The Michaels Companies Announces Q2 Fiscal 2016 Results

OREANDA-NEWS. The Michaels Companies, Inc. (NASDAQ:MIK) today announced financial results for the second quarter ended July 30, 2016.

“We are pleased that our team delivered second quarter results within our expectations, despite a retail environment which continues to be choppy. As anticipated, the quarter was uniquely challenged by the impact of investments we are making to support our Vision 2020 strategy, including the integration of Lamrite West and initiatives to reduce long-term product acquisition costs, as well as the unfavorable timing of distribution expenses,” said Chuck Rubin, Chairman and Chief Executive Officer. “As we move into the second half of the year and into fiscal 2017, we expect to see the benefits of our strategic investments on sales and profitability.”

Second Quarter Highlights

• Net sales increased 7.7%, or 8.1% on a constant currency basis, to $1,060.4 million, from $984.3 million in the second quarter of fiscal 2015.  The increase was primarily a result of the acquisition of Lamrite West in February 2016 and sales from 17 additional stores (net of closures) during the quarter.  Comparable store sales increased 0.7%, or 1.0% on a constant currency basis, driven by an increase in customer transactions.
   
• Gross profit increased 4.7% to $390.7 million, from $373.3 million in the second quarter of fiscal 2015.  As a percentage of net sales, gross profit was 36.8% compared to 37.9% in the second quarter of fiscal 2015. The decrease, as a percentage of net sales, was due to the acquisition of Lamrite West, including the impact of Lamrite West’s wholesale business, which has a lower gross margin rate than the Michaels business; the timing of distribution expenses; a higher mix of sales from merchandise sold on promotion; and the timing of profit recognition for the product Michaels buys through Lamrite West.  The decrease was partially offset by improved sourcing and pricing efficiencies and $1.4 million of net non-recurring, inventory-related purchase accounting adjustments related to the acquisition of Lamrite West. 
   
• Selling, general and administrative expense, including store pre-opening costs, (“SG&A”) increased 9.7% to $303.6 million, from $276.7 million in the second quarter of fiscal 2015. As a percent of net sales, SG&A was 28.6%, compared to 28.1% in the second quarter of fiscal 2015. The increase in SG&A was primarily due to $17.4 million associated with the acquisition of Lamrite West, including: $1.9 million of integration expenses; expenses associated with operating 17 additional stores (net of closures); an unplanned credit card assessment of $2.9 million; and higher professional fees.  The increase was partially offset by lower in-store signage expense.  
   
• Operating income was $87.1 million, compared to $96.6 million in the second quarter of fiscal 2015.  As a percent of net sales, operating income was 8.2% compared to 9.8% in the second quarter of fiscal 2015.
   
• Interest expense decreased $2.4 million to $32.0 million, from $34.3 million in the second quarter of fiscal 2015 due to a voluntary principal payment of $150.0 million on the Restated Term Loan Credit Facility in the fourth quarter of fiscal 2015 and interest savings from the refinancing of the Restated Revolving Credit Facility.  The Company recorded a loss on the early extinguishment of debt of $0.4 million during the second quarter of fiscal 2016 related to the refinancing of the Restated Revolving Credit Facility in May 2016. The Company recorded a loss on the early extinguishment of debt of $6.1 million during the second quarter of fiscal 2015 related to the redemption of the PIK Notes in May 2015.
   
• The effective tax rate was 35.5% for the second quarter of fiscal 2016, compared to 36.6% for the second quarter of fiscal 2015. 
   
• Net income was $35.6 million, compared to $35.7 million in the second quarter of fiscal 2015. Diluted earnings per common share was $0.17, compared to $0.17 in the second quarter of fiscal 2015. 
   
• During the second quarter of fiscal 2016, the Company opened five new Michaels stores and two new Pat Catan’s stores and closed three Aaron Brothers stores, compared with nine new Michaels store openings in the second quarter of 2015. At the end of the second quarter, the Company operated 1,209 Michaels stores, 112 Aaron Brothers stores, and 35 Pat Catan’s stores.
   
• The Company ended the second quarter of fiscal 2016 with $114.8 million in cash, $2.8 billion in debt and $597.1 million in availability under its asset-based revolving credit facility.
   
• Inventory at the end of the second quarter increased $71.7 million, or 6.7%, to $1,145.4 million, compared to $1,073.7 million in the second quarter of fiscal 2015.  The increase in inventory was due to $96.2 million in additional inventory from the acquisition of Lamrite West.  Average Michaels inventory on a per store basis, inclusive of distribution centers, in transit and inventory for the Company’s e-commerce site, decreased 3.9% to $846,000, compared to $880,000 at the end of the second quarter of fiscal 2015.  This decrease in inventory per store was primarily a result of higher inventory in fiscal 2015 resulting from the early receipt of seasonal merchandise in an effort to mitigate the impact of West Coast port issues in early 2015.
   
• During the quarter, the Company purchased 2.4 million shares, or $67.6 million, under its share repurchase authorization. The total remaining authorization for future repurchases is approximately $73.1 million.  The share repurchase program does not have an expiration date, and the timing and number of repurchase transactions under the program will depend on market conditions, corporate considerations, debt agreements, and regulatory requirements.

Third Quarter and Fiscal Year 2016 Outlook:

Commenting on expectations for the rest of fiscal 2016, Mr. Rubin said, "Although sales growth in the first half of fiscal 2016 was more challenging than we anticipated, we believe that we continue to gain market share. We are excited about our plans to engage customers and drive traffic into our stores in the second half. However, we believe it is prudent to be conservative with our comparable store sales expectations for the rest of fiscal 2016 to reflect a continuation of the current retail environment. Our team continues to manage the business well against this backdrop, and we remain confident that the investments we are making, including our sourcing initiatives and our tax planning efforts related to the acquisition of Lamrite West, will help drive double-digit earnings growth for the year.”

For fiscal 2016, the Company expects:

• Comparable store sales to increase 1.0% to 1.5%; 
• Total net sales growth, including revenues from Lamrite West, of 6.8% to 7.8%;
• Approximately 1.3% sales growth from 23 net new store openings, including 3 new Pat Catan’s stores;
• Lamrite West to generate $225 million to $250 million in revenues;
• Adjusted operating income to be in the range of $750 million to $770 million, excluding approximately $14 million to $15 million of integration costs and net non-recurring, inventory-related purchase accounting entries;
• Annual interest expense to be approximately $129 million;
• The effective tax rate to be approximately 35.4%;
• Adjusted diluted earnings per common share to be between $1.92 and $1.98, based on diluted weighted average common shares of approximately 207 million; and
• Capital expenditures of between $125 million and $135 million.

For the third quarter of fiscal 2016, the Company expects:

• Comparable store sales growth of 0.5% to 1.5%;
• Approximately 13 net new store openings;
• Adjusted operating income of $160 million to $165 million;
• Interest expense to be approximately $32 million;
• The effective tax rate to be approximately 31.4%; and
• Adjusted diluted earnings per common share of $0.42 to $0.44, based on diluted weighted average common shares of 206 million. 

The outlook for fiscal 2016 includes approximately $0.01 of favorable earnings per share impact related to 2.4 million shares repurchased in the second quarter of fiscal 2016.

Conference Call Information

A conference call to discuss second quarter financial results is scheduled for today, August 25, 2016, at 8:00 am Central Time.  Analysts and investors who would like to join the conference call are encouraged to pre-register for the conference call using the following link: http://dpregister.com/10091269. Callers who pre-register will be given a conference call passcode and a unique PIN to gain immediate access to the call and bypass the live operator. Participants may pre-register at any time, including up to and after the call start time.  Investors without internet access or who are unable to pre-register can join the call by dialing (866) 777-2509 or (412)-317-5413.

The conference call will also be webcast at http://investors.michaels.com/. To listen to the live call, please go to the website at least 15 minutes before the call is scheduled to begin to register and download any necessary audio software. The webcast will be accessible for 30 days after the call.  Additionally, a telephone replay will be available until September 8, 2016, by dialing (877) 344-7529 or (412) 317-0088, access code 10091269.

Non-GAAP Information

This press release includes non-GAAP measures including Adjusted EBITDA, operating income excluding integration benefits and costs and non-recurring, inventory-related purchase accounting entries related to the acquisition of Lamrite West (“Adjusted operating income”), net income excluding integration benefits and costs and non-recurring, inventory-related purchase accounting entries related to the acquisition of Lamrite West (“Adjusted net income”), and earnings per share excluding integration benefits and costs and non-recurring, inventory-related purchase accounting entries related to the acquisition of Lamrite West (“Adjusted earnings per share”).  The Company has reconciled these non-GAAP financial measures with the most directly comparable GAAP financial measures in a table accompanying this release. The Company believes that these non-GAAP financial measures not only provide its management with comparable financial data for internal financial analysis but also provide meaningful supplemental information to investors. Specifically, these non-GAAP financial measures allow investors to better understand the performance of the Company's business and facilitate a meaningful evaluation of its quarterly and fiscal 2016 diluted earnings per common share and actual results on a comparable basis with its quarterly and fiscal 2015 results.  

In evaluating these non-GAAP financial measures, investors should be aware that in the future the Company may incur expenses or be involved in transactions that are the same as or similar to some of the adjustments in this presentation. The Company's presentation of non-GAAP financial measures should not be construed to imply that its future results will be unaffected by any such adjustments. The Company has provided this information as a means to evaluate the results of its ongoing operations. Other companies in the Company's industry may calculate these items differently than it does. Each of these measures is not a measure of performance under GAAP and should not be considered as a substitute for the most directly comparable financial measures prepared in accordance with GAAP. Non-GAAP financial measures have limitations as analytical tools, and investors should not consider them in isolation or as a substitute for analysis of the Company's results as reported under GAAP.

Forward-Looking Statements

This news release includes forward-looking statements which reflect management's current views and estimates regarding the Company's industry, business strategy, goals and expectations concerning its market position, future operations, margins, profitability, capital expenditures, share repurchases, liquidity and capital resources, and other financial and operating information. The words "anticipate", "assume", "believe", "continue", "could", "estimate", "expect", “forecast”, "future", “guidance”, “imply”, "intend", "may", “outlook”, "plan", "potential", "predict", "project", and similar terms and phrases are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. The Company cannot assure investors that future developments affecting the Company will be those that it has anticipated. Actual results may differ materially from these expectations due to risks relating to the effect of economic uncertainty, risks associated with our substantial outstanding indebtedness of $2.8 billion, changes in customer demand, risks relating to our failure to adequately maintain security and prevent unauthorized access to electronic and other confidential information, increased competition including internet-based competition from other retailers, risks relating to our reliance on foreign suppliers, risks relating to how well we manage our business, risks related to our ability to open new stores and increase comparable store sales growth, damage to the reputation of the Michaels brand or our private and exclusive brands, risks associated with executing or integrating an acquisition, a business combination or major business initiative, and other risks and uncertainties including those identified under the heading “Risk Factors” in the Company’s Form 10-K filed with the Securities and Exchange Commission ("SEC"), which is available at www.sec.gov, and other filings that the Company may make with the SEC in the future. If one or more of these risks or uncertainties materialize, or if any of the Company's assumptions prove incorrect, the Company's actual results may vary in material respects from those projected in these forward-looking statements. Any forward-looking statement made by the Company in this news release speaks only as of the date on which the Company makes it. Factors or events that could cause the Company's actual results to differ may emerge from time to time, and it is not possible for the Company to predict all of them. The Company does not undertake and specifically disclaims any obligation to publicly update any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by any applicable securities laws.

 

The Michaels Companies, Inc.
Consolidated Statements of Comprehensive Income
(Unaudited)
		13 Weeks Ended										26 Weeks Ended
		July 30,					August 1,					July 30,					August 1,
(in thousands, except per share data)		2016					2015					2016					2015
Net sales		$		1,060,353			$		984,270			$		2,219,233			$		2,061,870
Cost of sales and occupancy expense				669,656					610,949					1,363,785					1,246,752
Gross profit				390,697					373,321					855,448					815,118
Selling, general and administrative				302,712					275,699					620,512					571,270
Store pre-opening costs				908					1,040					2,534					3,284
Operating income				87,077					96,582					232,402					240,564
Interest expense				31,954					34,311					64,173					72,127
Losses on early extinguishments of debt and refinancing costs				405					6,072					405					6,072
Other (income) expense, net				(515	)				(136	)				(69	)				59
Income before income taxes				55,233					56,335					167,893					162,306
Provision for income taxes				19,616					20,624					61,511					59,857
Net income		$		35,617			$		35,711			$		106,382			$		102,449
Other comprehensive income, net of tax:
Foreign currency translation adjustment and other				(4,759	)				(7,223	)				9,450					(2,907	)
Comprehensive income		$		30,858			$		28,488			$		115,832			$		99,542
Earnings per common share:
Basic		$		0.17			$		0.17			$		0.51			$		0.49
Diluted		$		0.17			$		0.17			$		0.51			$		0.49
Weighted-average common shares outstanding:
Basic				205,881					206,941					206,437					206,283
Diluted				207,547					209,423					208,269					209,240
The following table sets forth the percentage relationship to net sales of each line item of our unaudited consolidated statements of comprehensive income:
			13 Weeks Ended										26 Weeks Ended
			July 30,					August 1,					July 30,					August 1,
				2016					2015					2016					2015
Net sales				100.0		%			100.0		%			100.0		%			100.0		%
Cost of sales and occupancy expense				63.2					62.1					61.5					60.5
Gross profit				36.8					37.9					38.5					39.5
Selling, general and administrative				28.5					28.0					28.0					27.7
Store pre-opening costs				0.1					0.1					0.1					0.2
Operating income				8.2					9.8					10.5					11.7
Interest expense				3.0					3.5					2.9					3.5
Losses on early extinguishments of debt and refinancing costs				—					0.6					—					0.3
Other (income) expense, net				—					—					—					—
Income before income taxes				5.2					5.7					7.6					7.9
Provision for income taxes				1.8					2.1					2.8					2.9
Net income				3.4		%			3.6		%			4.8		%			5.0		%

The Michaels Companies, Inc.
Consolidated Balance Sheets
(Unaudited)
		July 30,					January 30,					August 1,
(in thousands, except per share data)		2016					2016					2015*
ASSETS
Current Assets:
Cash and equivalents		$		114,849			$		409,391			$		70,368
Merchandise inventories				1,145,422					1,002,607					1,073,722
Prepaid expenses and other				77,472					77,000					75,027
Accounts receivable, net				26,920					9,484					8,217
Income tax receivables				42,676					1,231					53,499
Total current assets				1,407,339					1,499,713					1,280,833
Property and equipment, at cost				1,724,291					1,661,234					1,632,755
Less accumulated depreciation and amortization				(1,325,603	)				(1,282,727	)				(1,238,069	)
Property and equipment, net				398,688					378,507					394,686
Goodwill				119,074					94,290					94,290
Other intangible assets, net				23,703					471					505
Deferred income taxes				39,780					40,399					42,496
Other assets				12,387					9,897					6,059
Total assets		$		2,000,971			$		2,023,277			$		1,818,869
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current Liabilities:
Accounts payable		$		462,099			$		457,704			$		418,745
Accrued liabilities and other				347,349					377,606					349,777
Current portion of long-term debt				66,900					24,900					48,900
Income taxes payable				—					44,640					873
Total current liabilities				876,348					904,850					818,295
Long-term debt				2,735,187					2,744,942					2,902,099
Other liabilities				97,232					97,580					91,032
Total liabilities				3,708,767					3,747,372					3,811,426
Stockholders’ Deficit:
Common Stock, $0.06775 par value, 350,000 shares authorized; 205,824 shares issued and outstanding at July 30, 2016; 208,996 shares issued and outstanding at January 30, 2016; and 208,011 shares issued and outstanding at August 1, 2015				13,770					13,979					13,952
Additional paid-in-capital				493,096					592,420					577,104
Accumulated deficit				(2,202,056	)				(2,308,438	)				(2,568,901	)
Accumulated other comprehensive loss				(12,606	)				(22,056	)				(14,712	)
Total stockholders’ deficit				(1,707,796	)				(1,724,095	)				(1,992,557	)
Total liabilities and stockholders’ deficit		$		2,000,971			$		2,023,277			$		1,818,869
*Certain reclassifications of the amounts for fiscal 2015 have been made to conform to the presentation for fiscal 2016.

The Michaels Companies, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
		26 Weeks Ended
		July 30,					August 1,
(in thousands)		2016					2015*
Cash flows from operating activities:
Net income		$		106,382			$		102,449
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization				58,468					55,949
Share-based compensation				6,590					6,225
Debt issuance costs amortization				3,760					4,366
Accretion of long-term debt, net				(124	)				(66	)
Deferred income taxes				619					6,514
Losses on early extinguishments of debt and refinancing costs				405					6,072
Losses on disposition of property and equipment				35					—
Excess tax benefits from share-based compensation				(7,271	)				(12,952	)
Changes in assets and liabilities, excluding acquired net assets:
Merchandise inventories				(58,612	)				(115,198	)
Prepaid expenses and other				639					(2,875	)
Accounts receivable				4,858					4,534
Other assets				(445	)				(86	)
Accounts payable				(20,171	)				(19,546	)
Accrued interest				(5,045	)				89
Accrued liabilities and other				(35,091	)				(53,634	)
Income taxes				(78,816	)				(62,845	)
Other liabilities				(605	)				(2,067	)
Net cash used in operating activities				(24,424	)				(83,071	)
Cash flows from investing activities:
Additions to property and equipment				(38,395	)				(63,241	)
Acquisition of Lamrite West, net of cash acquired				(151,100	)				—
Net cash used in investing activities				(189,495	)				(63,241	)
Cash flows from financing activities:
Payment of PIK notes				—					(184,467	)
Payments on restated term loan credit facility				(12,450	)				(12,450	)
Borrowings on asset-based revolving credit facility				42,000					24,000
Payment of debt issuance costs				(3,048	)				—
Payment of dividends				(415	)				(443	)
Proceeds from stock options exercised				15,058					19,586
Excess tax benefits from share-based compensation				7,271					12,952
Common stock repurchased				(129,039	)				(19,822	)
Other financing activities				—					(971	)
Net cash used in financing activities				(80,623	)				(161,615	)
Net change in cash and equivalents				(294,542	)				(307,927	)
Cash and equivalents at beginning of period				409,391					378,295
Cash and equivalents at end of period		$		114,849			$		70,368
*Certain reclassifications of the amounts for fiscal 2015 have been made to conform to the presentation for fiscal 2016.

The Michaels Companies, Inc.
Summary of Operating Data
(Unaudited)
The following table sets forth certain of our unaudited operating data:
		13 Weeks Ended								26 Weeks Ended
		July 30,				August 1,				July 30,				August 1,
			2016				2015				2016				2015
Michaels stores:
Open at beginning of period			1,204				1,177				1,196				1,168
New stores			5				9				16				19
Relocated stores opened			4				3				10				13
Closed stores			—				—				(3	)			(1	)
Relocated stores closed			(4	)			(3	)			(10	)			(13	)
Michaels stores open at end of period			1,209				1,186				1,209				1,186
Aaron Brothers stores:
Open at beginning of period			115				118				117				120
Closed stores			(3	)			—				(5	)			(2	)
Aaron Brothers stores open at end of period			112				118				112				118
Pat Catan's stores:
Open at beginning of period			33				—				—				—
Acquired stores			—				—				32				—
New stores			2				—				3				—
Pat Catan's stores open at end of period			35				—				35				—
Total store count at end of period			1,356				1,304				1,356				1,304
Other Operating Data:
Average inventory per Michaels store (in thousands)1		$	846			$	880			$	846			$	880
Comparable store sales			0.7	%			1.6	%			0.8	%			0.9	%
Comparable store sales, at constant currency			1.0	%			2.9	%			1.2	%			2.1	%
1 The calculation of average inventory per Michaels store excludes our Aaron Brothers and Pat Catan's stores.

The Michaels Companies, Inc.
Reconciliation of Adjusted EBITDA (Excluding losses on early extinguishments of debt and refinancing costs)
(Unaudited)
		13 Weeks Ended										26 Weeks Ended
		July 30,					August 1					July 30,					August 1
(in thousands)		2016					2015					2016					2015
Net cash used in operating activities		$		(561	)		$		(11,194	)		$		(24,424	)		$		(83,071	)
Depreciation and amortization				(28,998	)				(28,004	)				(58,468	)				(55,949	)
Share-based compensation				(3,461	)				(3,505	)				(6,590	)				(6,225	)
Debt issuance costs amortization				(1,786	)				(2,089	)				(3,760	)				(4,366	)
Accretion of long-term debt, net				62					33					124					66
Deferred income taxes				(4,610	)				(1,410	)				(619	)				(6,514	)
Losses on early extinguishments of debt and refinancing costs				(405	)				(6,072	)				(405	)				(6,072	)
Losses on disposition of property and equipment				(3	)				—					(35	)				—
Excess tax benefits from share-based compensation				2,672					2,753					7,271					12,952
Changes in assets and liabilities				72,707					85,199					193,288					251,628
Net income				35,617					35,711					106,382					102,449
Interest expense				31,954					34,311					64,173					72,127
Losses on early extinguishments of debt and refinancing costs				405					6,072					405					6,072
Provision for income taxes				19,616					20,624					61,511					59,857
Depreciation and amortization				28,998					28,004					58,468					55,949
Interest income				(173	)				(57	)				(453	)				(180	)
EBITDA (Excluding losses on early extinguishments of debt and refinancing costs)				116,417					124,665					290,486					296,274
Adjustments:
Share-based compensation				3,461					3,505					6,590					6,225
Severance costs				174					302					920					1,162
Store pre-opening costs				939					1,047					2,568					3,310
Store remodel costs				71					1,167					(10	)				1,827
Foreign currency transaction (gains) losses				(388	)				14					548					(23	)
Store closing costs				1,054					332					2,152					(361	)
Lamrite integration costs				1,874					—					6,019					—
Other (a)				748					1,449					1,526					2,476
Adjusted EBITDA		$		124,350			$		132,481			$		310,799			$		310,890
(a) Other adjustments primarily relate to items such as moving and relocation expenses, franchise taxes, sign on bonuses, and certain legal expenses.

The Michaels Companies, Inc.
Reconciliation of GAAP basis to Adjusted operating income, Adjusted net income and Adjusted earnings per share
(Unaudited)
		13 Weeks Ended								26 Weeks Ended
		July 30,					August 1,			July 30,					August 1,
(In thousands, except per share)		2016					2015			2016					2015
Operating income		$		87,077			$	96,582		$		232,402			$	240,564
Add: Non-recurring, inventory-related purchase				(1,363	)			—				2,214				—
accounting adjustments (a)
Add: Non-recurring integration expenses (b)				1,874				—				6,019				—
Adjusted operating income		$		87,588			$	96,582		$		240,635			$	240,564
Net income		$		35,617			$	35,711		$		106,382			$	102,449
Add: Non-recurring, inventory-related purchase				(1,363	)			—				2,214				—
accounting adjustments (a)
Add: Non-recurring integration expenses (b)				1,874				—				6,019				—
Less tax adjustment for above add-backs (c)				(206	)			—				(3,200	)			—
Adjusted net income		$		35,922			$	35,711		$		111,415			$	102,449
Earnings per common share, diluted		$		0.17			$	0.17		$		0.51			$	0.49
Adjusted earnings per common share, diluted		$		0.17			$	0.17		$		0.53			$	0.49
(a) Excludes non-recurring, inventory-related purchase accounting adjustments related to the acquisition of Lamrite West.
(b) Excludes non-recurring integration expenses related to the acquisition of Lamrite West.
(c) Adjusts for the tax impact of integration costs and purchase accounting adjustments related to the acquisition of Lamrite West.