 1999, in conformity with generally
accepted accounting principles.
/s/ ERNST & YOUNG LLP
Dallas, Texas
March 3, 1999
25
MICHAELS STORES, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS EXCEPT SHARE DATA)
JANUARY 30, JANUARY 31,
1999 1998
--------------- ---------------
ASSETS
CURRENT ASSETS:
Cash and equivalents............................ $ 96,124 $ 162,283
Merchandise inventories......................... 501,239 385,580
Income taxes receivable and deferred income
taxes......................................... 9,654 11,291
Prepaid expenses and other...................... 14,911 14,029
--------------- ---------------
Total current assets.......................... 621,928 573,183
--------------- ---------------
PROPERTY AND EQUIPMENT, AT COST................... 381,289 331,755
Less accumulated depreciation................... (171,829) (138,719)
--------------- ---------------
209,460 193,036
--------------- ---------------
COSTS IN EXCESS OF NET ASSETS OF ACQUIRED
OPERATIONS, NET................................. 128,488 136,827
DEFERRED INCOME TAXES............................. -- 2,695
OTHER ASSETS...................................... 2,774 2,753
--------------- ---------------
131,262 142,275
--------------- ---------------
Total assets...................................... $ 962,650 $ 908,494
--------------- ---------------
--------------- ---------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable................................ $ 106,173 $ 109,456
Income taxes payable............................ 12,623 --
Accrued liabilities and other................... 111,905 105,036
--------------- ---------------
Total current liabilities..................... 230,701 214,492
--------------- ---------------
SENIOR NOTES...................................... 125,000 125,000
CONVERTIBLE SUBORDINATED NOTES.................... 96,940 96,940
DEFERRED INCOME TAXES............................. 2,642 --
OTHER LONG-TERM LIABILITIES....................... 26,388 30,151
--------------- ---------------
Total long-term liabilities................... 250,970 252,091
--------------- ---------------
481,671 466,583
--------------- ---------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $.10 par value, 2,000,000
shares authorized, none issued................ -- --
Common stock, $.10 par value, 150,000,000 shares
authorized and 29,706,760 shares issued
(50,000,000 shares authorized and 29,033,908
shares issued at January 31, 1998)............ 2,971 2,903
Additional paid-in capital...................... 367,308 350,977
Retained earnings............................... 131,072 88,031
Treasury stock, at cost, 1,145,000 shares (no
shares at January 31, 1998)................... (20,372) --
--------------- ---------------
Total stockholders' equity.................... 480,979 441,911
--------------- ---------------
Total liabilities and stockholders' equity........ $ 962,650 $ 908,494
--------------- ---------------
--------------- ---------------
See accompanying notes to consolidated financial statements.
26
MICHAELS STORES, INC
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS EXCEPT PER SHARE DATA)
FISCAL YEAR
----------------------------------------
1998 1997 1996
------------ ------------ ------------
NET SALES............................................................... $ 1,573,965 $ 1,456,524 $ 1,378,277
Cost of sales and occupancy expense..................................... 1,051,266 988,990 1,003,815
------------ ------------ ------------
GROSS PROFIT............................................................ 522,699 467,534 374,462
Selling, general and administrative expense............................. 425,690 396,216 392,243
Store pre-opening costs................................................. 7,897 2,376 3,206
------------ ------------ ------------
OPERATING INCOME (LOSS)................................................. 89,112 68,942 (20,987)
Interest expense........................................................ 22,678 23,448 21,038
Other (income) and expense, net......................................... (3,890) (3,013) (952)
------------ ------------ ------------
INCOME (LOSS) BEFORE INCOME TAXES....................................... 70,324 48,507 (41,073)
Provision (benefit) for income taxes.................................... 26,723 18,430 (9,840)
------------ ------------ ------------
NET INCOME (LOSS)....................................................... $ 43,601 $ 30,077 $ (31,233)
------------ ------------ ------------
------------ ------------ ------------
EARNINGS (LOSS) PER COMMON SHARE:
Basic................................................................. $1.49 $1.11 $(1.35)
Diluted............................................................... $1.43 $1.05 $(1.35)
See accompanying notes to consolidated financial statements.
27
MICHAELS STORES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
FISCAL YEAR
-----------------------------------
1998 1997 1996
----------- ---------- ----------
OPERATING ACTIVITIES:
Net income (loss)......................................................... $ 43,601 $ 30,077 $ (31,233)
Adjustments:
Depreciation............................................................ 45,972 41,387 37,545
Amortization............................................................ 4,281 4,247 4,184
Other................................................................... 1,017 2,009 1,052
Change in assets and liabilities:
Merchandise inventories............................................... (115,659) (34,372) 14,894
Prepaid expenses and other............................................ (882) (1,970) (1,076)
Deferred income taxes and other....................................... 10,464 17,604 (1,314)
Accounts payable...................................................... (3,283) 4,490 6,166
Income taxes payable.................................................. 15,854 -- --
Accrued liabilities and other......................................... 4,673 14,435 (469)
----------- ---------- ----------
Net change in assets and liabilities................................ (88,833) 187 18,201
----------- ---------- ----------
Net cash provided by operating activities........................... 6,038 77,907 29,749
----------- ---------- ----------
INVESTING ACTIVITIES:
Additions to property and equipment....................................... (77,994) (43,997) (33,609)
Net proceeds from sales of property and equipment......................... 18,427 1,623 175
Net proceeds from sales of investments.................................... -- 3,386 1,122
----------- ---------- ----------
Net cash used in investing activities............................... (59,567) (38,988) (32,312)
----------- ---------- ----------
FINANCING ACTIVITIES:
Net payments under bank credit facilities................................. -- -- (87,200)
Payment of other long-term liabilities.................................... (5,378) (4,354) (2,503)
Proceeds from issuance of Senior Notes.................................... -- -- 120,542
Acquisition of treasury stock............................................. (20,372) -- --
Proceeds from stock options exercised..................................... 7,060 61,309 3,299
Proceeds from issuance of common stock and other.......................... 6,060 7,340 24,624
----------- ---------- ----------
Net cash (used in) provided by financing activities................. (12,630) 64,295 58,762
----------- ---------- ----------
NET (DECREASE) INCREASE IN CASH AND EQUIVALENTS............................. (66,159) 103,214 56,199
CASH AND EQUIVALENTS AT BEGINNING OF YEAR................................... 162,283 59,069 2,870
----------- ---------- ----------
CASH AND EQUIVALENTS AT END OF YEAR......................................... $ 96,124 $ 162,283 $ 59,069
----------- ---------- ----------
----------- ---------- ----------
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest.................................................... $ 20,708 $ 22,486 $ 19,291
----------- ---------- ----------
----------- ---------- ----------
Cash refunds received for income taxes.................................... $ 1,618 $ 4,858 $ 17,366
----------- ---------- ----------
----------- ---------- ----------
See accompanying notes to consolidated financial statements.
28
MICHAELS STORES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE THREE YEARS ENDED JANUARY 30, 1999
(IN THOUSANDS EXCEPT SHARE DATA)
ADDITIONAL TREASURY
NUMBER OF COMMON PAID-IN RETAINED STOCK, AT
SHARES STOCK CAPITAL EARNINGS COST TOTAL
------------ ----------- ---------- ---------- ------------- ----------
BALANCE AT JANUARY 28, 1996.......... 21,504,110 $ 2,150 $ 243,325 $ 90,478 $ -- $ 335,953
Proceeds from private placement.... 2,000,000 200 24,800 -- -- 25,000
Exercise of stock options and
other............................ 186,816 19 3,280 (217) -- 3,082
Net loss........................... -- -- -- (31,233) -- (31,233)
------------ ----------- ---------- ---------- ------------- ----------
BALANCE AT FEBRUARY 1, 1997.......... 23,690,926 2,369 271,405 59,028 -- 332,802
Exercise of stock options and
other............................ 5,101,612 510 62,046 (1,074) -- 61,482
Tax benefit from exercise of stock
options.......................... -- -- 9,678 -- -- 9,678
Proceeds from Stock Purchase
Plan............................. 241,370 24 7,848 -- -- 7,872
Net income......................... -- -- -- 30,077 -- 30,077
------------ ----------- ---------- ---------- ------------- ----------
BALANCE AT JANUARY 31, 1998.......... 29,033,908 2,903 350,977 88,031 -- 441,911
Exercise of stock options and
other............................ 494,122 50 6,900 (560) -- 6,390
Tax benefit from exercise of stock
options.......................... -- -- 3,231 -- -- 3,231
Proceeds from Stock Purchase
Plan............................. 178,730 18 6,200 -- -- 6,218
Acquisition of treasury stock...... (1,145,000) -- -- -- (20,372) (20,372)
Net income......................... -- -- -- 43,601 -- 43,601
------------ ----------- ---------- ---------- ------------- ----------
BALANCE AT JANUARY 30, 1999.......... 28,561,760 $ 2,971 $ 367,308 $ 131,072 $ (20,372) $ 480,979
------------ ----------- ---------- ---------- ------------- ----------
------------ ----------- ---------- ---------- ------------- ----------
See accompanying notes to consolidated financial statements.
29
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
Michaels Stores, Inc. (the "Company") owns and operates a chain of 496
specialty retail stores in 46 states, Canada and Puerto Rico featuring arts,
crafts, framing, floral, decorative wall decor and seasonal merchandise for the
hobbyist and do-it-yourself home decorator. A Michaels store typically carries
over 40,000 items. The Company's wholly owned subsidiary, Aaron Brothers, Inc.,
operates a chain of 78 framing and art supply stores. Aaron Brothers stores are
located primarily on the West Coast.
FISCAL YEAR
The Company reports on the basis of a 52/53-week fiscal year, which ends on
the Saturday closest to January 31. Fiscal 1998 ("1998"), fiscal 1997 ("1997")
and fiscal 1996 ("1996") ended on January 30, 1999, January 31, 1998 and
February 1, 1997, respectively; thus, 1998 and 1997 had 52 weeks and 1996 had 53
weeks.
CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and all wholly owned subsidiaries. All intercompany balances and transactions
have been eliminated.
ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires the Company to make estimates and
assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes. Actual results could differ from those
estimates.
CASH AND EQUIVALENTS
Cash and equivalents are generally comprised of highly liquid instruments
with original maturities of three months or less. Cash equivalents are carried
at cost, which approximates fair value.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to current year
presentations.
MERCHANDISE INVENTORIES
Store merchandise inventories are valued as determined by a retail inventory
method at the lower of average cost or market. Distribution center inventories
are valued at the lower of cost or market determined by the first-in, first-out
method.
Fiscal 1996 included a $41.2 million charge recorded in the third quarter to
cover losses on a sale to liquidate merchandise that was eliminated following
store resets, markdowns on discontinued furniture and other home decor
merchandise, and reserves for the closure of four stores and the write-down of
leasehold improvements in three stores.
30
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PROPERTY AND EQUIPMENT
Property and equipment is recorded at cost. Depreciation is provided on a
straight-line basis over the estimated useful lives of the assets. Useful lives
of buildings, fixtures and equipment, leasehold improvements, and capital leases
for computer equipment are generally estimated to be 30, 8, 10 and 5 years,
respectively. Amortization of assets recorded under capital leases and leasehold
improvements is included in depreciation expense.
COSTS IN EXCESS OF NET ASSETS OF ACQUIRED OPERATIONS
Costs in excess of net assets of acquired operations are being amortized
over 40 years on a straight-line basis. Accumulated amortization was $21,664,000
and $17,862,000 as of the end of 1998 and 1997, respectively. The Company
assesses the recoverability of costs in excess of net assets acquired based on
existing facts and circumstances. The Company periodically measures the
recoverability of this asset based on projected undiscounted cash flows of the
acquired operations. Should the Company's assessment indicate an impairment of
this asset in the future, an appropriate write-down will be recorded.
ADVERTISING COSTS
Advertising costs are expensed in the period in which the advertising first
occurs. Net advertising expense was $58,928,000, $55,143,000 and $63,505,000 for
1998, 1997 and 1996, respectively.
STORE PRE-OPENING COSTS
In April 1998 the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position 98-5, REPORTING THE COSTS OF START-UP
ACTIVITIES ("SOP 98-5"), which requires that costs related to start-up
activities be expensed as incurred. Prior to 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 1998 and, as a result, began expensing pre-opening costs as incurred.
The adoption of SOP 98-5 resulted in additional expense of $654,000 in 1998. The
Company incurred store pre-opening costs of $7,897,000, $2,376,000 and
$3,206,000 for 1998, 1997 and 1996, respectively.
REVENUE RECOGNITION
Revenue from sales of the Company's merchandise and services is recognized
at the time of the merchandise sale.
31
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings
per common share:
FISCAL YEAR
--------------------------------
1998 1997 1996
--------- --------- ----------
(IN THOUSANDS EXCEPT PER SHARE
DATA)
NUMERATOR:
Net income.......................................... $ 43,601 $ 30,077 $ (31,233)
--------- --------- ----------
--------- --------- ----------
DENOMINATOR:
Denominator for basic earnings per share-weighted
average shares.................................... 29,218 27,215 23,180
Effect of dilutive securities:
Employee stock options............................ 1,360 1,449 --
--------- --------- ----------
Denominator for diluted earnings per share-weighted
average shares adjusted for dilutive securities... 30,578 28,664 23,180
--------- --------- ----------
--------- --------- ----------
BASIC EARNINGS (LOSS) PER COMMON SHARE................ $1.49 $1.11 $(1.35)
--------- --------- ----------
--------- --------- ----------
DILUTED EARNINGS (LOSS) PER COMMON SHARE.............. $1.43 $1.05 $(1.35)
--------- --------- ----------
--------- --------- ----------
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.
NEW PRONOUNCEMENTS
The AICPA issued Statement of Position 98-1, ACCOUNTING FOR COSTS OF
COMPUTER SOFTWARE DEVELOPED OR OBTAINED FOR INTERNAL USE ("SOP 98-1"), which is
effective for fiscal years beginning after December 15, 1998. Beginning in the
first quarter of fiscal year 1999, the Company will adopt SOP 98-1. The Company
believes that the adoption of SOP 98-1 will not have a material effect on the
Company's financial statements. In June 1998 the Financial Accounting Standards
Board issued Statement of Financial Accounting Standards No. 133, ACCOUNTING FOR
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES ("SFAS No. 133"). SFAS No. 133
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities. It requires that an entity recognize all derivatives as
either assets or liabilities in the statement of financial position and measure
those instruments at fair value. SFAS No. 133 is effective for fiscal years
beginning after June 15, 1999. The Company's use of derivatives has been
minimal, historically, and therefore we do not expect this standard to have a
material impact on the Company's reporting requirements.
32
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2--DETAIL OF CERTAIN BALANCE SHEET ACCOUNTS
FISCAL YEAR
----------------------
1998 1997
---------- ----------
(IN THOUSANDS)
PROPERTY AND EQUIPMENT:
Land and buildings.................................................. $ 3,119 $ 3,119
Fixtures and equipment.............................................. 260,629 221,906
Leasehold improvements.............................................. 90,911 82,832
Capital leases...................................................... 26,630 23,898
---------- ----------
$ 381,289 $ 331,755
---------- ----------
---------- ----------
ACCRUED LIABILITIES AND OTHER:
Salaries, bonuses and other payroll-related costs................... $ 39,846 $ 39,031
Taxes, other than income and payroll................................ 18,348 16,220
Rent................................................................ 8,496 7,485
Current portion of capital lease obligations........................ 5,973 4,662
Other............................................................... 39,242 37,638
---------- ----------
$ 111,905 $ 105,036
---------- ----------
---------- ----------
NOTE 3--DEBT
In June 1996 the Company completed a public offering of $125 million of
Senior Notes (the "Notes"). The Notes bear interest at a rate of 10 7/8% payable
June 15 and December 15 of each year and mature on June 15, 2006. The Notes are
not redeemable prior to June 15, 2001, except that, until June 15, 1999, the
Company may redeem, at its option, up to an aggregate of $25 million principal
amount of the Notes at 110.00%, plus accrued interest to the date of redemption,
with the net proceeds of one or more equity offerings if at least $100 million
aggregate principal amount of the Notes remains outstanding after each
redemption. On or after June 15, 2001, the Notes are redeemable at the option of
the Company, in whole or in part, at redemption prices ranging from 105.44% in
2001 to 100.00% in 2004, plus accrued interest to the date of redemption. In
addition, the indenture under which the Notes have been issued contains certain
covenants, including but not limited to restrictions on (1) debt; (2) payments
such as dividends, repurchases of the Company's Common Stock or repurchases of
subordinated obligations; (3) distributions from subsidiaries; (4) sales of
assets; (5) transactions with affiliates; (6) liens; and (7) mergers,
consolidations and transfers of all or substantially all assets. The Company
used the full amount of the net proceeds from the sale of the Notes to reduce
indebtedness under a bank credit agreement. The fair value, based on dealer
quotes, of the outstanding Notes as of January 30, 1999 and January 31, 1998 was
$131.6 million and $139.5 million, respectively.
In January 1993 the Company issued $97.75 million of convertible
subordinated notes ("Subordinated Notes") due January 15, 2003. Interest,
payable semi-annually on January 15 and July 15, was computed at the rate of
4 3/4% from the date of issuance to January 15, 1996, and at 6 3/4% thereafter.
Interest expense is accrued by the Company based on an effective interest rate
of 6.38% (including amortization of deferred issuance costs) over the full term.
The Subordinated Notes are redeemable at the option of the Company at redemption
prices ranging from 102.62% currently to 100.00% in 2003, and are not entitled
to any sinking fund. They are convertible into the Company's Common Stock at any
time, at a conversion price of $38 per share. A total of 2,551,053 shares of
Common Stock are reserved for conversion. The fair value,
33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--DEBT (CONTINUED)
based on dealer quotes, of the outstanding Subordinated Notes as of January 30,
1999 and January 31, 1998 was $84.6 million and $100.3 million, respectively.
In August 1998 the Company entered into a new unsecured revolving credit
agreement with BankBoston, N.A. and other lending institutions (the "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 Credit Agreement. Borrowings available under the Credit Agreement are
reduced by the aggregate amount of letters of credit outstanding. There were no
borrowings outstanding under the previous revolving line of credit at any time
during 1997, and in 1998 borrowings under the Credit Agreement were outstanding
for 54 days during our peak season of seasonal inventory buildup (with average
outstanding borrowings of $23 million and a weighted average interest rate of
7.09%), with no borrowings outstanding at January 30, 1999. The interest rate on
the 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 Credit Agreement. The Company is required to pay a
facility fee from .2% to .3% per annum on the unused portion of the revolving
line of credit. The Credit Agreement provides certain annual restrictions on the
aggregate amount of capital expenditures, restricts the payment of dividends and
requires the Company to maintain compliance with various financial ratios. The
Credit Agreement expires in August 2001.
NOTE 4--INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
deferred tax assets and liabilities as of the respective year end balance sheets
are as follows:
FISCAL YEAR
---------------------
1998 1997
--------- ----------
(IN THOUSANDS)
Deferred tax assets:
Net operating loss, general business credit and alternative minimum
tax credit carryforwards........................................... $ 31,587 $ 41,748
Accrued expenses..................................................... 14,660 15,392
Other................................................................ 1,448 4,669
--------- ----------
Deferred tax assets................................................ 47,695 61,809
Valuation allowance.................................................. (7,870) (15,258)
--------- ----------
Total deferred tax assets.......................................... 39,825 46,551
--------- ----------
Deferred tax liabilities:
Depreciation and amortization........................................ 19,958 22,261
Other................................................................ 13,327 11,974
--------- ----------
Total deferred tax liabilities..................................... 33,285 34,235
--------- ----------
Net deferred tax assets................................................ $ 6,540 $ 12,316
--------- ----------
--------- ----------
34
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4--INCOME TAXES (CONTINUED)
The federal and state income tax provision (benefit) is as follows:
FISCAL YEAR
-------------------------------
1998 1997 1996
--------- --------- ---------
(IN THOUSANDS)
Federal:
Current.................................................... $ 16,015 $ 15,946 $ (9,250)
Deferred................................................... 10,620 3,581 (590)
--------- --------- ---------
Total federal................................................ 26,635 19,527 (9,840)
--------- --------- ---------
State:
Current.................................................... 463 890 --
Deferred................................................... (375) (1,987) --
--------- --------- ---------
Total state.................................................. 88 (1,097) --
--------- --------- ---------
Total provision (benefit).................................. $ 26,723 $ 18,430 $ (9,840)
--------- --------- ---------
--------- --------- ---------
Reconciliation between the actual income tax provision (benefit) and the
income tax provision (benefit) calculated by applying the federal statutory rate
is as follows:
FISCAL YEAR
--------------------------------
1998 1997 1996
--------- --------- ----------
(IN THOUSANDS)
Income tax provision (benefit) at statutory rate............ $ 24,613 $ 16,978 $ (14,376)
Foreign loss not benefited.................................. -- 1,597 2,602
Increase (decrease) in valuation allowance.................. (3,572) -- 3,271
State income taxes, net of federal income tax effect........ 2,554 (239) --
Utilization of net operating losses previously not
benefited................................................. (1,439) -- --
Amortization of intangibles................................. 1,331 1,331 1,331
Other....................................................... 3,236 (1,237) (2,668)
--------- --------- ----------
Total provision (benefit)................................. $ 26,723 $ 18,430 $ (9,840)
--------- --------- ----------
--------- --------- ----------
At January 30, 1999, the Company had federal and state net operating loss
carryforwards to reduce future taxable income of approximately $14 million and
$122 million, respectively, expiring at various dates between 1999 and 2012. The
Company utilized $9 million of acquired net operating loss carryforwards in 1998
for which the benefit was recorded as a reduction to goodwill. The Company also
has tax credit carryforwards of approximately $8 million available to offset
future income taxes.
35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5--STOCKHOLDERS' EQUITY
In April 1996 the Company completed a private placement of 2,000,000 shares
of the Company's Common Stock at a price of $12.50 per share (the "Private
Placement"). The Common Stock was sold through three private transactions with
separate entities owned by independent trusts of which family members of Sam
Wyly and Charles J. Wyly, Jr. (the "Wyly Family") are beneficiaries. Sam Wyly
and Charles J. Wyly, Jr. are Chairman and Vice Chairman of the Board of
Directors of the Company, respectively.
In February 1997 options to purchase 2,000,000 shares of the Company's
Common Stock were exercised through private transactions with entities owned by
independent trusts of which Wyly Family members are beneficiaries. The options
were purchased in December of 1996 with an exercise price equal to the then
current market price. The exercise of the options provided the Company with $20
million of additional capital in 1997.
In October 1997 the Company began issuing Common Stock through its Dividend
Reinvestment and Stock Purchase Plan (the "Stock Purchase Plan"). The Stock
Purchase Plan provides owners of shares of Common Stock and other interested
investors with a convenient and economical method to purchase Common Stock. The
Stock Purchase Plan also provides the Company with a cost-efficient and flexible
mechanism to raise equity capital. The Company may establish a discount of 0% to
5% in certain transactions to purchase shares under the Stock Purchase Plan.
During 1998 and 1997 the Company issued 178,730 and 241,370 shares,
respectively, through the Stock Purchase Plan, generating $6,218,000 and
$7,872,000, respectively, in new equity.
In October 1998 the Company repurchased 1,145,000 shares of its Common Stock
for an aggregate purchase price of $20.4 million and placed the shares in
treasury.
Select employees and key advisors of the Company, including directors, may
participate in the 1997 Stock Option Plan (the "Plan"), with an aggregate of
3,815,088 shares of Common Stock remaining for issuance thereunder. Options
issued to employees under the Plan generally have a three or five year term and
vest over a two or three year period following the date of grant and those
issued to directors generally vest immediately.
The Company has elected to follow Accounting Principles Board Opinion No.
25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES ("APB 25") and related
Interpretations in accounting for its employee stock options. The exercise price
of the Company's employee stock options equals the market price of the
underlying stock on the date of grant and, as a result, the Company does not
recognize compensation expense for stock option grants in accordance with the
provisions of APB 25.
Pro forma information regarding net income and earnings per share, as
required by the provisions of Statement of Financial Accounting Standards No.
123, ACCOUNTING FOR STOCK-BASED COMPENSATION ("SFAS No. 123"), has been
determined as if the Company had accounted for its employee stock options under
the fair value method. The fair value for the options was estimated at the date
of grant using the Black-Scholes option valuation model with the following
weighted-average assumptions for 1998, 1997 and 1996, respectively: risk-free
interest rates of 4.93%, 5.69% and 6.08%; no dividend yield; volatility factors
of the expected market price of the Company's Common Stock of 58.4%, 54.7% and
56.6%; and a weighted-average expected life of the options of 2.14, 1.81 and
2.95 years.
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options that have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. The
Company's employee stock options have characteristics significantly different
from those of traded options
36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5--STOCKHOLDERS' EQUITY (CONTINUED)
and changes in the subjective input assumptions can materially affect the fair
value estimate. In addition, options vest over several years and additional
option grants are expected. As a result, the Company believes the existing
models do not necessarily provide a reliable single measure of the fair value of
its employee stock options and the effects of the following hypothetical
calculations are not likely to be representative of similar future calculations.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The pro forma
effects of applying SFAS No. 123 are not indicative of future amounts because
this statement does not apply to options granted prior to fiscal 1996. The
Company's pro forma information is as follows:
FISCAL YEAR
--------------------------------
1998 1997 1996
--------- --------- ----------
(IN THOUSANDS EXCEPT PER SHARE
DATA)
Pro forma net income (loss)........................... $ 36,661 $ 15,477 $ (50,694)
Pro forma earnings (loss) per common share:
Basic............................................... $1.25 $0.57 $(2.19)
Diluted............................................. $1.21 $0.54 $(2.19)
For 1998, 1997 and 1996, the Company's stock option activity is summarized
below:
FISCAL YEAR
----------------------------------------------------------------------------
1998 1997 1996
------------------------ ------------------------ ------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
----------- ----------- ----------- ----------- ----------- -----------
(IN THOUSANDS EXCEPT PER SHARE DATA)
Outstanding at beginning of year.................... 6,627 $ 18.10 7,540 $ 12.07 4,067 $ 16.48
Granted............................................. 1,150 25.89 4,368 21.60 4,214 11.72
Exercised........................................... (494) 14.79 (5,102) 12.32 (187) 12.31
Forfeited/Expired................................... (297) 19.96 (179) 14.26 (554) 14.09
----- ----------- ----------- ----------- ----- -----------
Outstanding at end of year.......................... 6,986 $ 19.54 6,627 $ 18.10 7,540 $ 12.07
----- ----------- ----------- ----------- ----- -----------
----- ----------- ----------- ----------- ----- -----------
Exercisable at end of year.......................... 5,313 $ 18.39 4,857 $ 17.72 5,117 $ 11.86
Weighted average fair value of options granted
during the year................................... $ 11.95 $ 4.67 $ 3.48
37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5--STOCKHOLDERS' EQUITY (CONTINUED)
The following table summarizes information about stock options outstanding
at January 30, 1999:
STOCK OPTIONS
STOCK OPTIONS OUTSTANDING
----------------------------------- EXERCISABLE
WEIGHTED -----------------------
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
LIFE EXERCISE EXERCISE
RANGE OF EXERCISE PRICES SHARES (YEARS) PRICE SHARES PRICE
- ------------------------------------------------------ ---------- ---------- ----------- ---------- -----------
$10.00 - 15.63........................................ 2,167,445 1.5 $ 12.51 2,000,023 $ 12.48
16.62 - 20.00........................................ 199,545 2.8 18.61 52,788 18.37
20.93 - 24.44........................................ 3,943,320 1.8 21.39 3,063,115 21.38
29.93 - 32.75........................................ 548,678 3.2 30.69 154,671 30.94
34.00 - 37.38........................................ 126,866 2.2 35.13 42,252 35.14
---------- ---------- ----------- ---------- -----------
6,985,854 1.9 $ 19.54 5,312,849 $ 18.39
---------- ---------- ----------- ---------- -----------
---------- ---------- ----------- ---------- -----------
NOTE 6--RETIREMENT PLAN
The Company sponsors a 401(k) savings plan (the "401(k) Plan") for eligible
employees of the Company and certain of its subsidiaries. Participation in the
401(k) Plan is voluntary and available to any employee who is 21 years of age
and has completed 500 hours of service in a six-month eligibility period.
Participants may elect to contribute up to 15% of their compensation on a
pre-tax basis and up to 10% on an after-tax basis. In accordance with the
provisions of the 401(k) Plan, the Company makes a matching contribution to the
account of each participant in an amount equal to 50% of the first 6% of
eligible compensation contributed by each participant not to exceed 3% of the
participant's total compensation for the year. The Company's matching
contribution expense, net of forfeitures, was $1,293,000, $1,095,000 and
$1,338,000 for 1998, 1997 and 1996, respectively.
NOTE 7--COMMITMENTS AND CONTINGENCIES
COMMITMENTS
The Company operates stores and uses distribution centers, office facilities
and equipment generally leased under noncancelable operating leases, the
majority of which provide for renewal options. In addition, the Company also
leases its POS system under a five-year capital lease with IBM at an interest
rate of approximately 8% (the "IBM Capital Lease"). Financing activities not
affecting cash during 1998, 1997 and 1996 included capital lease obligations
incurred in connection with the IBM Capital Lease of
38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7--COMMITMENTS AND CONTINGENCIES (CONTINUED)
$2,735,000, $2,515,000 and $18,879,000, respectively. Future minimum annual
rental commitments for all noncancelable leases as of January 30, 1999 are as
follows:
OPERATING CAPITAL
LEASES LEASES
---------- ---------
(IN THOUSANDS)
For the Fiscal Year:
1999............................................................ $ 115,634 $ 6,826
2000............................................................ 110,804 6,703
2001............................................................ 101,065 2,547
2002............................................................ 92,745 196
2003............................................................ 83,550 --
Thereafter...................................................... 262,692 --
---------- ---------
Total minimum rental commitments.................................... $ 766,490 16,272
----------
----------
Less: amounts representing interest................................. 1,343
---------
Present value of obligations........................................ 14,929
Less: current portion............................................... 5,973
---------
Long-term obligations............................................... $ 8,956
---------
---------
Rental expense applicable to noncancelable operating leases was
$103,735,000, $92,659,000 and $87,941,000 in 1998, 1997 and 1996, respectively.
The Company has entered into an operating lease for two distribution
facilities that requires that the Company guarantee payment of the residual
value of the property to the lessor at the end of the lease. As of January 30,
1999, the guaranteed residual value of assets subject to this lease was
$24,063,000.
CONTINGENCIES
A lawsuit was commenced against the Company and several other parties on
September 19, 1994 on behalf of a former employee, Naomi Snyder, her child and
her husband. The complaint alleged that the former employee and her then-unborn
child were exposed to excessive levels of carbon monoxide in one of the
Company's stores, resulting in severe and permanent injuries to the child.
Plaintiffs' Statement of Damages sought $11 million. A settlement agreement was
reached by the parties and the Company's portion of the settlement amount was
fully covered by insurance. The lawsuit was dismissed with prejudice on January
4, 1999.
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.
39
MICHAELS STORES, INC.
UNAUDITED SUPPLEMENTAL QUARTERLY FINANCIAL DATA
(IN THOUSANDS EXCEPT PER SHARE DATA)
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
---------- ---------- ---------- ----------
1998:
Net sales........................................................ $335,770 $314,171 $382,841 $541,183
Cost of sales and occupancy expense.............................. 224,874 215,325 254,080 356,987
Operating income................................................. 12,547 5,621 17,145 53,799
Net income....................................................... 5,501 634 7,256 30,210
Earnings per common share:
Basic.......................................................... $0.19 $0.02 $0.25 $1.06
Diluted........................................................ $0.18 $0.02 $0.24 $0.99
Common shares used in per share calculations:
Basic.......................................................... 29,321 29,602 29,402 28,548
Diluted(1)..................................................... 31,277 31,408 30,604 31,575
1997:
Net sales........................................................ $321,318 $278,038 $350,070 $507,098
Cost of sales and occupancy expense.............................. 220,128 190,998 237,528 340,336
Operating income................................................. 9,306 1,493 12,943 45,200
Net income (loss)................................................ 3,170 (2,895) 4,422 25,380
Earnings (loss) per common share:
Basic.......................................................... $0.13 $(0.11) $0.16 $0.88
Diluted........................................................ $0.12 $(0.11) $0.15 $0.79
Common shares used in per share calculations:
Basic.......................................................... 25,229 26,299 28,423 28,908
Diluted(1)..................................................... 26,186 26,299 30,149 33,292
- ------------------------
(1) The convertible subordinated notes were not included in the diluted earnings
per common share calculation for the first, second and third quarters
because they were antidilutive. The convertible subordinated notes were
included in the diluted earnings per common share in the fourth quarter.
40
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Date: April 30, 1999 By: /s/ R. MICHAEL ROULEAU
-----------------------------------------
R. Michael Rouleau
PRESIDENT AND CHIEF EXECUTIVE OFFICER
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
/s/ SAM WYLY
- ------------------------------ Chairman of the Board of April 30, 1999
Sam Wyly Directors
/s/ CHARLES J. WYLY, JR.
- ------------------------------ Vice Chairman of the Board April 30, 1999
Charles J. Wyly, Jr. of Directors
President and Chief
/s/ R. MICHAEL ROULEAU Executive Officer
- ------------------------------ (Principal Executive April 30, 1999
R. Michael Rouleau Officer)
Executive Vice
/s/ BRYAN M. DECORDOVA President-Chief
- ------------------------------ Financial Officer April 30, 1999
Bryan M. DeCordova (Principal Financial and
Accounting Officer)
/s/ F. JAY TAYLOR
- ------------------------------ Director April 30, 1999
F. Jay Taylor
- ------------------------------ Director April 30, 1999
Richard E. Hanlon
Director and Vice
- ------------------------------ President-Market April 30, 1999
Donald R. Miller, Jr. Development
/s/ KELLY ELLIOTT
- ------------------------------ Director April 30, 1999
Kelly Elliott
/s/ MICHAEL C. FRENCH
- ------------------------------ Director April 30, 1999
Michael C. French
/s/ EVAN A. WYLY
- ------------------------------ Director April 30, 1999
Evan A. Wyly
41
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- ----------- -----------------------------------------------------------------------------------------
3.1 Bylaws of the Registrant, as amended and restated (previously filed as Exhibit 3.1 to
Form 10-K for the year ended January 30, 1994, filed by Registrant on April 28, 1994, SEC
File No. 000-11822).
3.2 Restated Certificate of Incorporation of the Registrant (previously filed as Exhibit 4.1
to Form S-8 (No. 33-54726), filed by Registrant on November 20, 1992.
3.3 Certificate of Amendment to the Restated Certificate of Incorporation of the Registrant
(Filed herewith).
4.1 Form of Common Stock Certificate (previously filed as Exhibit 4.1 to Form 10-K for the
year ended January 30, 1994, filed by Registrant on April 28, 1994, SEC File No.
000-11822).
4.2 Indenture, dated as of January 22, 1993, between Michaels Stores, Inc. and NationsBank of
Texas, N.A., as Trustee, including the form of 4 3/4%/6 3/4% Step-up Convertible
Subordinated Note included therein (previously filed as Exhibit 19.1 to Form 10-K for the
year ended January 31, 1993, filed by Registrant on April 29, 1993, SEC File No.
000-11822).
4.3 Indenture, dated as of June 21, 1996, between Michaels Stores, Inc. and The Bank of New
York (previously filed as Exhibit 19.1 to Form 10-Q for the quarter ended July 28, 1996,
filed by Registrant on September 11, 1996, SEC File No. 000-11822).
10.1 Michaels Stores, Inc. Employees 401(k) Plan, as amended and restated, effective October
1, 1996 (previously filed as Exhibit 99.2 to Form 8-K, filed by Registrant on September
30, 1996, SEC File No. 000-11822).*
10.2 Michaels Stores, Inc. Employees 401(k) Trust, dated July 11, 1996 (previously filed as
Exhibit 99.3 to Form 8-K, filed by Registrant on September 30, 1996, SEC File No.
000-11822).
10.3 Form of Indemnity Agreement between Michaels Stores, Inc. and certain officers and
directors of the Registrant (previously filed as Exhibit 10.8 to Form 10-K for the year
ended January 31, 1993, filed by Registrant on April 29, 1993, SEC File No. 000-11822).
10.4 Form of Employment Agreement between Michaels Stores, Inc. and Sam Wyly (previously filed
as Exhibit 10.4 to Form 10-K for the year ended January 31, 1998, filed by Registrant on
May 1, 1998, SEC File No. 000-11822).*
10.5 Form of Employment Agreement between Michaels Stores, Inc. and Douglas B. Sullivan
(previously filed as Exhibit 10.5 to Form 10-K for the year ended January 31, 1998, filed
by Registrant on May 1, 1998, SEC File No. 000-11822).*
10.6 Michaels Stores, Inc. Amended and Restated Key Employee Stock Compensation Program
(previously filed as Exhibit 10.9 to Form 10-K for the year ended February 1, 1997, filed
by Registrant on May 2, 1997, SEC File No. 000-11822).*
10.7 Michaels Stores, Inc. Amended and Restated 1992 Non-Statutory Stock Option Plan
(previously filed as Exhibit 99.1 to Form S-8 (No. 333-21407), filed by Registrant on
February 7, 1997).*
42
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- ----------- -----------------------------------------------------------------------------------------
10.8 Michaels Stores, Inc. Amended and Restated 1994 Non-Statutory Stock Option Plan
(previously filed as Exhibit 99.1 to Form S-8 (No. 333-21635), filed by Registrant on
February 12, 1997).*
10.9 Amended, Modified and Restated Master Lease Agreement, dated as of December 18, 1995,
between Jacksonville Funding Corporation as Lessor and Michaels Stores, Inc. as Lessee
(previously filed as Exhibit 10.17 to Form 10-K for the year ended January 28, 1996,
filed by Registrant on April 29, 1996, SEC File No. 000-11822).
10.10 Amendment No. 1 to Amended, Modified and Restated Master Lease Agreement, dated as of
April 22, 1996, between Jacksonville Funding Enterprises, LLC as Lessor and Michaels
Stores, Inc. as Lessee (previously filed as Exhibit 10.13 to Form 10-K for the year ended
January 31, 1998, filed by Registrant on May 1, 1998, SEC File No. 000-11822).
10.11 Amendment No. 2 to Amended, Modified and Restated Master Lease Agreement, dated as of
July 11, 1996, between Jacksonville Funding Enterprises, LLC as Lessor and Michaels
Stores, Inc. as Lessee (previously filed as Exhibit 10.14 to Form 10-K for the year ended
January 31, 1998, filed by Registrant on May 1, 1998, SEC File No. 000-11822).
10.12 Amendment No. 3 to Amended, Modified and Restated Master Lease Agreement, dated as of
August 15, 1996, between Jacksonville Funding Enterprises, LLC as Lessor and Michaels
Stores, Inc. as Lessee (previously filed as Exhibit 10.15 to Form 10-K for the year ended
January 31, 1998, filed by Registrant on May 1, 1998, SEC File No. 000-11822).
10.13 Amendment No. 4 to Amended, Modified and Restated Master Lease Agreement and Waiver,
dated as of March 11, 1997, between Jacksonville Funding Corporation as Lessor and
Michaels Stores, Inc. as Lessee (previously filed as Exhibit 10.17 to Form 10-K for the
year ended February 1, 1997, filed by Registrant on May 2, 1997, SEC File No. 000-11822).
10.14 Consulting Agreement, dated as of October 1, 1996, between Michaels Stores, Inc. and
Michael C. French (previously filed as Exhibit 10.17 to Form 10-K for the year ended
January 31, 1998, filed by Registrant on May 1, 1998, SEC File No. 000-11822). *
10.15 Term Lease Master Agreement between IBM Credit Corporation as Lessor and Michaels Stores,
Inc. as Lessee (previously filed as Exhibit 10.18 to Form 10-K for the year ended
February 1, 1997, filed by Registrant on May 2, 1997, SEC File No. 000-11822).
10.16 Common Stock and Warrant Agreement, dated as of October 16, 1984, between Michaels
Stores, Inc. and Peoples Restaurants, Inc., including form of Warrant (previously filed
as Exhibit 4.2 to Form 10-K for the year ended January 31, 1993, filed by Registrant on
April 29, 1993, SEC File No. 000-11822).
10.17 First Amendment to Common Stock and Warrant Agreement, dated October 31, 1984, between
The First Dallas Group, Ltd. and Michaels Stores, Inc. (previously filed as Exhibit 4.3
to Form 10-K for the year ended January 31, 1993, filed by Registrant on April 29, 1993,
SEC File No. 000-11822).
43
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- ----------- -----------------------------------------------------------------------------------------
10.18 Second Amendment to Common Stock and Warrant Agreement, dated November 28, 1984, between
First Dallas Investments-Michaels I, Ltd. and Michaels Stores, Inc. (previously filed as
Exhibit 4.4 to Form 10-K for the year ended January 31,1993, filed by Registrant on April
29, 1993, SEC File No. 000-11822).
10.19 Third Amendment to Common Stock and Warrant Agreement, dated February 27, 1985, between
First Dallas Investments-Michaels I, Ltd., The First Dallas Group, Ltd., Sam Wyly,
Charles J. Wyly, Jr. and Michaels Stores, Inc. (previously filed as Exhibit 10.23 to Form
S-1 (No. 33-09456), filed by Registrant on October 14, 1986).
10.20 Amendment to Common Stock and Warrant Agreement, dated as of September 1, 1992, between
Michaels Stores, Inc. and the other parties named therein (previously filed as Exhibit
4.8 to Form S-8 (No. 33-54726), filed by Registrant on November 20, 1992).
10.21 Bonus Plan for Officers and Employees (Filed herewith).*
10.22 Employment Agreement, effective as of April 29, 1997, between Michaels Stores, Inc. and
R. Michael Rouleau (previously filed as Exhibit 10.32 to Form 10-K for the year ended
February 1, 1997 filed by Registrant on May 2, 1997, SEC File No. 000-11822).*
10.23 Michaels Stores, Inc. Stock Option Agreement, dated as of June 6, 1997, between Michaels
Stores, Inc. and R. Michael Rouleau (previously filed as Exhibit 99.1 to Form S-8 (No.
333-29417), filed by Registrant on June 17, 1997).*
10.24 Michaels Stores, Inc. 1997 Employees Stock Purchase Plan (previously filed as Exhibit
10.33 to Form 10-K for the year ended February 1, 1997, filed by Registrant on May 2,
1997, SEC File No. 000-11822).*
10.25 Michaels Stores, Inc. 1997 Stock Option Plan (previously filed as Exhibit 10.2 to Form
10-Q for quarter ended May 3, 1997, filed by Registrant on June 17, 1997, SEC File No.
000-11822).*
10.26 Revolving Credit Agreement, dated as of August 28, 1998, among Michaels Stores, Inc.,
BankBoston, N.A. and the other lenders named therein (previously filed as Exhibit 4 to
Form 10-Q for quarter ended August 1, 1998, filed by Registrant on September 15,1998, SEC
File No. 000-11822).*
10.27 Stock Purchase Agreement, dated as of March 29, 1996, between Michaels Stores, Inc. and
Quayle Limited (previously filed as Exhibit 4.7 to Form 10-K for the year ended January
28, 1996, filed by Registrant on April 29, 1996, SEC File No. 000-11822).
10.28 Stock Purchase Agreement, dated as of March 29, 1996, between Michaels Stores, Inc. and
Locke Limited (previously filed as Exhibit 4.8 to Form 10-K for the year ended January
28, 1996, filed by Registrant on April 29, 1996, SEC File No. 000-11822).
10.29 Stock Purchase Agreement, dated as of March 29, 1996, between Michaels Stores, Inc. and
Fugue Limited (previously filed as Exhibit 4.9 to Form 10-K for the year ended January
28, 1996, filed by Registrant on April 29, 1996, SEC File No. 000-11822).
44
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- ----------- -----------------------------------------------------------------------------------------
10.30 Option Agreement, dated as of December 23, 1996, between Michaels Stores, Inc. and
Devotion Limited (previously filed as Exhibit 10.28 to Form 10-K for the year ended
February 1, 1997, filed by Registrant on May 2, 1997, SEC File No. 000-11822).
10.31 Option Agreement, dated as of December 23, 1996, between Michaels Stores, Inc. and
Elegance Limited (previously filed as Exhibit 10.29 to Form 10-K for the year ended
February 1, 1997, filed by Registrant on May 2, 1997, SEC File No. 000-11822).
21.1 Subsidiaries of Michaels Stores, Inc. (Filed herewith).
23.1 Consent of Ernst & Young LLP (Filed herewith).
27.1 Financial Data Schedule (Filed herewith).
- ------------------------
* Management contract or compensatory plan or arrangement required to
be filed as an exhibit to this form pursuant to Item 14(c).
45