AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON AUGUST 1, 2001
REGISTRATION NO. 333-
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM S-4
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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MICHAELS STORES, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 5945 75-1943604
(State or Other Jurisdiction of (Primary Standard (I.R.S. Employer
Incorporation or Organization) Industrial Identification Number)
Classification Code Number)
8000 BENT BRANCH DRIVE
IRVING, TEXAS 75063
P.O. BOX 619566
DFW, TEXAS 75261-9566
(972) 409-1300
(Address, including zip code, and telephone number, including area code,
of registrant's principal executive offices)
BRYAN M. DECORDOVA
EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER
8000 BENT BRANCH DRIVE
IRVING, TEXAS 75063
(972) 409-1300
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
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COPIES TO:
Mark V. Beasley, Esq. Mark V. Minton, Esq.
Michaels Stores, Inc. Jones, Day, Reavis & Pogue
8000 Bent Branch Drive 2727 North Harwood Street
Irving, Texas 75063 Dallas, Texas 75201-1515
(972) 409-1300 (214) 220-3939
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable following the effective date of this registration statement.
If the securities being registered on this form are being offered in
connection with the formation of a holding company and there is compliance with
General Instruction G, check the following box. / /
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. / /
If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / /
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CALCULATION OF REGISTRATION FEE
PROPOSED MAXIMUM PROPOSED MAXIMUM
TITLE OF EACH CLASS OF AMOUNT TO OFFERING PRICE AGGREGATE AMOUNT OF
SECURITIES TO BE REGISTERED BE REGISTERED PER UNIT OFFERING PRICE REGISTRATION FEE
9 1/4% Senior Notes Due 2009......... $200,000,000(1) 100% $200,000,000 $50,000
(1) Represents the maximum principal amount at maturity of 9 1/4% Senior Notes
due 2009 that may be issued pursuant to the exchange offer described in this
registration statement.
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THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION, ACTING
PURSUANT TO SAID SECTION 8(A), MAY DETERMINE.
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The information in this prospectus is not complete. Michaels Stores, Inc. may
not sell or offer these securities until the registration statement filed with
the Securities and Exchange Commission is effective. This prospectus is not an
offer to sell these securities and Michaels Stores is not soliciting an offer to
buy these securities in any state where the offer or sale is not permitted.
SUBJECT TO COMPLETION, DATED AUGUST 1, 2001
PROSPECTUS
$200,000,000
[LOGO]
OFFER TO EXCHANGE
ALL OUTSTANDING 9 1/4% SENIOR NOTES DUE 2009
FOR 9 1/4% SENIOR NOTES DUE 2009
OF
MICHAELS STORES, INC.
THIS EXCHANGE OFFER WILL EXPIRE AT 5:00 P.M.,
NEW YORK CITY TIME, ON , 2001.
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The Exchange Notes
- The terms of the notes to be issued are substantially identical to the
outstanding notes that Michaels Stores issued on July 6, 2001, except for
transfer restrictions, registration rights and liquidated damages
provisions relating to the outstanding notes that will not apply to the
notes.
- Interest on the notes accrues at the rate of 9 1/4% per year, payable in
cash every six months on January 1 and July 1, with the first payment on
January 1, 2002.
- The notes are senior, unsecured obligations of Michaels Stores and rank
equally with our other senior indebtedness and are effectively
subordinated to the obligations of our subsidiaries.
Material Terms of the Exchange Offer
- Expires at 5:00 p.m., New York City time, on , 2001, unless
extended.
- The exchange offer is not subject to any condition other than that it must
not violate applicable law or any applicable interpretation of the Staff
of the Securities and Exchange Commission.
- All outstanding notes that are validly tendered and not validly withdrawn
will be exchanged for an equal principal amount of notes which are
registered under the Securities Act of 1933.
- Tenders of outstanding notes may be withdrawn at any time prior to the
expiration of the exchange offer.
- Michaels Stores will not receive any cash proceeds from the exchange
offer.
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PLEASE CONSIDER CAREFULLY THE "RISK FACTORS" BEGINNING ON PAGE 12 OF THIS
PROSPECTUS.
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NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED THE NOTES TO BE DISTRIBUTED IN THE EXCHANGE OFFER, NOR
HAVE ANY OF THESE ORGANIZATIONS DETERMINED THAT THIS PROSPECTUS IS ACCURATE OR
COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
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The date of this prospectus is , 2001.
REFERENCES TO ADDITIONAL INFORMATION
This prospectus incorporates important business and financial information
about Michaels Stores that is not included in or delivered with this prospectus.
You may obtain documents that are filed by Michaels Stores with the Securities
and Exchange Commission and incorporated by reference in this prospectus by
requesting the documents, in writing or by telephone, from the Securities and
Exchange Commission or:
Michaels Stores, Inc.
8000 Bent Branch Drive
Irving, Texas 75063
Attention: Investor Relations
Telephone: (972) 409-1300
If you would like to request copies of these documents, please do so by
, 2001 in order to receive them before the expiration of the
exchange offer. See "Where You Can Find More Information."
TABLE OF CONTENTS
Forward-Looking Statements.............. i
Where You Can Find More Information..... i
Incorporation of Certain Documents by
Reference............................. ii
Industry and Market Data................ ii
Summary................................. 1
Risk Factors............................ 12
Use of Proceeds......................... 18
Capitalization.......................... 18
Selected Consolidated Financial and
Operating Data........................ 19
Management's Discussion and Analysis of
Financial Condition and Results of
Operations............................ 21
Industry Overview....................... 29
Business................................ 30
Management.............................. 40
Description of Other Indebtedness....... 42
The Exchange Offer...................... 44
Description of the Notes................ 54
Plan of Distribution.................... 86
Legal Matters........................... 86
Experts................................. 86
Index to Consolidated Financial
Statements and Supplementary Data..... F-1
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FORWARD-LOOKING STATEMENTS
Some of our statements contained in this prospectus are forward-looking
statements that reflect our plans, estimates, and beliefs. Words such as
"anticipates," "plans," "estimates," "expects," "believes," and similar
expressions often identify forward-looking statements. Our actual results could
differ materially from those anticipated in these forward-looking statements as
a result of the risk factors set forth below and other factors set forth in or
incorporated by reference in this prospectus. These factors include:
- customer demand and trends in the arts and crafts industry,
- impact of competitor's locations, pricing and products,
- related inventory risks due to shifts in customer demand,
- impact of economic conditions,
- availability of acceptable locations for new stores,
- difficulties in implementing information system technologies,
- supply constraints,
- results of financing efforts, and
- effectiveness of advertising strategies.
All subsequent written and oral forward-looking statements attributable to
us and persons acting on our behalf are qualified in their entirety by the
cautionary statements contained in this section and elsewhere in this
prospectus. You should carefully review the risks detailed in "Risk Factors,"
which may also impact our forward-looking statements.
WHERE YOU CAN FIND MORE INFORMATION
We file periodic reports, proxy statements and other information with the
SEC in accordance with the requirements of the Securities and Exchange Act of
1934. Our filings with the SEC are available to the public over the Internet at
the SEC's web site at http://www.sec.gov. You may also read and copy any
document we file with the SEC at the SEC's Public Reference Room at 450 Fifth
Street, N.W., Room 1024, Washington, D.C. 20549. You may obtain information on
the operation of the Public
i
Reference Room by calling the SEC at 1-800-SEC-0330. You may also read copies of
reports, proxy statements and other documents at the offices of the Nasdaq
National Market at 1735 K Street, N.W., Washington, D.C. 20006.
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INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
We "incorporate by reference" into this prospectus the information we file
with the SEC, which means that we can disclose important information to you by
referring you to those documents. The information incorporated by reference is
an important part of this prospectus. Information we later file with the SEC
prior to the consummation of the offering under this prospectus will
automatically modify, update or supersede information in this prospectus, in an
amendment or supplement to this prospectus, or in a document incorporated or
deemed to be incorporated by reference herein. Any statement so modified,
updated, or superseded shall not be deemed, except as so modified, updated, or
superseded, to constitute a part of this prospectus. We incorporate by reference
the documents listed below and any filings we make with the SEC under Sections
13(a), 13(c), 14 or 15(d) of the Exchange Act after the date of this prospectus
and before the exchange of the exchange notes for the outstanding notes:
- our annual report on Form 10-K for the fiscal year ended February 3, 2001,
- our quarterly report on Form 10-Q for the fiscal quarter ended May 5,
2001,
- our current report on Form 8-K filed with the SEC on June 19, 2001,
- our current report on Form 8-K filed with the SEC on July 6, 2001,
- our current report on Form 8-K filed with the SEC on July 9, 2001, and
- our current report on Form 8-K filed with the SEC on July 27, 2001.
You may request a copy of these filings at no cost by writing to or
telephoning our Investor Relations Department at the following address:
Michaels Stores, Inc.
8000 Bent Branch Drive
Irving, Texas 75063
Telephone: (972) 409-1300
The information relating to Michaels Stores contained in this prospectus
should be read together with the information in the documents incorporated by
reference.
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INDUSTRY AND MARKET DATA
The industry and market data presented in this prospectus are inherently
estimates and are based upon third-party data, including information compiled by
the Hobby Industry Association, industry analysts, and reports filed by other
market participants with the SEC, discussions with our customers and suppliers,
and our own internal estimates. While we believe that these data are reasonable,
in some cases these data are based on our or others' estimates and cannot be
verified by us. Accordingly, readers are cautioned not to place undue reliance
on these industry and market data.
ii
SUMMARY
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY THE MORE DETAILED
INFORMATION INCLUDED ELSEWHERE OR INCORPORATED BY REFERENCE IN THIS PROSPECTUS.
YOU SHOULD READ THE MORE DETAILED INFORMATION AND CONSOLIDATED FINANCIAL
STATEMENTS AND THE RELATED NOTES APPEARING ELSEWHERE IN THIS PROSPECTUS AND
INCORPORATED BY REFERENCE INTO THIS PROSPECTUS. AS USED IN THIS PROSPECTUS, ALL
REFERENCES TO "MICHAELS STORES," "MICHAELS," "WE," "US" AND ALL SIMILAR
REFERENCES ARE TO MICHAELS STORES, INC., A DELAWARE CORPORATION, AND ITS
CONSOLIDATED SUBSIDIARIES, UNLESS OTHERWISE EXPRESSLY STATED OR THE CONTEXT
OTHERWISE REQUIRES. OUR FISCAL YEAR INCLUDES 52 OR 53 WEEKS AND ENDS ON THE
SATURDAY CLOSEST TO JANUARY 31. REFERENCES TO FISCAL YEAR MEAN THE YEAR IN WHICH
THAT FISCAL YEAR BEGAN. OUR FISCAL YEAR 1996 ENDED ON FEBRUARY 1, 1997 AND
FISCAL YEAR 2000 ENDED ON FEBRUARY 3, 2001 AND EACH CONTAINED 53 WEEKS. OUR
FISCAL YEAR 1997 ENDED ON JANUARY 31, 1998, FISCAL YEAR 1998 ENDED ON
JANUARY 30, 1999 AND FISCAL YEAR 1999 ENDED ON JANUARY 29, 2000 AND EACH
CONTAINED 52 WEEKS.
MICHAELS STORES, INC.
We are the largest national specialty retailer providing materials, ideas,
and education for creative activities in home decor, art, and craft projects. As
of May 5, 2001, we operate 644 Michaels retail stores in 48 states, as well as
Canada and Puerto Rico, averaging 18,100 square feet of selling space. Through
our Michaels stores, we offer more than 40,000 stock keeping units, or SKUs,
including:
- products for the do-it-yourself home decorator, including picture framing
materials and custom framing services, silk and dried floral products, and
seasonal decor items,
- art supplies, including memory books, surfaces and pads, brushes, paints,
adhesives, and finishes, and
- craft supplies, including beads, jewelry, needlework and knitting
supplies, and kids' craft materials.
In addition, through Aaron Brothers, our wholly-owned subsidiary, we operate
123 stores, averaging 5,900 square feet of selling space as of May 5, 2001.
Through our Aaron Brothers stores, we offer an average of 7,900 SKUs including
photo frames, a full line of ready-made frames, custom framing services, and a
wide selection of art supplies.
For the latest 53 weeks ended May 5, 2001, we generated approximately
$2.3 billion in revenues and approximately $215.9 million in Adjusted EBITDA,
which excludes the effects of unusual, non-recurring charges.
Since 1996, under the leadership of Michael Rouleau, our President and Chief
Executive Officer, we have improved profitability while experiencing significant
growth, resulting in an improvement in Adjusted EBITDA margins from 4.6% in
fiscal 1996 to 9.7% in fiscal 2000. Through June 2, 2001, we reported 28 months
of consecutive comparable store sales growth. Our performance has been the
result of a variety of initiatives, including:
- chain-wide installation of a point-of-sale, or POS, system to record
item-level sales,
- implementation of plan-o-grams for increased coordination and
centralization, including elimination of non-core merchandise,
- reduction of costs through centralized negotiated pricing,
- development and use of a new store prototype and store opening process,
- increased SKUs replenished from Michaels distribution centers thereby
decreasing direct shipments from suppliers, which lowers our overall
inventory costs and improves store merchandise in-stock position, and
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- strengthening the quality and depth of our management team.
INDUSTRY
As the leading specialty retailer providing materials, ideas, and education
for creative activities in home decor, art, and craft projects, we believe that
we are well positioned to benefit from several favorable consumer trends. Based
on our historical sales trends, we believe demographic changes, particularly an
aging baby boomer population, and a favorable economic environment have led to
increases in investment in the home and purchases of new homes, an increasing
focus on home-based, family activities, and the trend towards making, rather
than buying, gift items. According to the most recently published industry
study, a 1997 report by the Hobby Industry Association, 65% of United States
households surveyed had at least one member who engaged in a craft activity
within the prior year. We compete across several industries in addition to arts
and crafts, including home decor, party supplies, candles, photo frames, and
custom framing. For example, approximately 46% of our sales are derived from
three decorative categories--silk and dried flowers, picture framing, and
seasonal products. When this broader focus is considered, a recently published
research report estimates the markets in which our products are sold at over
$30 billion.
COMPETITIVE STRENGTHS
We believe that we have the following competitive strengths within our industry:
- CATEGORY LEADER IN A FRAGMENTED INDUSTRY. The market in which we compete
is highly fragmented and is comprised of thousands of stores nationwide
operated primarily by small, independent retailers. We are the largest and
only national specialty retailer dedicated to serving the arts and crafts
market. We believe that there are only four other major specialty arts and
crafts retailers in the United States and Canada with annual sales in
excess of $200 million. Moreover, we believe that our fiscal 2000 sales
were more than twice as large as those of our largest direct competitor.
- STRONG BRAND NAMES AND LOYAL CUSTOMER BASE. Our Michaels and Aaron
Brothers brand names are identified with arts and crafts and custom
framing throughout our market areas in the United States and Canada. From
fiscal 1996 through fiscal 2000, we have spent approximately
$414.4 million on advertising, which has strengthened and reinforced our
brand names. Additionally, our strong brand names enhance our ability to
open new stores economically as our target customers are generally
familiar with us. Through our broad, in-stock product assortments,
friendly, knowledgeable and well-trained sales associates, educational
in-store events, project instruction displays, MICHAELS CREATE! magazine,
and our Internet site, www.michaels.com, we offer an interactive shopping
experience. As a result, we have built a loyal customer base of arts and
crafts enthusiasts.
- SIGNIFICANT PURCHASING POWER AND LIMITED VENDOR CONCENTRATION. We purchase
merchandise from over 1,400 suppliers. We believe that our buying power
enables us to acquire products on favorable terms. Centralized
merchandising management teams for Michaels and Aaron Brothers negotiate
with vendors on behalf of all their stores to obtain the lowest net
merchandise costs and improve control over product mix and inventory. In
fiscal 2000, our top 10 vendors accounted for approximately 19% of total
purchases with no single vendor accounting for more than 4% of total
purchases.
- POS AND REORDERING SYSTEMS. Each of our stores is supported by our POS and
reordering systems. Our POS systems provide us with valuable data
regarding sales trends that permit us to adjust our merchandise ordering
in response to customer demands. We intend to use this information to
further track customer spending habits and product correlations. Our
Michaels stores' reordering system utilizes in-store radio frequency, or
RF, guns, which provide per item historical
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sales trend feedback to facilitate the reordering process. In addition, RF
guns are connected to our distribution centers allowing for easy and
accurate merchandise reordering. Our Aaron Brothers stores utilize a
perpetual inventory and automated replenishment system. These in-store
technologies are closely integrated with our distribution centers, which
utilize computerized warehouse management systems and radio frequency
terminals.
- FAVORABLE REAL ESTATE. We believe our stores' locations in high-traffic
"power centers" is integral to our success. We generally obtain store
sites in shopping centers with other nationally recognized retailers that
draw similar customer demographics as our stores. As market demographics
change, we often relocate stores to remain in high-traffic areas.
- HIGHLY EXPERIENCED MANAGEMENT TEAM WITH A PROVEN TRACK RECORD. Our
management team is composed of seasoned retail executives, with an average
of more than 30 years of retail industry experience among our senior
management team. Our management team has achieved consistent growth and
profitability over the past four years. From fiscal 1996 through fiscal
2000, our sales and Adjusted EBITDA have grown at a compound annual rate
of 13.0% and 36.5%, respectively.
BUSINESS STRATEGY
We intend to increase our revenues and profits by strengthening our position
as the leading national retailer within the arts and crafts and home decor
sector through the following strategies:
- INCREASE SALES AND PRODUCTIVITY OF MICHAELS STORES. Our Michaels stores
that have been open for more than 12 months currently average
$3.5 million in sales per store. We believe we can increase average sales
per store to $5.0 million. We intend to achieve this objective by
increasing the dollar amount per sale and by creating additional demand
for our products.
- INCREASING DOLLAR AMOUNT PER SALE. We believe if a customer
consistently finds the desired product in-stock, the customer will
view Michaels stores as a store-of-choice and purchase additional
merchandise while in the store. We intend to enhance each store's
in-stock position of key merchandise by improving our supply chain.
Our distribution centers allow us to leverage our price negotiations
with our suppliers by ordering significant quantities, while also
providing us the ability to break large orders into smaller
quantities to allow for a timely and economical response to stores'
in-stock demands. Through our distribution initiatives in fiscal 2001
and 2002, we will add distribution capacity of 1.1 million square
feet to our existing 1.8 million square feet. We are also testing a
perpetual inventory system, with an expected roll-out starting in
fiscal 2002, to further enhance our capability to monitor and manage
our in-store inventories.
- CREATING ADDITIONAL DEMAND FOR OUR PRODUCTS. We are currently
targeting increased demand for our products through traditional
retail and advertising and multimedia channels. We are implementing
this strategy by:
u holding in-store classes, demonstrations, and other educational
events utilizing merchandise available in our stores,
u promoting craft ideas and projects in our recently launched
bi-monthly MICHAELS CREATE! magazine, which has become the second
most popular arts and crafts publication in its debut issue. The
magazine will be carried by other major retailers, including
K-mart and Target,
u promoting craft ideas on our www.michaels.com website, and
u participating in industry-wide promotion campaigns.
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- ENHANCE MERCHANDISE OPERATING MARGINS. We intend to enhance operating
margins through additional leverage of our consolidated purchasing
activities. We plan to leverage our technology systems to improve margins
on seasonal products through our implementation of allocation technologies
that more efficiently allocate merchandise among stores, and to maximize
margins on promotional sales by determining more accurately the most
profitable promotional price for each product. We continue to seek
value-added opportunities to complement our core businesses, such as our
recent expansion into art prints and Michaels-manufactured framing
products, which extends and enhances our custom framing business. In
addition, we continue to evaluate opportunities to further reduce our
merchandise costs and ensure adequate supplies through vertical
integration.
- GROW THROUGH NEW MICHAELS STORE OPENINGS. We believe the United States and
Canadian markets can support up to 1,100 Michaels stores. We plan to open
approximately 75 new Michaels stores each year beginning in fiscal 2001
and extending into the foreseeable future, funded primarily through
operating earnings and seasonal borrowings. Since the beginning of fiscal
1998, we have opened or relocated 268 Michaels stores using our
standardized opening procedures, which contain more than 500 steps to
ensure a smooth opening with a merchandise assortment and presentation
consistent with our existing stores. We have developed and are refining
our Michaels store prototype to constantly incorporate improved
merchandising techniques and store layouts.
- EXPAND AARON BROTHERS NATIONWIDE. We plan to open approximately 20 new
Aaron Brothers stores in fiscal 2001, also funded primarily through
operating earnings and seasonal borrowings. Assuming successful openings
in new markets, we plan to roll out this concept nationwide and open 25 to
75 new Aaron Brothers stores per year in each of the subsequent three
fiscal years. We believe the United States and Canadian markets can
support up to 600 Aaron Brothers stores.
RECENT EVENTS
In May 2001, we entered into a new senior unsecured bank credit facility,
which replaced our previous $100 million senior unsecured bank credit facility.
Our new bank credit facility provides for a $200 million revolving line of
credit with a $25 million competitive bid loan feature and a $70 million letter
of credit sub-facility. See "Description of Other Indebtedness."
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Our principal executive offices are located at 8000 Bent Branch Drive,
Irving, Texas 75063. Our telephone number is (972) 409-1300. Our website address
is www.michaels.com. Information on our website is not part of this prospectus.
4
THE EXCHANGE OFFER
The Exchange Offer................... Michaels Stores offers to exchange $200.0 million in
principal amount of its 9 1/4% Senior Notes due July 1,
2009, which have been registered under the federal
securities laws, for $200.0 million principal amount of its
outstanding unregistered 9 1/4% Senior Notes due July 1,
2009 which Michaels Stores issued on July 6, 2001 in a
private offering. You have the right to exchange your
outstanding notes for exchange notes with substantially
identical terms.
In order for your outstanding notes to be exchanged, you
must properly tender them prior to the expiration of the
exchange offer. All outstanding notes that are validly
tendered and not validly withdrawn will be exchanged.
Michaels Stores will issue the exchange notes on or promptly
after the expiration of the exchange offer.
Registration Rights Agreement........ Michaels Stores sold the outstanding notes on July 6, 2001
to a limited number of initial purchasers. At that time,
Michaels Stores signed a registration rights agreement with
those initial purchasers, which requires Michaels Stores to
conduct this exchange offer. This exchange offer is intended
to satisfy those rights set forth in the registration rights
agreement. After the exchange offer is complete, you will no
longer be entitled to registration rights with respect to
outstanding notes you do not exchange.
If You Fail to Exchange Your
Outstanding Notes.................. If you do not exchange your outstanding notes for exchange
notes in the exchange offer, you will continue to be subject
to the restrictions on transfer provided in the outstanding
notes and the indenture governing those notes. In general,
you may not offer or sell your outstanding notes unless they
are registered under the federal securities laws or are sold
in a transaction exempt from or not subject to the
registration requirements of the federal securities laws and
applicable state securities laws.
Expiration Date...................... The exchange offer will expire at 5:00 p.m., New York City
time, on , 2001 unless Michaels Stores decides to
extend the expiration date. See "The Exchange
Offer--Expiration Date; Extensions; Amendments."
Conditions to the Exchange
Offer.............................. The exchange offer is subject to conditions which Michaels
Stores may waive. The exchange offer is not conditioned upon
any minimum amount of outstanding notes being tendered for
exchange. See "The Exchange Offer--Conditions."
Michaels Stores reserves the right, subject to applicable
law, at any time and from time to time:
- to delay the acceptance of the outstanding notes;
5
- to terminate the exchange offer if specified
conditions have not been satisfied;
- to extend the expiration date of the exchange offer
and retain all tendered outstanding notes subject to the
right of tendering holders to withdraw their tender of
outstanding notes; and
- to waive any condition or otherwise amend the terms of
the exchange offer in any respect. See "The Exchange
Offer--Expiration Date; Extensions; Amendments."
Procedures for Tendering Notes....... If you wish to tender your outstanding notes for exchange,
you must:
- complete and sign the enclosed letter of transmittal
by following the related instructions; and
- send the letter of transmittal, as directed in the
instructions, together with any other required
documents, to the exchange agent, either (1) with the
outstanding notes to be tendered or (2) in compliance
with the specified procedures for guaranteed delivery
of the outstanding notes.
Brokers, dealers, commercial banks, trust companies and
other nominees may also effect tenders by book-entry
transfer.
Please do not send your letter of transmittal or
certificates representing your outstanding notes to Michaels
Stores. Those documents should only be sent to the exchange
agent. Questions regarding how to tender and requests for
information should be directed to the exchange agent. See
"The Exchange Offer--Exchange Agent."
Special Procedures for
Beneficial Owners.................. If your outstanding notes are registered in the name of a
broker, dealer, commercial bank, trust company or other
nominee, Michaels Stores urges you to contact that person
promptly if you wish to tender your outstanding notes
pursuant to the exchange offer. See "The Exchange
Offer--Procedures for Tendering."
Withdrawal Rights.................... You may withdraw the tender of your outstanding notes at any
time prior to the expiration date of the exchange offer by
delivering a written notice of your withdrawal to the
exchange agent. You must also follow the withdrawal
procedures as described under the heading "The Exchange
Offer--Withdrawal of Tenders."
Resale of Exchange Notes............. Michaels Stores believes that you will be able to offer for
resale, resell or otherwise transfer exchange notes issued
in the exchange offer without compliance with the
registration and prospectus delivery provisions of the
federal securities laws, provided that:
- you are acquiring the exchange notes in the ordinary
course of business;
6
- you are not participating, and have no arrangement or
understanding with any person to participate, in the
distribution of the exchange notes; and
- you are not an affiliate of Michaels Stores. An
affiliate of Michaels Stores is a person that "controls
or is controlled by or is under common control with"
Michaels Stores.
Michaels Stores' belief is based on interpretations by the
Staff of the SEC, as set forth in no-action letters issued
to third parties unrelated to Michaels Stores. The Staff has
not considered this exchange offer in the context of a
no-action letter, and Michaels Stores cannot assure you that
the Staff would make a similar determination with respect to
this exchange offer.
If Michaels Stores' belief is not accurate and you transfer
an exchange note without delivering a prospectus meeting the
requirements of the federal securities laws or without an
exemption from these laws, you may incur liability under the
federal securities laws. Michaels Stores does not and will
not assume or indemnify you against this liability.
Each broker-dealer that receives exchange notes for its own
account in exchange for outstanding notes which were
acquired by such broker-dealer as a result of market-making
or other trading activities must agree to deliver a
prospectus meeting the requirements of the federal
securities laws in connection with any resale of the
exchange notes. See "The Exchange Offer--Resale of the
Exchange Notes."
Exchange Agent....................... The exchange agent for the exchange offer is The Bank of New
York. The address, telephone number and facsimile number of
the exchange agent are set forth in "The Exchange
Offer--Exchange Agent" and in the letter of transmittal.
See "The Exchange Offer" for more detailed information
concerning the exchange offer.
THE EXCHANGE NOTES
Exchange Notes....................... $200.0 million principal amount of Michaels Stores' 9 1/4%
Senior Notes due July 1, 2009.
Interest Payment Dates............... January 1 and July 1, beginning on January 1, 2002.
Ranking.............................. The exchange notes will not be secured debt of Michaels
Stores and the exchange notes will rank equally with our
senior indebtedness and will be effectively subordinated to
the obligations of our subsidiaries.
7
As of May 5, 2001, after giving effect to the offering of
the notes and the use of proceeds from the outstanding notes
to redeem our 10 7/8% senior notes due 2006, we would have
had $200.6 million of senior debt outstanding and, except
for the guarantee by Aaron Brothers of our bank credit
facility, our subsidiaries would have had no debt
outstanding. We have no subordinated indebtedness except for
intercompany debt.
Optional Redemption.................. We may redeem some or all of the notes at any time on or
after July 1, 2005, at the redemption prices described in
this prospectus.
Public Equity Offering Optional
Redemption......................... Before July 1, 2004, we may redeem up to 35% of the
aggregate principal amount of the notes with the net
Redemption proceeds of one or more public equity offerings
at 109.25% of the principal amount of the notes, plus
accrued interest, if at least 65% of the aggregate principal
amount of the notes originally issued remains outstanding
after the redemption.
Change of Control.................... When a change of control occurs, each holder of notes may
require us to repurchase some or all of its notes at a
purchase price equal to 101% of the principal amount of the
notes, plus accrued interest.
Covenants............................ The indenture governing the notes contains covenants that,
among other things, limits our ability, and the ability of
our restricted subsidiaries, to:
- incur additional indebtedness,
- make restricted payments,
- create certain liens or enter into sale and leaseback
transactions,
- issue or sell preferred stock of our restricted
subsidiaries,
- sell assets,
- restrict dividend or other payments to us,
- engage in transactions with affiliates, and
- consolidate, merge or transfer all or substantially
all of our assets and the assets of our subsidiaries on
a consolidated basis.
These covenants are subject to important exceptions and
qualifications, which are described under the heading
"Description of the Notes."
To the extent we achieve and maintain investment grade
ratings on the notes, many of these covenants will no longer
be in effect.
8
See "The Exchange Notes" for more detailed information
concerning the exchange notes.
Risk Factors......................... See "Risk Factors" and the other information in this
prospectus for a discussion of factors you should carefully
consider.
Use of Proceeds...................... We will not receive any cash proceeds from the issuance of
the exchange notes.
9
SUMMARY CONSOLIDATED FINANCIAL AND OPERATING DATA
The results of operations, balance sheet and other financial data below for
fiscal years 1996, 1997, 1998, 1999 and 2000 has been derived from our audited
consolidated financial statements and related notes. Audited consolidated
financial statements as of January 29, 2000 and February 3, 2001 and for each of
the three fiscal years ended February 3, 2001 appear elsewhere in this
prospectus. References to fiscal year mean the year in which that fiscal year
began. Our fiscal year 1996 ended on February 1, 1997 and fiscal year 2000 ended
on February 3, 2001 and each contained 53 weeks. Our fiscal year 1997 ended on
January 31, 1998, fiscal year 1998 ended on January 30, 1999 and fiscal year
1999 ended on January 29, 2000 and each contained 52 weeks. The results of
operations, balance sheet and other financial data below for the 13 weeks ended
April 29, 2000 and May 5, 2001 and for the 53 weeks ended May 5, 2001 is derived
from our unaudited financial statements and reflects only normal recurring
adjustments and other items as disclosed in the footnotes to this summary which,
in the opinion of our management, are necessary for the fair presentation of
this information. You should not expect the consolidated results of operations
data, other financial data or other operating data of interim periods to be an
indication of results for a full year. You should read the following information
together with our consolidated financial statements and related notes included
elsewhere in this prospectus and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" in this prospectus.
FISCAL YEAR
--------------------------------------------------------------
1996(1) 1997 1998 1999(2) 2000(3)
---------- ---------- ---------- ---------- ----------
(IN THOUSANDS EXCEPT PER SHARE AND STORE DATA)
RESULTS OF OPERATIONS
DATA:
Net sales(5)............ $1,378,277 $1,456,524 $1,573,965 $1,882,522 $2,249,440
Operating income
(loss)................ (20,987) 68,942 89,112 122,672 148,417
Interest expense........ 21,038 23,448 22,678 22,654 18,026
Net income (loss)....... (31,233) 30,077 43,601 62,301 78,589
Diluted earnings (loss)
per common share...... (1.35) 1.05 1.43 2.01 2.29
BALANCE SHEET DATA:
Cash and equivalents.... $ 59,069 $ 162,283 $ 96,124 $ 77,398 $ 28,191
Merchandise
inventories........... 351,208 385,580 501,239 615,065 663,700
Total current assets.... 437,543 573,183 621,928 722,987 729,816
Total assets............ 784,435 908,494 962,650 1,096,703 1,158,436
Working capital......... 239,812 358,691 391,227 452,011 440,808
Long-term debt(6)....... 238,608 234,889 230,896 224,635 125,145
Total debt.............. 242,823 239,551 236,869 230,988 125,876
Total liabilities....... 451,633 466,583 481,671 529,905 453,790
Stockholders' equity.... 332,802 441,911 480,979 566,798 704,646
OTHER FINANCIAL DATA:
Ratio of earnings to
fixed charges(7)...... -- (8) 1.8x 2.0x 2.2x 2.4x
Cash flow from operating
activities............ $ 29,749 $ 77,907 $ 6,038 $ 60,770 $ 146,758
Cash flow from investing
activities............ (32,312) (38,988) (59,567) (90,759) (120,084)
Cash flow from financing
activities............ 58,762 64,295 (12,630) 11,263 (75,881)
EBITDA(9)............... 21,694 117,589 143,255 184,251 218,042
EBITDA margin(10)....... 1.6% 8.1% 9.1% 9.8% 9.7%
Adjusted EBITDA(11)..... $ 62,887 $ 117,589 $ 143,255 $ 185,751 $ 218,042
Adjusted EBITDA
margin(12)............ 4.6% 8.1% 9.1% 9.9% 9.7%
Total rental expense.... $ 92,293 $ 96,320 $ 109,251 $ 129,547 $ 157,824
OTHER OPERATING DATA:
Average net sales per
Michaels store(13).... $ 2,919 $ 3,122 $ 3,095 $ 3,310 $ 3,513
Comparable store sales
increase
(decrease)(14)........ (1)% 6% 1% 7% 5%
Total selling square
footage............... 7,821 8,082 8,981 10,411 12,063
13 WEEKS ENDED
----------------------- 53 WEEKS ENDED
APRIL 29, MAY 5, MAY 5,
2000(3) 2001(4) 2001(4)
---------- ---------- ---------------
(IN THOUSANDS EXCEPT PER SHARE AND STORE DATA)
RESULTS OF OPERATIONS
DATA:
Net sales(5)............ $ 474,152 $ 524,720 $2,300,008
Operating income
(loss)................ 21,338 16,084 143,163
Interest expense........ 5,520 3,778 16,284
Net income (loss)....... 8,230 7,289 77,648
Diluted earnings (loss)
per common share...... 0.25 0.22 2.26
BALANCE SHEET DATA:
Cash and equivalents.... $ 99,300 $ 21,365 $ 21,365
Merchandise
inventories........... 641,857 744,701 744,701
Total current assets.... 772,898 801,155 801,155
Total assets............ 1,147,645 1,234,718 1,234,718
Working capital......... 495,786 453,380 453,380
Long-term debt(6)....... 223,545 125,068 125,068
Total debt.............. 229,510 154,829 154,829
Total liabilities....... 535,635 514,327 514,327
Stockholders' equity.... 612,010 720,391 720,391
OTHER FINANCIAL DATA:
Ratio of earnings to
fixed charges(7)...... 1.7x 1.5x 2.4x
Cash flow from operating
activities............ $ 9,091 $ (24,825) $ 112,842
Cash flow from investing
activities............ (17,196) (19,027) (121,915)
Cash flow from financing
activities............ 30,007 37,026 (68,862)
EBITDA(9)............... 38,810 32,630 211,862
EBITDA margin(10)....... 8.2% 6.2% 9.2%
Adjusted EBITDA(11)..... $ 38,810 $ 36,702 $ 215,934
Adjusted EBITDA
margin(12)............ 8.2% 7.0% 9.4%
Total rental expense.... $ 36,008 $ 42,794 $ 164,610
OTHER OPERATING DATA:
Average net sales per
Michaels store(13).... N/A N/A $ 3,537
Comparable store sales
increase
(decrease)(14)........ 7% 3% 4%
Total selling square
footage............... 10,769 12,401 12,401
(CONTINUED ON FOLLOWING PAGE)
10
13 WEEKS ENDED
FISCAL YEAR -----------------------
-------------------------------------------------------------- APRIL 29, MAY 5,
1996 1997 1998 1999 2000 2000 2001
---------- ---------- ---------- ---------- ---------- ---------- ----------
STORES OPEN AT END OF
PERIOD:
Michaels................ 453 452 496 559 628 585 644
Aaron Brothers.......... 72 74 78 95 119 97 123
Star Wholesale.......... -- -- -- -- 1 -- 1
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total stores open at end
of period............. 525 526 574 654 748 682 768
========== ========== ========== ========== ========== ========== ==========
53 WEEKS ENDED
MAY 5,
2001
---------------
STORES OPEN AT END OF
PERIOD:
Michaels................ 644
Aaron Brothers.......... 123
Star Wholesale.......... 1
----------
Total stores open at end
of period............. 768
==========
------------------------------
(1) Operating loss in fiscal 1996 includes the effect of an unusual pre-tax
charge of $41.2 million for costs associated with the 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.
(2) Operating income for fiscal 1999 includes a $1.5 million charge for the
settlement of litigation.
(3) Net income and diluted earnings per common share in fiscal 2000 include the
cumulative effect of a change in accounting principle related to
recognizing sales of custom frames, net of tax, in the amount of
$1.9 million, or $0.06 per diluted share.
(4) Operating income for the 13 weeks and for the 53 weeks ended May 5, 2001
includes a $3.2 million charge for the settlement of litigation and a
$1.0 million charge relating to executive severance costs.
(5) Net sales represents gross sales less returns.
(6) Long-term debt includes the long-term portion of capital lease obligations,
convertible subordinated notes which we redeemed in June 2000, and our
10 7/8% senior notes due 2006 in the amount of $125 million, which we have
called for redemption. In connection with the redemption of the 10 7/8%
senior notes due 2006, we will incur an estimated after-tax extraordinary
loss of $5.3 million in the third quarter of fiscal 2001.
(7) For purposes of calculating the ratio of earnings to fixed charges,
earnings consist of income (loss) before income taxes for such period plus
fixed charges deducted in calculating income (loss) before income taxes for
such period. Fixed charges consist of interest incurred, amortization of
deferred financing fees and an amount representing the interest factor
included in rental expense.
(8) Earnings were insufficient to cover fixed charges in fiscal 1996. The
deficiency for fiscal 1996 was $41.1 million.
(9) EBITDA is calculated as income (loss) 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, but is not a financial measurement recognized by generally accepted
accounting principles, and therefore, may not be comparable to similarly
titled measures used by other entities. EBITDA should not be considered by
an investor as an alternative to net income as an indicator of our
operating performance, or as an alternative to cash flow as a measure of
liquidity.
(10) EBITDA margin is calculated as EBITDA, as defined above, divided by net
sales.
(11) Adjusted EBITDA is calculated as income (loss) before income taxes plus
interest, depreciation, amortization, and unusual, non-recurring charges.
Adjusted EBITDA for fiscal 1996 excludes the effect of an unusual pretax
charge of $41.2 million for costs associated with the 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. Adjusted EBITDA for fiscal 1999 excludes the effect of an
unusual $1.5 million pretax charge for the settlement of litigation
between us and a competitor. Adjusted EBITDA for the 13 and 53 weeks ended
May 5, 2001 excludes the effect of a $3.2 million pretax charge for the
settlement of litigation and a $1.0 million pretax charge for executive
severance.
(12) Adjusted EBITDA margin is calculated as Adjusted EBITDA, as defined above,
divided by net sales.
(13) The calculation of average net sales per Michaels store only includes
sales for stores open for the full 12 months.
(14) Comparable store sales increase (decrease) represents the increase or
decrease in net sales for stores open the same number of months in the
indicated and comparable period of the previous year, including stores
that were relocated or expanded during either period adjusted for unusual
circumstances year over year such as inclement weather, natural disasters
and other adjustments. A store is deemed to become comparable in its 14th
full month of operation. The calculation of comparable store sales
increases or decreases excludes the effect of deferring the recognition of
custom frame sales for orders that have not been picked up by the customer
at the end of the period.
11
RISK FACTORS
YOU SHOULD CAREFULLY CONSIDER THE RISK FACTORS DESCRIBED BELOW, TOGETHER
WITH THE OTHER INFORMATION INCLUDED IN THIS PROSPECTUS, BEFORE YOU DECIDE TO
EXCHANGE ANY OF THE NOTES.
THE AMOUNT OF DEBT WE HAVE COULD ADVERSELY AFFECT US BY REDUCING OUR FLEXIBILITY
TO RESPOND TO CHANGING BUSINESS AND ECONOMIC CONDITIONS
As of May 5, 2001, after giving effect to the offering of the notes and the
use of proceeds from the outstanding notes to redeem our 10 7/8% senior notes
due 2006, we would have had $200.6 million of senior debt outstanding and,
except for the guarantee by Aaron Brothers of our bank credit facility, our
subsidiaries would have had no debt outstanding. The terms of our indenture and
our credit agreement permit us to incur additional debt. See "Description of
Other Indebtedness" and "Description of the Notes--Certain Covenants--Limitation
on Indebtedness." Our debt could have important consequences to you, including
the following:
- our ability to obtain additional financing in the future for working
capital, capital expenditures, acquisitions, or general corporate purposes
may be impaired,
- a substantial portion of our cash flows from operations may be dedicated
to the payment of principal and interest on our debt, which would reduce
the funds available to us for our operations,
- the documents governing our debt contain financial and other restrictive
covenants, including those restricting the incurrence of additional debt,
- a portion of our borrowings is and will continue to be at variable rates
of interest which exposes us to the risk of greater interest rates, and
- we may be at a competitive disadvantage compared to our competitors with
less debt and more vulnerable to changing economic conditions.
Our needs for cash in the future will depend on many factors that are
difficult to predict, including our results of operations and efforts to expand
our existing operations. We believe, based on current circumstances, that our
cash flow, together with available borrowing under the new credit agreement, and
the notes, will be sufficient to meet our liquidity needs for the foreseeable
future. However, we cannot assure you that our business will generate cash flow
at or above current levels. If we are unable to generate sufficient cash flow
from operations in the future to repay our debt as it becomes due and make
necessary investments, we may be required to restructure or refinance all or a
portion of our existing debt, seek new borrowings, reduce or delay capital
expenditures, sell assets, seek additional equity capital or delay, scale back
or eliminate some aspects of our operations, including delaying our plans for
new store openings.
Moreover, it is possible that we may not be able to satisfy all of the
conditions and covenants of our debt. In addition, to the extent we seek to
replace or refinance our current debt, replacement financing may not be
available on terms that are favorable or acceptable to us. In addition, we may
not be able to obtain acceptable financing upon the expiration of our credit
agreement. Our ability to obtain additional or replacement financing will be
significantly impacted by, among other things, any change in the ratings
assigned to us by nationally recognized ratings agencies. Any of these events,
if they were to occur, could have a material adverse effect on our business,
financial condition, or results of operations.
SECURED INDEBTEDNESS AND BORROWINGS BY SUBSIDIARIES THAT DO NOT BECOME
GUARANTORS WILL BE EFFECTIVELY SENIOR TO THE NOTES
The notes are senior unsecured obligations and therefore will be effectively
subordinated to any of our or any of our subsidiaries' secured obligations to
the extent of the value of the assets securing such
12
obligations. The indenture permits us and our subsidiaries to incur additional
indebtedness, subject to limitations, including limitations on the amount of
secured indebtedness. See "Description of the Notes--Certain
Covenants--Limitation on Indebtedness" and "--Limitation on Liens."
We conduct a portion of our operations through subsidiaries, and in the
future, we may create additional subsidiaries. Contractual provisions, laws, or
regulations, as well as any subsidiary's financial condition and operating
requirements, may limit our ability to obtain cash from a subsidiary to pay our
debt service obligations, including payments on the notes. The notes will be
structurally subordinated to all existing and future obligations of our
subsidiaries (unless such subsidiaries guarantee the notes), including claims
with respect to trade payables and our Aaron Brothers subsidiary's guarantee of
our credit facility. Our Aaron Brothers subsidiary constituted approximately
5.0% of our revenue for the first quarter of fiscal 2001. In addition, the
guarantee of any subsidiary will be structurally subordinated to all existing
and future obligations of its subsidiaries (unless such subsidiaries also
guarantee the notes), including claims with respect to trade payables. Our
subsidiaries are limited in the amount of indebtedness they are permitted to
incur pursuant to the covenant described under "Description of the
Notes--Certain Covenants--Limitation on Indebtedness." This covenant is subject
to important exceptions described under such heading.
OUR GROWTH DEPENDS ON OUR ABILITY TO OPEN NEW STORES
Our key business strategy is to expand our base of Michaels and Aaron
Brothers stores. If we were unable to implement this strategy, our ability to
increase our sales, profitability and cash flow could be impaired significantly.
To the extent that we are unable to open new stores as we anticipate, our sales
growth would come only from increases in comparable store sales. Growth in
profitability in that case would depend significantly on our ability to reduce
our costs as a percentage of our sales. We may be unable to implement our
strategy if we cannot identify suitable sites for additional stores, negotiate
acceptable leases, access sufficient capital to support store growth, or hire
and train a sufficient number of qualified associates.
OUR SUCCESS WILL DEPEND ON HOW WELL WE MANAGE OUR GROWTH
Even if we are able to implement, to a significant degree, our key business
strategy of expanding our store base, we may experience problems, which may
prevent any significant increase in profitability or negatively impact our cash
flow. For example:
- the costs of opening and operating new stores may offset the increased
sales generated by the additional stores,
- the closure of unsuccessful stores may result in the retention of
liability for expensive leases,
- a significant portion of our management's time and energy may be consumed
with issues unrelated to advancing our core business strategy which could
possibly result in a deterioration of our operating results,
- our expansion may outpace our planned technological advances with the
possible consequences of breakdowns in our supply chain management and
increased weaknesses in our operational controls,
- we may be unable to hire and train sufficient qualified managers and other
associates,
- our suppliers may be unable to meet timely the increased demand as a
result of additional stores, and
- we may be unable to expand our existing distribution centers, or employ
third-party distribution services on a cost effective basis to provide
merchandise for sale by our new stores.
13
WE MAY FAIL TO ANTICIPATE CUSTOMER DEMANDS
Our success depends on our ability to anticipate and respond in a timely
manner to changing customer demand and preferences for products and supplies
used in creative activities. If we misjudge the market, we may significantly
overstock unpopular products and be forced to take significant inventory
markdowns, which would have a negative impact on our operating results and cash
flow. Conversely, shortages of key items could have a materially adverse impact
on our operating results.
OUR SUPPLIERS MAY FAIL US
Many of our suppliers are small firms that produce a limited number of
items. Given their limited resources, these firms are susceptible to cash flow
issues, production difficulties, quality control issues, and problems in
delivering agreed-upon quantities on schedule. We cannot assure you that we
would be able, if necessary, to return product to these suppliers and obtain
refunds of our purchase price or obtain reimbursement or indemnification from
them if their products prove defective. In addition, these suppliers may be
unable to withstand a downturn in economic conditions. Significant failures on
the part of our key suppliers could have a material adverse affect on our
operating results.
In addition, many of these suppliers require extensive advance notice of our
requirements in order to supply products in the quantities we desire. This long
lead time requires us to place orders far in advance of the time when certain
products will be offered for sale, exposing us to shifts in demand.
RISKS RELATING TO FOREIGN SUPPLIERS
We rely to a significant extent on foreign manufacturers of various products
that we sell. In addition, many of our domestic suppliers purchase a portion of
their products from foreign sources. This reliance increases the risk that we
will not have adequate and timely supplies of various products due to local
political or economic conditions, transportation delays, restrictive actions by
foreign governments or United States laws and regulations affecting imports.
Reliance on foreign manufacturers also increases our exposure to fluctuations in
exchange rates and trade infringement claims and reduces our ability to return
product for various reasons.
In addition, a significant portion of our inventory is manufactured in the
People's Republic of China. Since adoption of an "open-door policy" in 1978, the
Chinese government has been pursuing economic reform policies, including the
encouragement of foreign trade and investment and greater economic
decentralization. We cannot assure you, however, that China will continue to
pursue these policies.
All of our products manufactured overseas and imported into the United
States are subject to duties collected by the United States Customs Service. We
may be subjected to additional duties, significant monetary penalties, the
seizure and the forfeiture of the products we are attempting to import or the
loss of import privileges if we or our suppliers are found to be in violation of
U.S. laws and regulations applicable to the importation of our products.
OUR INFORMATION SYSTEMS MAY PROVE INADEQUATE
We depend on our management information systems for many aspects of our
business. We will be materially adversely affected if our management information
systems are disrupted or we are unable to improve, upgrade, and expand our
systems, particularly in light of our planned significant increase in number of
stores. In addition, we are in the process of upgrading our information systems
to provide us with perpetual inventory and automated replenishment capabilities,
which we believe are extremely important in the management of a chain of
hundreds of stores offering tens of thousands of SKUs. Delays in bringing these
new capabilities on line, or disruptions from an imperfect introduction of these
new capabilities, could have a materially adverse impact on our financial
condition and operating results.
14
A WEAK FOURTH QUARTER WOULD MATERIALLY ADVERSELY AFFECT OUR OPERATING RESULTS
Our business is highly seasonal. Our inventories and short-term borrowings
grow in the second and third fiscal quarters as we prepare for our peak selling
season in the third and fourth fiscal quarters. Our most important quarter in
terms of sales, profitability, and cash flow historically has been the fourth
fiscal quarter. If for any reason our fourth fiscal quarter results were
substantially below expectations, our operating results for the full year would
be materially adversely affected, and we could have substantial excess
inventory, especially in seasonal merchandise that is difficult to liquidate.
IMPROVEMENTS TO OUR SUPPLY CHAIN MAY NOT BE FULLY SUCCESSFUL
An important part of our efforts to achieve efficiencies, cost reductions,
and sales and cash flow growth is the identification and implementation of
improvements to our supply chain, including merchandise ordering, transportation
and receipt processing. Any failure to take full advantage of supply chain
opportunities could have a material adverse impact on our operating results.
COMPETITION COULD NEGATIVELY IMPACT OUR OPERATIONS
The retail arts and crafts industry is competitive, which could result in
the reduction of our prices and our loss of market share. We must remain
competitive in the areas of quality, price, selection, and convenience. Our
primary competition is comprised of specialty arts and crafts retailers, which
include Hobby Lobby, A.C. Moore Arts & Crafts, Inc., Jo-Ann etc. (operated by
Jo-Ann Stores, Inc.) and Garden Ridge Corporation. We also compete with mass
merchants, who dedicate a portion of their selling space to a limited selection
of craft supplies and seasonal and holiday merchandise, regional chains, and
local merchants. Some of our competitors, particularly the mass merchants, are
larger and have greater financial resources than we do. In addition, alternative
methods of selling crafts, such as over the Internet, could result in additional
competitors in the future and increased price competition since our customers
could more readily comparison shop. Furthermore, we ultimately compete with
alternative sources of entertainment and leisure for our customers.
ENERGY SHORTAGES, NATURAL DISASTERS OR A DECLINE IN ECONOMIC CONDITIONS IN
CALIFORNIA COULD INCREASE OUR OPERATING EXPENSES OR ADVERSELY AFFECT OUR SALES
REVENUE
As of May 5, 2001, we operate 176 stores in California. Because California
is experiencing energy and electricity shortages, we may be subject to increased
operating costs as a result of higher electricity and energy rates and may be
subject to rolling blackouts which could interrupt our retail business. Any such
impact could be material and adversely affect our profitability. A decline in
the economic conditions in California, whether or not such decline spreads
beyond California, could materially adversely affect our business. Furthermore,
a natural disaster or other catastrophic event, such as an earthquake affecting
California, could significantly disrupt our business.
THE COVENANT RESTRICTIONS IN THE NOTES AND IN OUR OTHER DEBT RESTRICT OUR
OPERATIONS
We and our subsidiaries are subject to significant operating and financial
restrictions contained in the instruments governing the notes and our other
indebtedness. Those restrictions affect, and in many respects significantly
limit or prohibit, among other things, our ability to:
- incur additional indebtedness,
- make various investments,
- issue or sell our restricted subsidiaries' capital stock,
- engage in transactions with affiliates,
- make various distributions,
- sell or securitize accounts receivables,
15
- provide negative pledges,
- make capital expenditures beyond specific limitations,
- engage in derivative transactions other than in the ordinary course of
business,
- create various liens, or
- merge, consolidate, and sell assets.
In addition, our bank credit agreement requires us to maintain specified
financial ratios. These restrictions could also limit our ability to obtain
financing in the future, make needed capital expenditures, withstand a future
downturn in our business or the economy in general or conduct necessary
corporate activities. If we or our subsidiaries fail to comply with these
restrictions, we may be in default under the terms of our indebtedness, even if
we are otherwise able to meet our debt service obligations. In the event of a
default, the holders of the indebtedness could elect to declare all of that
indebtedness, together with accrued interest, to be due and payable and a
significant portion of our other indebtedness (including the notes) may become
immediately due and payable as a result of cross-default clauses contained in
documentation evidencing debt. We cannot assure you that we would be able to
make those payments or borrow sufficient funds from alternative sources to make
those payments. Even if we were to obtain additional financing, that financing
may be on terms unfavorable to us.
WE MAY NOT HAVE ENOUGH FUNDS TO REPURCHASE THE NOTES UPON A CHANGE OF CONTROL
Should there be a change of control of Michaels, each holder of the notes
will have the right to require us, subject to various conditions, to repurchase
all or any part of that holder's notes at a price equal to 101% of the principal
of those notes, plus accrued and unpaid interest, if any, to the date of
repurchase. See "Description of the Notes--Change of Control." Existing senior
indebtedness under our bank credit agreement includes, and our future
indebtedness may include, change of control provisions. Under those provisions,
should a specified change of control event occur, we would be required to
repurchase, or the lender could demand the repayment of, that indebtedness.
Subject to some limitations, we could, in the future, enter into various
transactions, including acquisitions, refinancings or other recapitalizations
that would not constitute a change of control under the indenture for the notes,
but that could increase the amount of our debt outstanding at that time or
otherwise affect our capital structure or credit rating. We have no present
intention to engage in a transaction involving a change of control, although it
is possible that we could decide to do so in the future. The term "Change of
Control" with respect to the notes is defined in "Description of the
Notes--Change of Control."
We cannot assure you that we will have sufficient funds available or could
obtain the financing necessary to repurchase the notes and any other outstanding
indebtedness that rank equally with the notes tendered by holders of those
obligations following a change of control. If a change of control occurred and
we did not have the funds or financing available to pay for the notes and any
other indebtedness ranking equally with the notes that are tendered for
repurchase, an event of default would be triggered under the notes and under
that other outstanding indebtedness. Each of these defaults could have a
material adverse consequence for us and the holders of the notes. The ability of
a holder of the notes to require us to repurchase its notes as a result of our
sale or other disposition of less than all our properties and assets on a
consolidated basis to another person or related group of persons may be
uncertain. See "Description of the Notes--Change of Control."
ANY SUBSIDIARY GUARANTEES OF THE NOTES MAY BE SUBORDINATED OR AVOIDED BY A COURT
None of our subsidiaries will guarantee the notes initially. If any of our
existing or future restricted subsidiaries guarantee any of our other
indebtedness other than the guarantee from Aaron Brothers in favor of our bank
lenders, those subsidiaries may be required to guarantee the notes on a senior
basis.
16
See "Description of the Notes--Certain Covenants--Limitation on Indebtedness."
Various applicable fraudulent conveyance laws have been enacted for the
protection of creditors. A court may use those laws to subordinate or avoid any
guarantee of the notes issued by any of our subsidiaries. It is also possible
that under some circumstances a court could hold that the direct obligations of
a subsidiary guaranteeing the notes could be superior to the obligations under
that guarantee. A court could avoid or subordinate the guarantee of the notes by
any of our subsidiaries in favor of that subsidiary's other debts or liabilities
to the extent that the court determined either of the following were true at the
time the subsidiary issued the guarantee:
- the subsidiary incurred the guarantee with the intent to hinder, delay, or
defraud any of its present or future creditors or that such subsidiary
contemplated insolvency with a design to favor one or more creditors to
the total or partial exclusion of others; or
- the subsidiary did not receive fair consideration or reasonably equivalent
value for issuing the guarantee and, at the time it issued the guarantee,
the subsidiary:
- was insolvent or rendered insolvent by reason of the issuance of the
guarantee,
- was engaged or about to engage in a business or transaction for
which the remaining assets of the subsidiary constituted
unreasonably small capital, or
- intended to incur, or believed that it would incur, debts beyond its
ability to pay these debts as they matured.
Among other things, a legal challenge of a subsidiary's guarantee of the
notes on fraudulent conveyance grounds may focus on the benefits, if any,
realized by that subsidiary as a result of our issuance of the notes.
To the extent a subsidiary's guarantee of the notes is avoided as a result
of a fraudulent conveyance or held unenforceable for any other reason, the note
holders would cease to have any claim in respect of that guarantee and would be
creditors solely of us.
THERE MAY NOT BE A PUBLIC MARKET FOR THE EXCHANGE NOTES.
There is no existing trading market for the outstanding notes. If such a
market were to develop, the outstanding notes and, if issued, the exchange notes
could trade at prices that may be lower than the initial offering price
depending on many factors, including prevailing interest and dividend rates, our
operating results and the market for similar securities.
IF YOU DO NOT EXCHANGE YOUR OUTSTANDING NOTES YOU MAY HAVE DIFFICULTY IN
TRANSFERRING THEM AT A LATER TIME.
Michaels Stores will issue exchange notes in exchange for the outstanding
notes after the exchange agent receives your outstanding notes, the letter of
transmittal and all related documents. You should allow adequate time for
delivery if you choose to tender your outstanding notes for exchange.
Outstanding notes that are not exchanged will remain subject to restrictions on
transfer and will not have any rights to registration.
If you do participate in the exchange offer for the purpose of participating
in the distribution of the exchange notes, you must comply with the registration
and prospectus delivery requirements of the Securities Act of 1933 for any
resale transaction. Each broker-dealer who holds outstanding notes for its own
account due to market-making or other trading activities and who receives
exchange notes for its own account must acknowledge that it will deliver a
prospectus in connection with any resale of the exchange notes. If any
outstanding notes are not tendered in the exchange or are tendered but not
accepted, the trading market for such outstanding notes could be negatively
affected due to the limited amount expected to remain outstanding following the
completion of the exchange offer.
17
USE OF PROCEEDS
We will not receive any cash proceeds from the issuance of the exchange
notes. Because we are exchanging the exchange notes for the outstanding notes,
which have substantially identical terms, the issuance of the exchange notes
will not result in any increase in the indebtedness of Michaels Stores.
CAPITALIZATION
The following table sets forth our capitalization as of May 5, 2001, on an
actual basis and as adjusted to give effect to the offering of the outstanding
notes and our use of proceeds thereof to redeem the 10 7/8% senior notes due
2006 and pay amounts outstanding under our credit agreement. The exchange notes
exchanged for outstanding notes will not affect the amount of indebtedness
outstanding. You should read this information together with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
our consolidated financial statements and related notes included elsewhere in
this prospectus.
AS OF MAY 5, 2001
----------------------
ACTUAL AS ADJUSTED
-------- -----------
(IN THOUSANDS)
(UNAUDITED)
Cash and equivalents........................................ $ 21,365 $ 52,942
======== ========
Total debt:
Bank line of credit....................................... $ 29,200 $ --
9 1/4% Senior notes due 2009.............................. -- 200,000
10 7/8% Senior notes due 2006............................. 125,000 --
Capital lease obligations................................. 629 629
-------- --------
Total debt.............................................. 154,829 200,629
-------- --------
Stockholders' equity:
Common stock, $.10 par value; 150,000,000 shares
authorized;
32,172,812 shares issued and outstanding................ 3,217 3,217
Additional paid-in capital................................ 438,768 438,768
Retained earnings......................................... 278,406 273,088(1)
-------- --------
Total stockholders' equity.............................. 720,391 715,073
-------- --------
Total capitalization........................................ $875,220 $915,702
======== ========
------------------------
(1) Reflects the estimated after-tax extraordinary charge to earnings of
approximately $5.3 million in connection with the redemption of our 10 7/8%
senior notes due 2006.
18
SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA
The results of operations, balance sheet and other financial data below for
fiscal years 1996, 1997, 1998, 1999 and 2000 has been derived from our audited
consolidated financial statements and related notes. Audited consolidated
financial statements as of January 29, 2000 and February 3, 2001 and for each of
the three fiscal years ended February 3, 2001 appear elsewhere in this
prospectus. References to fiscal year mean the year in which that fiscal year
began. Our fiscal year 1996 ended on February 1, 1997 and fiscal year 2000 ended
on February 3, 2001 and each contained 53 weeks. Our fiscal year 1997 ended on
January 31, 1998, fiscal year 1998 ended on January 30, 1999 and fiscal year
1999 ended on January 29, 2000 and each contained 52 weeks. The results of
operations, balance sheet and other financial data below for the 13 weeks ended
April 29, 2000 and May 5, 2001 and for the 53 weeks ended May 5, 2001 is derived
from our unaudited financial statements and reflects only normal recurring
adjustments and other items as disclosed in the footnotes to these selected
consolidated financial and operating data which, in the opinion of our
management, are necessary for the fair presentation of this information. You
should not expect the consolidated results of operations data, other financial
data or other operating data of interim periods to be an indication of results
for a full year. You should read the following information together with our
consolidated financial statements and related notes included elsewhere in this
prospectus and "Management's Discussion and Analysis of Financial Condition and
Results of Operations" in this prospectus.
FISCAL YEAR
--------------------------------------------------------------
1996(1) 1997 1998 1999(2) 2000(3)
---------- ---------- ---------- ---------- ----------
(IN THOUSANDS EXCEPT PER SHARE AND STORE DATA)
RESULTS OF OPERATIONS
DATA:
Net sales(5)............ $1,378,277 $1,456,524 $1,573,965 $1,882,522 $2,249,440
Operating income
(loss)................ (20,987) 68,942 89,112 122,672 148,417
Interest expense........ 21,038 23,448 22,678 22,654 18,026
Net income (loss)....... (31,233) 30,077 43,601 62,301 78,589
Diluted earnings (loss)
per common share...... (1.35) 1.05 1.43 2.01 2.29
BALANCE SHEET DATA:
Cash and equivalents.... $ 59,069 $ 162,283 $ 96,124 $ 77,398 $ 28,191
Merchandise
inventories........... 351,208 385,580 501,239 615,065 663,700
Total current assets.... 437,543 573,183 621,928 722,987 729,816
Total assets............ 784,435 908,494 962,650 1,096,703 1,158,436
Working capital......... 239,812 358,691 391,227 452,011 440,808
Long-term debt(6)....... 238,608 234,889 230,896 224,635 125,145
Total debt.............. 242,823 239,551 236,869 230,988 125,876
Total liabilities....... 451,633 466,583 481,671 529,905 453,790
Stockholders' equity.... 332,802 441,911 480,979 566,798 704,646
OTHER FINANCIAL DATA:
Ratio of earnings to
fixed charges(7)...... -- (8) 1.8x 2.0x 2.2x 2.4x
Cash flow from operating
activities............ $ 29,749 $ 77,907 $ 6,038 $ 60,770 $ 146,758
Cash flow from investing
activities............ (32,312) (38,988) (59,567) (90,759) (120,084)
Cash flow from financing
activities............ 58,762 64,295 (12,630) 11,263 (75,881)
EBITDA(9)............... 21,694 117,589 143,255 184,251 218,042
EBITDA margin(10)....... 1.6% 8.1% 9.1% 9.8% 9.7%
Adjusted EBITDA(11)..... $ 62,887 $ 117,589 $ 143,255 $ 185,751 $ 218,042
Adjusted EBITDA
margin(12)............ 4.6% 8.1% 9.1% 9.9% 9.7%
Total rental expense.... $ 92,293 $ 96,320 $ 109,251 $ 129,547 $ 157,824
OTHER OPERATING DATA:
Average net sales per
Michaels store(13).... $ 2,919 $ 3,122 $ 3,095 $ 3,310 $ 3,513
Comparable store sales
increase
(decrease)(14)........ (1)% 6% 1% 7% 5%
Total selling square
footage............... 7,821 8,082 8,981 10,411 12,063
13 WEEKS ENDED
----------------------- 53 WEEKS ENDED
APRIL 29, MAY 5, MAY 5,
2000(3) 2001(4) 2001(4)
---------- ---------- --------------
(IN THOUSANDS EXCEPT PER SHARE AND STORE DATA)
RESULTS OF OPERATIONS
DATA:
Net sales(5)............ $ 474,152 $ 524,720 $2,300,008
Operating income
(loss)................ 21,338 16,084 143,163
Interest expense........ 5,520 3,778 16,284
Net income (loss)....... 8,230 7,289 77,648
Diluted earnings (loss)
per common share...... 0.25 0.22 2.26
BALANCE SHEET DATA:
Cash and equivalents.... $ 99,300 $ 21,365 $ 21,365
Merchandise
inventories........... 641,857 744,701 744,701
Total current assets.... 772,898 801,155 801,155
Total assets............ 1,147,645 1,234,718 1,234,718
Working capital......... 495,786 453,380 453,380
Long-term debt(6)....... 223,545 125,068 125,068
Total debt.............. 229,510 154,829 154,829
Total liabilities....... 535,635 514,327 514,327
Stockholders' equity.... 612,010 720,391 720,391
OTHER FINANCIAL DATA:
Ratio of earnings to
fixed charges(7)...... 1.7x 1.5x 2.4x
Cash flow from operating
activities............ $ 9,091 $ (24,825) $ 112,842
Cash flow from investing
activities............ (17,196) (19,027) (121,915)
Cash flow from financing
activities............ 30,007 37,026 (68,862)
EBITDA(9)............... 38,810 32,630 211,862
EBITDA margin(10)....... 8.2% 6.2% 9.2%
Adjusted EBITDA(11)..... $ 38,810 $ 36,702 $ 215,934
Adjusted EBITDA
margin(12)............ 8.2% 7.0% 9.4%
Total rental expense.... $ 36,008 $ 42,794 $ 164,610
OTHER OPERATING DATA:
Average net sales per
Michaels store(13).... N/A N/A $ 3,537
Comparable store sales
increase
(decrease)(14)........ 7% 3% 4%
Total selling square
footage............... 10,769 12,401 12,401
(CONTINUED ON FOLLOWING PAGE)
19
13 WEEKS ENDED
FISCAL YEAR -----------------------
-------------------------------------------------------------- APRIL 29, MAY 5,
1996 1997 1998 1999 2000 2000 2001
---------- ---------- ---------- ---------- ---------- ---------- ----------
STORES OPEN AT END OF
PERIOD:
Michaels................ 453 452 496 559 628 585 644
Aaron Brothers.......... 72 74 78 95 119 97 123
Star Wholesale.......... -- -- -- -- 1 -- 1
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total stores open at end
of period............. 525 526 574 654 748 682 768
========== ========== ========== ========== ========== ========== ==========
53 WEEKS ENDED
MAY 5,
2001
--------------
STORES OPEN AT END OF
PERIOD:
Michaels................ 644
Aaron Brothers.......... 123
Star Wholesale.......... 1
----------
Total stores open at end
of period............. 768
==========
------------------------------
(1) Operating loss in fiscal 1996 includes the effect of an unusual pre-tax
charge of $41.2 million for costs associated with the 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.
(2) Operating income for fiscal 1999 includes a $1.5 million charge for the
settlement of litigation.
(3) Net income and diluted earnings per common share in fiscal 2000 include the
cumulative effect of a change in accounting principle related to
recognizing sales of custom frames, net of tax, in the amount of
$1.9 million, or $0.06 per diluted share.
(4) Operating income for the 13 weeks and for the 53 weeks ended May 5, 2001
includes a $3.2 million charge for the settlement of litigation and a
$1.0 million charge relating to executive severance costs.
(5) Net sales represents gross sales less returns.
(6) Long-term debt includes the long-term portion of capital lease obligations,
convertible subordinated notes which we redeemed in June 2000, and our
10 7/8% senior notes due 2006 in the amount of $125 million, which we have
called for redemption. In connection with the redemption of the 10 7/8%
senior notes due 2006, we will incur an estimated after-tax extraordinary
loss of $5.3 million in the third quarter of fiscal 2001.
(7) For purposes of calculating the ratio of earnings to fixed charges,
earnings consist of income (loss) before income taxes for such period plus
fixed charges deducted in calculating income (loss) before income taxes for
such period. Fixed charges consist of interest incurred, amortization of
deferred financing fees and an amount representing the interest factor
included in rental expense.
(8) Earnings were insufficient to cover fixed charges in fiscal 1996. The
deficiency for fiscal 1996 was $41.1 million.
(9) EBITDA is calculated as income (loss) 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, but is not a financial measurement recognized by generally accepted
accounting principles, and therefore, may not be comparable to similarly
titled measures used by other entities. EBITDA should not be considered by
an investor as an alternative to net income as an indicator of our
operating performance, or as an alternative to cash flow as a measure of
liquidity.
(10) EBITDA margin is calculated as EBITDA, as defined above, divided by net
sales.
(11) Adjusted EBITDA is calculated as income (loss) before income taxes plus
interest, depreciation, amortization, and unusual, non-recurring charges.
Adjusted EBITDA for fiscal 1996 excludes the effect of an unusual pretax
charge of $41.2 million for costs associated with the 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. Adjusted EBITDA for fiscal 1999 excludes the effect of an
unusual $1.5 million pretax charge for the settlement of litigation between
us and a competitor. Adjusted EBITDA for the 13 and 53 weeks ended May 5,
2001 excludes the effect of a $3.2 million pretax charge for the settlement
of litigation and a $1.0 million pretax charge for executive severance.
(12) Adjusted EBITDA margin is calculated as Adjusted EBITDA, as defined above,
divided by net sales.
(13) The calculation of average net sales per Michaels store only includes sales
for stores open for the full 12 months.
(14) Comparable store sales increase (decrease) represents the increase or
decrease in net sales for stores open the same number of months in the
indicated and comparable period of the previous year, including stores that
were relocated or expanded during either period adjusted for unusual
circumstances year over year such as inclement weather, natural disasters
and other adjustments. A store is deemed to become comparable in its 14th
full month of operation. The calculation of comparable store sales
increases or decreases excludes the effect of deferring the recognition of
custom frame sales for orders that have not been picked up by the customer
at the end of the period.
20
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH OUR CONSOLIDATED
FINANCIAL STATEMENTS AND THE NOTES TO THOSE STATEMENTS INCLUDED ELSEWHERE IN
THIS PROSPECTUS. OUR FISCAL YEAR INCLUDES 52 OR 53 WEEKS AND ENDS ON THE
SATURDAY CLOSEST TO JANUARY 31. REFERENCES TO FISCAL YEAR MEAN THE YEAR IN WHICH
THAT FISCAL YEAR BEGAN. OUR FISCAL YEAR 1996 ENDED ON FEBRUARY 1, 1997 AND
FISCAL YEAR 2000 ENDED ON FEBRUARY 3, 2001 AND EACH CONTAINED 53 WEEKS. OUR
FISCAL YEAR 1997 ENDED ON JANUARY 31, 1998, FISCAL YEAR 1998 ENDED ON
JANUARY 30, 1999 AND FISCAL YEAR 1999 ENDED ON JANUARY 29, 2000 AND EACH
CONTAINED 52 WEEKS. THE FOLLOWING DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS
THAT REFLECT OUR PLANS, ESTIMATES, AND BELIEFS. OUR ACTUAL RESULTS COULD
MATERIALLY DIFFER FROM THOSE DISCUSSED IN THOSE FORWARD-LOOKING STATEMENTS.
FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES INCLUDE, BUT ARE NOT
LIMITED TO, THOSE DISCUSSED BELOW AND ELSEWHERE IN THIS PROSPECTUS, AND
PARTICULARLY IN "RISK FACTORS" AND "FORWARD-LOOKING STATEMENTS."
RESULTS OF OPERATIONS
The following table sets forth the percentage relationship to net sales of
each line item of our consolidated statements of income. This table should be
read in conjunction with the following discussion and with our consolidated
financial statements, including the related notes.
13 WEEKS ENDED
FISCAL YEAR --------------------
------------------------------ APRIL 29, MAY 5,
1998 1999 2000 2000 2001
-------- -------- -------- --------- --------
Net sales.............................................. 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of sales and occupancy expense.................... 66.8 66.1 66.4 66.1 66.2
----- ----- ----- ----- -----
Gross margin........................................... 33.2 33.9 33.6 33.9 33.8
Selling, general, and administrative expense........... 27.0 26.7 26.5 28.8 29.8
Store pre-opening costs................................ 0.5 0.6 0.5 0.6 0.3
Litigation settlement.................................. -- 0.1 -- -- 0.6
----- ----- ----- ----- -----
Operating income....................................... 5.7 6.5 6.6 4.5 3.1
Interest expense....................................... 1.4 1.2 0.8 1.2 0.7
Other (income) and expense, net........................ (0.2) (0.1) (0.2) (0.2) (0.0)
----- ----- ----- ----- -----
Income before income taxes and cumulative effect of
accounting change.................................... 4.5 5.4 6.0 3.5 2.4
Provision for income taxes............................. 1.7 2.1 2.4 1.4 1.0
----- ----- ----- ----- -----
Income before cumulative effect of accounting change... 2.8 3.3 3.6 2.1 1.4
Cumulative effect of accounting change for revenue
recognition, net of tax.............................. -- -- 0.1 0.4 --
----- ----- ----- ----- -----
Net income............................................. 2.8% 3.3% 3.5% 1.7% 1.4%
===== ===== ===== ===== =====
QUARTER ENDED MAY 5, 2001 COMPARED TO THE QUARTER ENDED APRIL 29, 2000
Net sales for the 13 weeks ended May 5, 2001 increased $50.6 million, or
11%, over the 13 weeks ended April 29, 2000. At the end of the first quarter of
fiscal 2001, we operated 644 Michaels and 123 Aaron Brothers retail stores. The
results for the first quarter of fiscal 2001 included sales from 62 Michaels and
27 Aaron Brothers retail stores that were opened and a wholesale operation that
was acquired during the 12-month period ended May 5, 2001, more than offsetting
lost sales from three Michaels and one Aaron Brothers store closures. Sales at
the new stores (net of closures) and the acquired wholesale operation during the
first quarter of fiscal 2001 accounted for $46.4 million of the increase in net
sales. Comparable store sales increased 3% in the first quarter of fiscal 2001
compared
21
to the first quarter of fiscal 2000, which contributed $11.7 million to the net
sales increase. The improvement in comparable store sales was due to a strong
performance in our core categories of seasonal, ribbon, custom framing, general
arts and crafts, and ready-made frames. Going forward, we expect to achieve
comparable store sales increases for the remainder of fiscal 2001, taken as a
whole. Our ability to continue to generate comparable store sales increases is
dependent, in part, on our ability to continue to maintain 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. The above increases
in net sales were partially offset by the net deferral of revenue related to the
sale of custom frames, which resulted in a decrease in net sales of
$7.5 million from the first quarter of fiscal 2000 to the first quarter of
fiscal 2001. This decrease was due to the fluctuation in custom frame sales
volume during the last two weeks of each fiscal quarter as a result of, but not
limited to, seasonal trends and the timing of custom framing promotional
activities. For purposes of calculating comparable store sales, a store is
deemed to become comparable in its 14th full month of operation in order to
eliminate grand opening sales distortions, and results are reported on a 52-week
basis for the yearly period and a 13-week basis for the quarterly period.
Cost of sales and occupancy expense, as a percentage of net sales, for the
first quarter of fiscal 2001 was 66.2%, an increase of 0.1% compared to the
first quarter of fiscal 2000. This increase was primarily attributable to higher
occupancy costs associated with new and relocated stores and higher utilities
costs compared to the first quarter of fiscal 2000, partially offset by improved
merchandise margins.
Selling, general, and administrative expense, as a percentage of net sales,
increased by 1.0% from the first quarter of fiscal 2000 to the first quarter of
fiscal 2001. This increase resulted principally from increased store payroll and
related expenses, as a percentage of net sales, and higher advertising expenses.
In addition, we incurred costs of approximately $1.0 million in the first
quarter of fiscal 2001 related to severance agreements with former senior
executives.
Store pre-opening costs, as a percentage of net sales, decreased by 0.3% in
the first quarter of fiscal 2001 compared to the first quarter of fiscal 2000.
In the first quarter of fiscal 2001, we opened or relocated 20 Michaels and four
Aaron Brothers stores compared to 30 Michaels and two Aaron Brothers stores
opened or relocated in the first quarter of fiscal 2000.
On June 6, 2001, we negotiated a tentative settlement of a purported class
action with a former assistant manager of the company, Taiyeb Raniwala. Pursuant
to the terms of the settlement, in exchange for a full release of claims, we are
obligated to pay a maximum of $3.0 million covering all claims and attorneys'
fees, plus estimated payroll taxes of approximately $153,000, which amount was
accrued in the first quarter of fiscal 2001. The specific terms of the
settlement are currently being finalized between the parties and must then be
approved by the court. While we believe that it is likely that the settlement
will be approved, we can provide no assurance to that effect.
Operating income, as a percentage of net sales, decreased by 1.4% to
$16.1 million in the first quarter of fiscal 2001 compared to $21.3 million for
the first quarter of fiscal 2000. Operating income for the first quarter of
fiscal 2001 was negatively impacted by $2.5 million resulting from the net
deferral of custom framing revenue for reasons disclosed above, severance costs
of approximately $1.0 million, and the litigation settlement charge of
$3.2 million. Operating income for the first quarter of fiscal 2000 was
positively impacted by $665,000 related to the net deferral of custom framing
revenue. Excluding the effects of the net deferrals related to sales of custom
frames, the one-time severance charge, and the litigation settlement charge,
operating income increased 10% from $20.7 million in the first quarter of fiscal
2000 to $22.7 million in the first quarter of fiscal 2001, on a 12% increase in
net sales during the same period. For more information, see Note 2 of Notes to
22
Consolidated Financial Statements for the three months ended May 5, 2001
included elsewhere in this prospectus.
Interest expense (net of interest income), as a percentage of net sales,
decreased by 0.3% in the first quarter of fiscal 2001 compared to the first
quarter of fiscal 2000. This decrease resulted from interest savings related to
the conversion and redemption of our convertible subordinated notes in
June 2000, discussed under "Liquidity and Capital Resources" below, partially
offset by lower investment income on lower average cash balances during the
first quarter of fiscal 2001.
The effective tax rate was 41% for the first quarter of fiscal 2001 and 40%
for the first quarter of fiscal 2000.
We changed our accounting policy with respect to revenue recognition related
to the sale of custom frames effective retroactively as of the beginning of
fiscal 2000. As a result, we recorded a non-cash charge of $1.9 million, net of
tax, in the first quarter of fiscal 2000 for the cumulative effect of the change
on fiscal years prior to fiscal 2000. Including this one-time charge, net income
for the first quarter of fiscal 2000 was $8.2 million, or $0.25 per diluted
share. Excluding this one-time charge, net income for the first quarter of
fiscal 2000 was $10.1 million, or $0.31 per diluted share.
FISCAL 2000 COMPARED TO FISCAL 1999
Net sales in fiscal 2000 increased $366.9 million, or 19.5%, over fiscal
1999. The results for fiscal 2000 included sales from 72 Michaels and 25 Aaron
Brothers stores that were opened and a wholesale operation that was acquired
during the year, more than offsetting lost sales from three Michaels and one
Aaron Brothers store closures. Sales at the new stores (net of closures) and the
acquired wholesale operation during fiscal 2000 accounted for $242.0 million of
the increase in net sales. Comparable store sales increased 5% in fiscal 2000
compared to fiscal 1999, which contributed $93.0 million to the net sales
increase. In addition, fiscal 2000 net sales includes sales from the 53rd week
of $31.9 million. The improvement in comparable store sales was due to a strong
performance in our core categories of general crafts, ribbon, art supplies,
framing, and floral as well as substantial increases in the seasonal product
categories.
Cost of sales and occupancy expense, as a percentage of net sales, for
fiscal 2000 was 66.4%, an increase of 0.3% compared to fiscal 1999. This
increase was primarily attributable to higher fiscal 2000 seasonal inventory
markdowns related to holiday clearance merchandise and higher occupancy costs
associated with new and relocated stores.
Selling, general, and administrative expense, as a percentage of net sales,
decreased by 0.2% in fiscal 2000 compared to fiscal 1999. This decrease was
primarily due to improved expense leverage in advertising and depreciation and
amortization expenses, partially offset by increased payroll and related
expenses, as a percentage of net sales, and costs associated with our supply
chain initiative totaling $4.5 million.
Store pre-opening costs, as a percentage of net sales, decreased by 0.1% in
fiscal 2000 compared to fiscal 1999, as we opened or relocated 89 Michaels and
28 Aaron Brothers stores in fiscal 2000 compared to 95 Michaels and 23 Aaron
Brothers stores in the prior fiscal year.
Operating income, as a percentage of net sales, increased by 0.1% in fiscal
2000 compared to fiscal 1999. Operating income increased 21.0% from fiscal 1999
to fiscal 2000, on a 19.5% increase in net sales, to $148.4 million compared to
$122.7 million in the prior fiscal year.
Interest expense (net of interest income), as a percentage of net sales, in
fiscal 2000 decreased by 0.5% compared to fiscal 1999. This decrease resulted
from interest savings related to the conversion and redemption of the
convertible subordinated notes in June 2000 and a leveraging of interest expense
on expanded sales.
23
As more fully described in Note 2 of Notes to Consolidated Financial
Statements for fiscal 2000 included elsewhere in this prospectus, we changed our
accounting policy with respect to revenue recognition related to the sale of
custom frames effective retroactively as of the beginning of fiscal 2000. As a
result, we recorded a charge of $1.9 million, net of tax, or $0.06 per diluted
share, in the first quarter of fiscal 2000 for the cumulative effect of the
change on prior years. Including this one-time charge, net income for fiscal
2000 was $78.6 million, or $2.29 per diluted share. Excluding this one-time
charge, net income for fiscal 2000 was $80.4 million, or $2.35 per diluted
share.
FISCAL 1999 COMPARED TO FISCAL 1998
Net sales in fiscal 1999 increased $308.5 million, or 20%, over fiscal 1998.
The results for fiscal 1999 included sales from 69 Michaels and 17 Aaron
Brothers stores that were opened during the year, more than offsetting lost
sales from six Michaels and no Aaron Brothers store closures. Sales at the new
stores (net of closures) during fiscal 1999 accounted for $198.9 million of the
increase in net sales. Comparable store sales increased 7% in fiscal 1999
compared to fiscal 1998, which contributed $109.6 million to the net sales
increase. The improvement in comparable store sales was due to a strong
performance in our core categories of framing, general crafts, art supplies,
floral, ribbon, home decor, and books as well as substantial increases in the
seasonal product categories.
Cost of sales and occupancy expense, as a percentage of net sales, for
fiscal 1999 was 66.1%, a decrease of 0.7% compared to fiscal 1998. This decrease
was primarily attributable to improved initial markup on inventories,
improvements in the margins associated with fourth quarter promotional
activities, and better margins on season-end clearance merchandise. This
decrease was partially offset by larger investments in information systems
infrastructure and higher occupancy costs associated with new and relocated
stores.
Selling, general, and administrative expense, as a percentage of net sales,
decreased by 0.3% in fiscal 1999 compared to fiscal 1998. This decrease resulted
from improved expense leverage in store payroll and related expenses, partially
offset by higher bank fees associated with an increase in the percentage of
sales via credit card.
Store pre-opening costs, as a percentage of net sales, increased by 0.1% in
fiscal 1999 compared to fiscal 1998, as we opened or relocated 95 Michaels and
23 Aaron Brothers stores in fiscal 1999 compared to 64 Michaels and 10 Aaron
Brothers stores in the prior fiscal year.
On January 15, 1999, MJDesigns, Inc., a competitor, filed a complaint
alleging that some of our representatives disseminated negative information
about the financial stability of MJDesigns, which, it was contended, contributed
to MJDesigns' bankruptcy filing. On August 5, 1999, we reached an agreement to
settle the litigation and, accordingly, we recorded a $1.5 million charge in the
second quarter of fiscal 1999 to reflect the terms of the agreement. In addition
to the settlement payment, we executed mutual releases with MJDesigns. The court
approved the settlement on October 19, 1999. Including the litigation settlement
charge, operating income in fiscal 1999 was $122.7 million. Excluding the
litigation settlement charge, operating income in fiscal 1999 increased 39% from
the prior fiscal year to $124.2 million compared to $89.1 million in fiscal
1998.
Operating income, as a percentage of net sales, increased by 0.8% in fiscal
1999 compared to fiscal 1998. This improvement represented a 38% increase over
the prior fiscal year, on a 20% increase in net sales, to $122.7 million
compared to $89.1 million in the prior fiscal year.
Interest expense (net of interest income), as a percentage of net sales,
decreased by 0.1% for fiscal 1999 compared to fiscal 1998. This decrease
resulted from a leveraging of interest expense on expanded sales, partially
offset by lower invested cash balances in fiscal 1999 compared to fiscal 1998.
Net income for fiscal 1999, including the litigation settlement charge, was
$62.3 million, or $2.01 per diluted share. Excluding the litigation settlement
charge, net income increased 45% from the prior
24
fiscal year to $63.2 million, or $2.03 per diluted share, compared to
$43.6 million, or $1.43 per diluted share, in fiscal 1998.
LIQUIDITY AND CAPITAL RESOURCES
We require cash principally to finance capital investments, inventory for
new, relocated, and expanded stores, and seasonal working capital. We opened 86
Michaels and Aaron Brothers stores in fiscal 1999 and 97 stores in fiscal 2000,
relocated 32 Michaels and Aaron Brothers stores in fiscal 1999 and 20 stores in
fiscal 2000, and expanded three Michaels stores in fiscal 1999 and one Michaels
store in fiscal 2000. In recent years, we have financed our operations and new
store openings primarily with cash from operations, borrowings under our bank
credit facility, the issuance of our common stock, and proceeds from the
exercise of outstanding stock options.
We currently estimate that our capital expenditures will be approximately
$145 million in fiscal 2001, which amount is net of proceeds of approximately
$26.9 million from the completion in June 2001 of a sale/leaseback transaction
for two distribution centers which we purchased in December 2000. We anticipate
spending approximately $47 million to open approximately 75 new Michaels and 20
new Aaron Brothers stores; $30 million for improvements in existing stores;
$29 million for new and existing distribution centers; $11 million on
information systems projects; $4 million on corporate expansion; and
$24 million for various other capital investment activities. We expect to spend
on average approximately $1.25 million to open a new Michaels store, which
includes $570,000 in net inventory and $110,000 of pre-opening costs and
$436,000 to open a new Aaron Brothers store, which includes $133,000 in net
inventory and $28,000 of pre-opening costs. We anticipate that our new Michaels
and Aaron Brothers stores, as a group, will become profitable within the first
12 months of operation of each store.
On June 9, 2000, we called for the redemption on June 29, 2000 of our
convertible subordinated notes due January 15, 2003. The aggregate principal
amount of the convertible subordinated notes outstanding was $96,935,000. The
holders had the option to convert their convertible subordinated notes into
shares of our common stock prior to 5:00 p.m., Eastern Time, on June 22, 2000,
at a price of $38.00 per share. Alternatively, holders could have their
convertible subordinated notes redeemed on June 29, 2000 at a total redemption
price of $1,051.25 per $1,000 principal amount of convertible subordinated
notes, which includes a premium for early redemption and accrued interest. As a
result, a majority of the convertible subordinated notes was surrendered by the
June 22, 2000 conversion date and were converted into 2,445,565 shares of our
common stock. The remaining convertible subordinated notes were redeemed at a
total redemption price of $4,206,051 on June 29, 2000. The loss from the
redemption was not material.
In fiscal 1998, we repurchased and placed in treasury 1,145,000 shares of
our common stock for an aggregate purchase price of $20.4 million. On July 14,
1999, our Board of Directors authorized the repurchase of up to 5,000,000 shares
of our common stock. Pursuant to this plan, in fiscal 1999 we repurchased and
placed in treasury 364,000 shares of our common stock for an aggregate purchase
price of $11.5 million. In the first quarter of fiscal 2000, we retired all of
our common stock held in treasury. Subsequent to the first quarter of fiscal
2000, through December 14, 2000, we repurchased and retired 4,636,000 shares of
our common stock for an aggregate purchase price of $139.4 million (average of
$30.06 per share) and, as a result, we completed the July 1999 stock repurchase
plan.
On December 14, 2000, our Board of Directors authorized the repurchase of an
additional 1,000,000 shares of our outstanding common stock. As of May 5, 2001,
we have repurchased and retired 525,000 shares under this plan at an aggregate
price of $17.2 million (average cost of $32.67 per share). We may continue our
stock repurchases provided that market prices of our common stock make it
advantageous. We are restricted by regulations of the SEC from making
repurchases during specified
25
time periods. Finally, under the agreements governing our outstanding
indebtedness, we can only repurchase shares if we maintain or comply with
specified financial ratios and other covenants.
Proceeds from the exercise of outstanding stock options have served as a
source of cash for us, and we expect to receive proceeds from the exercise of
outstanding stock options in the future. For the first quarter of fiscal 2001,
proceeds from the exercise of stock options were $7.8 million. For fiscal 2000,
proceeds from the exercise of stock options were $89.5 million. During fiscal
1999, proceeds from the exercise of stock options were $28.8 million.
In October 1997, we began issuing our common stock through our dividend
reinvestment and stock purchase plan. The plan provides owners of shares of our
common stock with a convenient and economical means of purchasing our common
stock. During fiscal 2000, 1999, and 1998, we issued 411,982, and 178,730
shares, respectively, through the plan, generating $14,000, $27,000, and
approximately $6.2 million, respectively, in new equity.
In October 1999, we began issuing our common stock through our employees
stock purchase plan. The plan provides our employees with a convenient and
economical means of purchasing our common stock. The plan also provides us with
an additional way to raise equity capital. During fiscal 2000 and 1999, we
issued 33,288 and 8,035 shares, respectively, through the plan, generating
approximately $922,000 and $208,000, respectively, in proceeds. Prior to
October 1999, shares for the employees stock purchase plan were acquired through
open market purchases.
CHANGES IN CASH AND EQUIVALENTS
FIRST QUARTER OF FISCAL 2001 COMPARED TO FIRST QUARTER OF FISCAL 2000
Cash flow used in operating activities during the first quarter of fiscal
2001 was $24.8 million, compared with cash flow provided by operating activities
of $9.1 million during the first quarter of fiscal 2000. Cash flow used in
operating activities for the first quarter of fiscal 2001 was principally the
result of higher investments in merchandise inventories, net of accounts
payable, in the amount of $54.9 million compared with the first quarter of
fiscal 2000 primarily as a result of new store openings and purchases made in
the first quarter of fiscal 2001 to improve our in-stock position on core
merchandise. Inventories per Michaels store of $1.106 million at May 5, 2001
increased 5% from $1.055 million at April 29, 2000. In connection with our
continuing supply chain management initiatives, our plans are to continue to
increase the basic inventory levels carried in our distribution centers in an
effort to reduce the number of direct vendor shipments to our stores, thereby
reducing the safety stock required at the store level.
Cash flow used in investing activities in the first quarter of fiscal 2001
was $19.0 million compared to $17.2 million in the first quarter of fiscal 2000.
Cash flow from investing activities in the first quarter of fiscal 2001 was
primarily the result of capital expenditures related to the opening of 16
Michaels and four Aaron Brothers stores and the relocation of four Michaels
stores in the first quarter of fiscal 2001. The following table sets forth
capital expenditures for the first quarter of fiscal 2001 and the first quarter
of fiscal 2000:
13 WEEKS ENDED
--------------------
APRIL 29, MAY 5,
2000 2001
--------- --------
(IN THOUSANDS)
New and relocated stores and stores not yet opened........ $10,453 $ 9,691
Existing stores........................................... 997 3,413
Distribution system expansion............................. 210 1,992
Information systems....................................... 4,635 1,984
Corporate and other....................................... 925 1,960
------- -------
$17,220 $19,040
======= =======
26
We anticipate additional capital expenditures during the remainder of fiscal
2001 to total approximately $126.0 million, which amount is net of proceeds of
$26.9 million from the completion in June 2001 of a sale/leaseback transaction
for the two distribution centers which we purchased in December 2000.
Cash flow provided by financing activities in the first quarter of fiscal
2001 was $37.0 million compared to $30.0 million in the first quarter of fiscal
2000. The increase in cash provided by financing activities was primarily due to
net borrowings outstanding under the credit agreement of $29.2 million as of
May 5, 2001 partially offset by a decrease in the proceeds from the exercise of
stock options. Proceeds from the exercise of stock options were $7.8 million for
325,667 shares of our common stock in the first quarter of fiscal 2001 and
$31.3 million for 1,471,529 shares of our common stock in the first quarter of
fiscal 2000.
FISCAL 2000 COMPARED TO FISCAL 1999
Our net cash provided by operating activities in fiscal 2000 was
$146.8 million compared to $60.8 million in fiscal 1999. This increase was due
to increased profitability before depreciation and amortization and a smaller
increase in merchandise inventories for fiscal 2000 compared to fiscal 1999.
Our net cash used in investing activities in fiscal 2000 was $120.1 million
compared to $90.8 million during fiscal 1999. Our cash used in investment
activities resulted from opening 72 Michaels and 25 Aaron Brothers stores and
relocating 17 Michaels and three Aaron Brothers stores during fiscal 2000.
Capital expenditures were approximately $55.1 million for the newly opened
stores, approximately $35.3 million related to existing stores and information
systems enhancements, and approximately $27.6 million related to the exercise of
our option to purchase two distribution facilities that were previously leased.
In addition, we spent approximately $2.2 million related to the acquisition of
the Star Wholesale operation. During fiscal 1999, we opened 69 Michaels and 17
Aaron Brothers stores and relocated 26 Michaels and six Aaron Brothers stores.
Capital expenditures for the newly opened stores were approximately
$58.5 million during fiscal 1999.
Our net cash used in financing activities for fiscal 2000 was $75.9 million
compared to net cash provided by financing activities of $11.3 million in fiscal
1999. This increase in net cash used in financing activities was primarily the
result of repurchases of more shares of our common stock pursuant to the
July 1999 stock repurchase program, partially offset by an increase in proceeds
from the exercise of stock options. During fiscal 2000, we received
$89.5 million from the exercise of stock options for 4,454,332 shares of our
common stock, compared to $28.8 million for 1,857,336 shares during fiscal 1999.
SENIOR UNSECURED BANK CREDIT FACILITY
In May 2001, we completed a new senior unsecured revolving credit facility
of $200 million with our bank lenders, which replaced our previous senior
unsecured $100 million credit facility. Our new bank credit facility provides
for a $200 million revolving line of credit with a $25 million competitive bid
loan feature and a $70 million letter of credit sub-facility. Our new bank
credit facility is further described in "Description of Other Indebtedness." We
are in compliance with all terms and conditions of our credit agreement.
Borrowings outstanding under our credit facility were $29.2 million as of
May 5, 2001. Borrowings available under the credit agreement are reduced by the
aggregate amount of letters of credit outstanding under the credit agreement
($8.7 million at May 5, 2001). Borrowings in the first quarter of fiscal 2001
were outstanding for 79 days, with an average outstanding borrowing of
$13.0 million and a weighted average interest rate of 7.33%.
Borrowings in fiscal 2000 and fiscal 1999 were outstanding under our
previous $100 million credit facility for 47 days and 121 days, respectively, in
connection with the inventory buildup for peak selling seasons (with average
outstanding borrowings of $25 million and $40 million, respectively, and a
weighted average interest rate of 7.80% and 6.29%, respectively).
27
GENERAL
We believe that our available cash, funds generated by operating activities,
funds available under our credit facility, the net proceeds from the outstanding
notes, and proceeds from the exercise of stock options will be sufficient to
redeem the 10 7/8% senior notes due 2006 and fund anticipated capital
expenditures, working capital requirements, and any stock repurchases, for the
foreseeable future.
SEASONALITY
Our business is highly seasonal, with higher sales in the third and fourth
fiscal 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 60% of our operating income. For information with
respect to our quarterly results for fiscal 2000, see the Unaudited Supplemental
Quarterly Financial Data schedule in our Consolidated Financial Statements for
fiscal 2000 included elsewhere in this prospectus.
28
INDUSTRY OVERVIEW
As the leading specialty retailer providing materials, ideas, and education
for creative activities in home decor, art, and craft projects, we believe that
we are well positioned to benefit from several favorable consumer trends. Based
on our historical sales trends, we believe demographic changes, particularly an
aging baby boomer population, and a favorable economic environment have led to
increases in investment in the home and purchases of new homes, an increasing
focus on home-based, family activities, and the trend towards making, rather
than buying, gift items. According to the industry study most recently published
by the Hobby Industry Association, 65% of United States households surveyed had
at least one member who engaged in a craft activity within the prior year. We
compete across several additional industries, including home decor, party
supplies, candles, photo frames, and custom framing. For example, approximately
46% of our sales are derived from three decorative categories--silk and dried
flowers, picture framing, and seasonal products. When this broader focus is
considered, a recently published research report estimates the market in which
our products are sold at over $30 billion.
The market in which we compete is highly fragmented, containing thousands of
stores nationwide operated primarily by small, independent retailers. We are the
largest and only national retailer dedicated to serving the arts and crafts
market, and we believe that there are only four other major arts and crafts
retailers in the United States with annual sales in excess of $200 million.
Moreover, we believe that our fiscal 2000 sales were more than twice as large as
those of our largest direct competitor.
Customers tend to choose where to shop based upon store location, selection,
price, quality of merchandise, availability of product, and customer service. We
compete with many different types of retailers and classify our competition
within the following categories:
- MULTI-STORE CHAINS. This category includes several multi-store chains
operating more than 35 stores in a region and comprises: Hobby Lobby, a
chain which operates approximately 256 stores primarily in the Midwestern
United States; A.C. Moore Arts & Crafts, Inc., a chain which operates
approximately 53 stores in the mid-Atlantic and Northeast regions; Jo-Ann
etc. (operated by Jo-Ann Stores, Inc.), which operates approximately
59 stores across the country; and Garden Ridge Corporation, which operates
approximately 36 stores across the country. All of these chains are
significantly smaller than Michaels with respect to number of stores and
total net sales. While more sophisticated than the small, local specialty
retailer, we believe none of these chains has buying power, distribution,
and advertising capabilities comparable to ours.
- SMALL, LOCAL SPECIALTY RETAILERS. This category includes thousands of
local "Mom & Pop" art and craft retailers. Typically, these are single
store operations managed by the owner. The stores generally offer a
limited selection and have limited resources for advertising, purchasing,
and distribution. Many of these stores have established a loyal customer
base within a given community and compete on customer service.
- MASS MERCHANDISERS. This category includes companies such as Wal-Mart
Stores, Inc. and other mass merchandisers. These retailers typically
dedicate only a small portion of their selling space to a limited
selection of home decor, art and craft supplies, and seasonal merchandise.
In addition, these mass merchandisers generally have limited customer
service staffs with little or no experience in crafting projects.
29
BUSINESS
GENERAL
We are the largest national specialty retailer providing materials, ideas,
and education for creative activities. As of May 5, 2001, we operate
644 Michaels retail stores in 48 states, as well as Canada and Puerto Rico,
which offer products for the do-it-yourself home decorator and art and craft
supplies. We also operate 123 Aaron Brothers stores as of May 5, 2001, primarily
on the West Coast, which offer photo frames, a full line of ready-made frames,
custom framing services, and a wide selection of art supplies. We also own and
operate Star Wholesale, a single wholesale operation located in Dallas, Texas,
offering merchandise primarily to interior decorators/designers, wedding/event
planners, florists, hotels, restaurants, and commercial display companies.
RECENT HISTORY
During the early 1990s, we embarked on an aggressive national expansion
program. By 1995, we had tripled our store base to over 500 stores through new
store openings and acquisitions, accomplishing our goal of becoming the nation's
largest specialty retailer in our industry. However, as a result of the lack of
adequate information systems and infrastructure to support our rapid growth, our
financial results began to weaken. In fiscal 1996, we hired Michael Rouleau, our
current President and Chief Executive Officer, who has focused on increasing the
profitability of our existing stores by implementing a variety of operating
initiatives. These initiatives included installing POS systems chain-wide to
record item-level sales, implementation of plan-o-grams, elimination of non-core
merchandise, reduction of costs through centralized negotiated pricing and
strengthening the quality and depth of our management team.
During fiscal 1997, we continued to focus on key initiatives, including
increasing the number of SKUs replenished and shipped from our distribution
centers to our stores, testing a new store prototype and store opening process,
and improving merchandising in our stores. With the success of these
initiatives, we resumed an accelerated new store opening strategy by opening
50 new Michaels stores during fiscal 1998. We opened 69 Michaels stores and
17 Aaron Brothers stores in fiscal 1999 and 72 Michaels stores and 25 Aaron
Brothers stores in fiscal 2000. Included in our fiscal 1999 and 2000 Michaels
store openings are 15 and one stores, respectively, for which we acquired the
leases from MJDesigns, Inc. During the first quarter of fiscal 2001, we opened
16 Michaels stores and four Aaron Brothers stores.
MERCHANDISING AND MARKETING
PRODUCT SELECTION
Our Michaels store merchandising strategy is to provide a broad selection of
products in an appealing store environment that emphasizes superior customer
service. Each Michaels store offers more than 40,000 SKUs in a number of product
categories. The following table shows a breakdown of sales for Michaels stores
by department as a percentage of total sales for fiscal 1998, 1999, and 2000:
FISCAL YEAR
------------------------------
1998 1999 2000
-------- -------- --------
General crafts............................................. 29% 28% 27%
Picture framing............................................ 18 18 18
Silk and dried floral...................................... 18 17 17
Fine art materials......................................... 16 17 17
Hobby, party, and candles.................................. 11 11 10
Seasonal................................................... 8 9 11
--- --- ---
100% 100% 100%
=== === ===
30
The merchandise offered within each major category is as follows:
- products for the do-it-yourself home decorator, including wall decor,
candles, containers, baskets and potpourri; custom framing services,
ready-made frames, mat boards, glass, backing materials and related
supplies, framed art, and photo albums; and 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;
- art supplies, including memory book materials; surfaces and pads;
adhesives and finishes; and pastels, watercolors, oil paints, acrylics,
easels, brushes, paper, canvas, and stenciling materials; and
- craft supplies, including beads, wood, doll making supplies, jewelry
making supplies, 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, and quilt and
afghan kits; ribbon and wedding accessories; gifts; hobby items including
plastic model kits and related supplies, kids' craft materials, plush
toys, and paint-by-number kits; party needs including paper party goods,
balloons, gift wrap, candy making supplies, and cake decorating supplies;
and candle making supplies.
Our Michaels stores regularly feature seasonal merchandise that complements
our core merchandising strategy. Seasonal merchandise is offered for several
holiday periods, including Valentine's Day, Easter, Mother's Day, Halloween,
Thanksgiving, and Christmas. For example, seasonal merchandise for the Christmas
season includes home decorating components such as 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 decorations and gift making merchandise. Because of the
project-oriented nature of these products, the Christmas selling season begins
in August and extends 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 to meet higher demand from increased
customer traffic.
We routinely identify merchandise that requires some price reduction to
accelerate sales of the product. The need for this reduction is generally
attributable to either seasonal product remaining at the end of the season or
product that is being displaced from its assigned location in the store to make
room for new merchandise. Additional product candidates for repricing are
identified using the POS sales data. In each case, the appropriate repricing is
determined at our corporate office and sent to the stores with instructions on
how to promote sales of the repriced product.
Our Aaron Brothers stores offer on average 7,900 SKUs, including photo
frames, a full line of ready-made frames, and a wide selection of art supplies
and custom framing services. Our merchandising strategy for our Aaron Brothers
stores is to provide guaranteed everyday low-priced custom framing services and
selection, with a 10-day delivery guarantee. In addition, we strive to provide a
fashion forward framing merchandise selection in an appealing environment with
superior customer service.
CUSTOMER SERVICE
We believe that customer service is an important component of our
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, we have displays in every store in an effort to
stimulate new project ideas and we supply free project sheets with detailed
instructions on how to
31
assemble the product. We also offer project sheets on our Internet site,
www.michaels.com, and in our MICHAELS CREATE! magazine. In addition, many
Michaels sales associates are craft enthusiasts who are able to help customers
with ideas and instructions. We periodically offer inexpensive classes and
demonstrations utilizing merchandise available in our stores as a means of
promoting craft trends and expanding our customer base.
ADVERTISING
We focus on circular and newspaper advertising. We have found full-color
circular advertising, primarily as an insert into newspapers, to be the most
effective medium of advertising. The circulars advertise numerous products in
order to emphasize the wide selection of products available at Michaels stores.
We believe that our ability to advertise through circulars and newspapers
throughout the year in each of our markets provides us with an advantage over
our smaller competitors. In addition, our advertising reinforces and strengthens
our brand name. In fiscal 2000, we spent approximately $108.8 million on
advertising.
STORE DESIGN AND OPERATIONS
Our store design encourages purchases in a friendly, interactive
environment. Our Michaels stores average 18,100 square feet of selling space,
and our Aaron Brothers stores average 5,900 square feet of selling space. Many
of the craft supplies sold in our Michaels stores can be assembled into unique
end products with an appropriate amount of guidance and direction. Accordingly,
we display completed projects in every Michaels store in an effort to stimulate
new project ideas and we supply free project sheets with detailed instructions
on how to assemble the product.
Store design is developed centrally and implemented at the store level
through the use of plan-o-grams which provide store associates with detailed
descriptions and illustrations with respect to store layout and merchandise
presentation. Plan-o-grams are also used to cluster various products that can be
combined to create individual projects.
We strive to complement our innovative store design with superior customer
service to provide an enjoyable shopping experience. We believe that prompt,
knowledgeable, and enthusiastic service fosters customer loyalty and can
differentiate us from our competition. Many of our sales associates are craft
enthusiasts who are able to help customers with ideas and instructions.
A Michaels store is typically managed by a store manager, one assistant
manager, and three department managers. The field organization for Michaels 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 12 to 13 district managers. There are a total of 50 districts.
Typically, an Aaron Brothers store is managed by a store manager and one or two
assistant managers. The field organization for Aaron Brothers is headed by a
divisional vice president and is divided into 10 districts, each with a district
manager. We believe this organizational structure enhances the communication
among the individual stores and between the stores and corporate headquarters.
PURCHASING
We purchase merchandise from over 1,400 suppliers. We believe that our
buying power and ability to make centralized purchases enable us to acquire
products on favorable terms. Central merchandising management teams for Michaels
and Aaron Brothers negotiate with vendors on behalf of all their stores in order
to obtain the lowest net merchandise costs and improve control over product mix
and inventory. In fiscal 2000, our top 10 vendors accounted for approximately
19% of total purchases with no single vendor accounting for more than 4% of
total purchases.
32
In addition to purchasing from outside suppliers, our Michaels and Aaron
Brothers stores purchase ready-made frames from our manufacturing division. This
division, which also manufactures and sells custom framing materials and
services to our stores, consists of a manufacturing facility and three regional
processing centers to support our retail stores.
Substantially all of the products sold in Michaels stores are manufactured
in the United States, the Far East, Canada, and Mexico. Goods manufactured in
the Far East generally require long lead times and are ordered four to six
months in advance of delivery. Those products are either imported directly by us
or acquired from distributors based in the United States. In all cases,
purchases are denominated in United States dollars (or Canadian dollars for
purchases of certain items delivered directly to stores in Canada).
Our in-store merchandise assortments are selected by our centralized buying
staff. More than 80% of our SKUs are carried year round and are considered basic
items. These items are reordered by the stores on a weekly basis via a radio
frequency handheld ordering device, or RF gun, and an in-store back-office
computer. The in-store computer then generates an order to be faxed to a vendor
for SKUs not carried in our distribution centers or transmits a replenishment
order to the general office for items carried in our distribution centers.
Late in fiscal 1998, we enhanced the RF gun software to provide the store
order specialists with store specific sales history for any item. Early in
fiscal 1999, store order specialists were given revised ordering procedures that
encompassed the new expanded capability of the RF gun. Consequently, specialists
reordering merchandise now have both the on-hand quantity and the sales history
data at the time they determine order quantities. In fiscal 2000, additional
functionality was added to the RF gun to provide a recommended order quantity
for selected items. Further enhancements are anticipated during fiscal 2001.
DISTRIBUTION
We currently operate a distribution system that supplies our Michaels stores
with merchandise, including substantially all seasonal and promotional items.
Our distribution centers are located in Texas, California, Kentucky, and
Florida. In fiscal 2000, we initiated an expansion of our California
distribution center, and in fiscal 2001, we will begin building a new
distribution facility in the Northeast. These projects, to be completed in the
first half of fiscal 2002, will add approximately 1.1 million square feet to our
current 1.8 million square feet of capacity. Michaels stores generally receive
deliveries from the distribution centers each week through an internal
distribution network using contract carriers. Aaron Brothers stores receive
merchandise from their dedicated distribution center located in the Los Angeles,
California area. Star Wholesale receives its merchandise from direct vendor
shipments.
We believe that our distribution system, with its planned expansion, will
allow us to maintain sufficient inventory in each store to meet our customers'
demands while controlling our overall investment in inventory. We currently have
approximately 16,500 SKUs in our distribution centers. We intend to add
approximately 9,000 SKUs that we will replenish through our distribution centers
after our expansion is completed. We believe our distribution network provides
us with an advantage over our competitors, and we intend to increase the amount
of goods processed through our distribution system to reduce our supply chain
costs and more effectively manage our investment in inventories.
Approximately 57% of Michaels stores' merchandise is shipped through the
Michaels distribution system, with the remainder being shipped directly from
vendors. Approximately 63% of Aaron Brothers stores' merchandise is shipped
through the Aaron Brothers distribution center, with the remainder being shipped
directly from vendors. Each Aaron Brothers store is systematically restocked on
a weekly or biweekly basis.
33
INVENTORY MANAGEMENT
Our 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. We manage our inventory in several ways, including: weekly tracking
of inventory status; the use of plan-o-grams to control the merchandise
assortment; the use of store level RF guns to order merchandise 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 our assortments. The data that we are obtaining from our POS system
is an integral component in the inventory management process. In addition,
inventories are verified through periodic physical counts conducted throughout
the year on a rotating systematic schedule. We anticipate that the additional
information on SKU-level inventories at each store, as provided by a perpetual
inventory system, will dramatically improve our ability to balance our inventory
and improve our replenishment process. We began testing such a perpetual
inventory system in select stores in fiscal 2000, with plans to roll the process
out to all Michaels stores beginning in fiscal 2002.
BUSINESS STRATEGY
We intend to increase our revenues and profits by strengthening our position
as the leading national retailer within the arts and crafts and home decor
sector through the following strategies:
- INCREASE SALES AND PRODUCTIVITY OF MICHAELS STORES. Our Michaels stores
that have been open for more than 12 months currently average
$3.5 million in sales per store. We believe we can increase average sales
per store to $5.0 million. We intend to achieve this objective by
increasing the dollar amount per sale and by creating additional demand
for our products.
- INCREASING DOLLAR AMOUNT PER SALE. We believe if a customer
consistently finds the desired product in-stock, the customer will
view Michaels stores as a store-of-choice and purchase additional
merchandise while in the store. We intend to enhance each store's
in-stock position of key merchandise via the improvement of our
supply chain. Our distribution centers allow us to leverage our
price negotiations with our suppliers by ordering significant
quantities, while also providing us the ability to break large
orders into smaller quantities to allow for a timely and economical
response to stores' in-stock demands. Through our distribution
initiatives in fiscal 2001 and 2002, we will add distribution
capacity of 1.1 million square feet to our existing 1.8 million
square feet. We are also testing a perpetual inventory system, with
an expected roll-out starting in fiscal 2002, to further enhance our
capability to monitor and manage our in-store inventories.
- CREATING ADDITIONAL DEMAND FOR OUR PRODUCTS. We are currently
targeting increased demand for our products through traditional
retail and advertising and multimedia channels. We are implementing
this strategy by:
u holding in-store classes, demonstrations, and other educational
events utilizing merchandise available in our stores,
u promoting craft ideas and projects in our recently launched
bi-monthly MICHAELS CREATE! magazine, which has become the
second most popular arts and crafts publication in its debut
issue. The magazine will be carried by other major retailers,
including K-mart and Target,
u promoting craft ideas on our www.michaels.com website, and
u participating in industry-wide promotion campaigns.
- ENHANCE MERCHANDISE OPERATING MARGINS. We intend to enhance operating
margins through additional leverage of our consolidated purchasing
activities. We plan to leverage our technology
34
systems to improve margins on seasonal products through our implementation
of allocation technologies that more efficiently allocate merchandise
among stores, and to maximize margins on promotional sales by determining
more accurately the most profitable promotional price for each product. We
continue to seek value-added opportunities to complement our core
businesses, such as our recent expansion into art prints and
Michaels-manufactured framing products, which extends and enhances our
custom framing business. In addition, we continue to evaluate
opportunities to further reduce our merchandise costs and ensure adequate
supplies through vertical integration.
- GROW THROUGH NEW MICHAELS STORE OPENINGS. We believe the United States and
Canadian markets can support up to 1,100 Michaels stores. We plan to open
approximately 75 new Michaels stores each year beginning in fiscal 2001
and extending into the foreseeable future, funded primarily through
operating earnings and seasonal borrowings. Since the beginning of fiscal
1998, we have opened or relocated 268 Michaels stores using our standard
operating procedures, which contain more than 500 steps to ensure a smooth
opening with a merchandise assortment and presentation consistent with our
existing stores. We have developed and are refining our Michaels store
prototype to constantly incorporate improved merchandising techniques and
store layouts.
- EXPAND AARON BROTHERS NATIONWIDE. We plan to open approximately 20 new
Aaron Brothers stores in fiscal 2001, also funded primarily through
operating earnings and seasonal borrowings. Assuming successful openings
in new markets, we plan to roll out this concept nationwide and open 25 to
75 new Aaron Brothers stores per year in each of the subsequent three
fiscal years. We believe the United States and Canadian markets can
support up to 600 Aaron Brothers stores.
In addition to the above core business strategies, we also intend to
increase our revenues and profits through the following strategies:
- TEST A WHOLESALE BUSINESS CONCEPT. In May 2000, in connection with our
strategy of developing a wholesale business concept, we acquired Star
Wholesale in Dallas, Texas. The target customers for this concept are
interior decorators/designers, wedding/event planners, florists, hotels,
restaurants, and commercial display companies. Star Wholesale features
approximately 50,000 square feet of selling space and offers approximately
18,000 SKUs. This is a test concept that we see as an additional area in
which we can expand our customer base, leverage our experience and vendor
base, and add growth to our business.
- ENHANCE THE MICHAELS WEBSITE. We have created a Michaels.com division that
is focused on developing and maintaining an innovative online experience
for our customers. The primary focus of our Internet strategy is to
provide information, ideas, and education about crafting and to encourage
consumers using our website to visit our retail stores to purchase
merchandise they need for their projects. We look at our website as a
permanent marketing tool for Michaels and we will use it to enhance our
core retail business and the industry in general. The secondary focus for
our Michaels.com division is to offer merchandise for sale online.
STORE EXPANSION AND RELOCATION
Having achieved our objective of becoming the largest and only national
retailer of arts, crafts, and decorative items, we recognized in 1995 that we
had the critical mass to achieve improved operating efficiencies that could
result in higher returns on capital by focusing on key initiatives, such as
strengthening our information systems and infrastructure to support future store
growth. On August 23, 1995, we announced a shift in focus from sales growth to
realizing higher returns on capital and as a result, moderated our internal
growth rate in number of stores. In fiscal 1998, having successfully
35
completed these initiatives, we returned to an accelerated new store opening
program and have maintained that growth through fiscal 2000. The following table
shows our store growth:
FISCAL YEAR 13 WEEKS
---------------------------------------------------- ENDED
1996 1997 1998 1999 2000 MAY 5, 2001
-------- -------- -------- -------- -------- -----------
MICHAELS STORES:
Retail stores open at end of period................ 453 452 496 559 628 644
Retail stores opened during the period............. 13 9 50 69 72 16
Retail stores closed during the period............. 2 10 6 6 3 --
Retail stores relocated during the period.......... 22 14 14 26 17 4
AARON BROTHERS STORES:
Stores open at end of period....................... 72 74 78 95 119 123
Stores opened during the period.................... 4 3 5 17 25 4
Stores closed during the period.................... -- 1 1 -- 1 --
Stores relocated during the period................. 3 1 5 6 3 --
STAR WHOLESALE STORE:
Wholesale store open at end of period.............. -- -- -- -- 1 1
Wholesale store acquired during the period......... -- -- -- -- 1 --
In keeping with our plans to continue to seek store growth while realizing
higher returns on capital, in fiscal 2001, we plan to open approximately 75 new
and relocate approximately 25 Michaels stores. We also plan to open
approximately 20 new and relocate approximately five Aaron Brothers stores in
fiscal 2001. Assuming successful openings in new markets, we plan to roll this
concept out nationwide and open 25 to 75 new Aaron Brothers stores per year in
each of the subsequent three fiscal years.
Our 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. We believe that
few of our existing markets are saturated. The anticipated opening of Michaels
and Aaron Brothers stores in fiscal 2001 and the rate at which stores are opened
thereafter will depend upon a number of factors, including 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.
Michaels has developed a standardized procedure that allows for the
efficient opening of new stores and their integration into our 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 qualified store opening teams 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 2000, the average net
cost of opening a new Michaels store was approximately $1.2 million, which
included approximately $641,000 of leasehold improvements, furniture, fixtures
and equipment, and pre-opening costs, and an estimated initial inventory
investment (net of accounts payable) of $570,000. The total cost of opening a
new store depends 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 vendor terms and allowances.
In addition to new store openings, we continue to pursue a store relocation
program to improve the quality and performance of our existing store base.
During fiscal 1999 and 2000, we relocated 26 and 17 Michaels stores,
respectively, and six and three Aaron Brothers stores, respectively. We plan to
36
relocate approximately 25 Michaels stores and five Aaron Brothers stores during
fiscal 2001. During fiscal 1999 and 2000, we closed six and three Michaels
stores, respectively, and in fiscal 2000, one Aaron Brothers store. We plan to
close approximately five Michaels stores and no Aaron Brothers stores during
fiscal 2001.
INVESTMENT IN INFORMATION TECHNOLOGY
We are committed to utilizing technology to increase operating efficiencies
and to improve our ability to satisfy the needs of our customers. 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 fiscal 1998, we
completed installation of new networked computer systems in every store to
handle data communications, price management, enhanced radio frequency terminal
applications for inventory management, faster credit authorization, and gift
card processing. In addition, a new standardized warehouse management system
utilizing radio frequency terminals with bar code scanning technology was
installed in all distribution centers. We are continuing to install advanced
merchandise information systems software that will be closely integrated with
store systems and warehouse management systems to provide greatly enhanced
inventory management capabilities, including the benefits attributable to our
planned perpetual inventory and automated replenishment systems. We believe that
information is a competitive tool and intend to be the craft industry leader in
the effective and efficient utilization of this resource.
FOREIGN SALES
Our current international business is concentrated in Canada. Sales outside
the United States accounted for approximately 2% of total sales in fiscal 1998,
3% in fiscal 1999, and 3% in fiscal 2000. During the last three years, less than
5% of our assets have been located outside of the United States.
SERVICE AND TRADE MARKS
The names "Michaels" and "Aaron Brothers" and the Michaels logo are each
federally registered service marks.
EMPLOYEES
As of April 20, 2001, we employed approximately 33,000 associates,
approximately 21,700 of whom were employed on a part-time basis. The number of
part-time associates is substantially increased during the Christmas selling
season. Of our full-time associates, approximately 2,300 are engaged in various
executive, operating, training, distribution, and administrative functions in
our corporate and division offices and distribution centers, and the remainder
are engaged in store operations. None of our associates are members of labor
unions.
PROPERTIES
We lease substantially all of the sites for our Michaels and Aaron Brothers
stores, with lease terms generally ranging from five to 10 years. The base
rental rates for Michaels stores generally range from $85,000 to $340,000 per
year. Rental expense for our Michaels stores open for the full 12-month period
of fiscal 2000 averaged $204,000, and rental expense for our Aaron Brothers
stores open for the full 12-month period of fiscal 2000 averaged $116,000. The
leases are generally renewable with increases in lease rental rates. Lessors
have made leasehold improvements to prepare our stores for opening under a
majority of our existing leases.
In December 2000, we exercised our purchase option on properties we
previously leased and acquired the 423,000 square foot building at the Alliance
Airport in Tarrant County, Texas and the 506,000 square foot building in
Jacksonville, Florida that we use as distribution centers. In June 2001,
37
we completed a sale/leaseback transaction of these two properties. As a result,
we now lease these properties. In addition, we lease a 431,000 square foot
building in Lancaster, California and 421,000 square feet of space in Lexington,
Kentucky for use as distribution centers. Aaron Brothers leases 150,000 square
feet of space in the Los Angeles, California area for use as a distribution
center, a custom framing regional processing center, and other office space. Our
manufacturing division leases 66,000 square feet of space in Kernersville, North
Carolina for use as a manufacturing plant and a custom framing regional
processing center. We lease 144,000 square feet of space in Coppell, Texas for
Michaels.com and its related fulfillment operations, a custom framing regional
processing center, and other office space. We also lease 162,000 square feet of
space in Irving, Texas and 67,000 square feet in Coppell, Texas for our
corporate headquarters along with a 35,000 square foot building in Grand
Prairie, Texas as a processing center.
The following table indicates the number of our retail stores and wholesale
operations located in each state or province as of May 5, 2001:
NUMBER OF
STATE/PROVINCE STORES
-------------- ---------
Alabama........................... 10
Alaska............................ 2
Alberta........................... 5
Arizona(1)........................ 27
Arkansas.......................... 3
British Columbia.................. 3
California(1)..................... 176
Colorado(1)....................... 15
Connecticut....................... 7
Delaware.......................... 2
Florida........................... 35
Georgia........................... 24
Idaho............................. 3
Illinois.......................... 28
Indiana........................... 12
Iowa.............................. 6
Kansas............................ 5
Kentucky.......................... 5
Louisiana......................... 10
Maine............................. 2
Manitoba.......................... 1
Maryland.......................... 16
Massachusetts..................... 13
Michigan.......................... 21
Minnesota......................... 11
Mississippi....................... 3
Missouri.......................... 11
Montana........................... 3
NUMBER OF
STATE/PROVINCE STORES
-------------- ---------
Nebraska.......................... 2
Nevada(1)......................... 10
New Hampshire..................... 5
New Jersey........................ 13
New Mexico........................ 3
New York.......................... 22
North Carolina.................... 20
North Dakota...................... 1
Ohio.............................. 27
Oklahoma.......................... 7
Ontario........................... 17
Oregon(1)......................... 15
Pennsylvania...................... 21
Puerto Rico....................... 3
Rhode Island...................... 1
South Carolina.................... 6
South Dakota...................... 1
Tennessee......................... 10
Texas(1)(2)....................... 61
Utah.............................. 6
Vermont........................... 1
Virginia.......................... 23
Washington(1)..................... 24
West Virginia..................... 3
Wisconsin......................... 7
------
Total............................. 768
======
------------------------
(1) Of the store counts indicated in Arizona, California, Colorado, Nevada,
Oregon, Texas, and Washington, Aaron Brothers accounts for 8, 85, 3, 5, 4,
11, and 7 stores, respectively.
(2) The store count for Texas includes one Star Wholesale store.
38
LEGAL PROCEEDINGS
On May 2, 2000, Taiyeb Raniwala, a former assistant manager of the company,
filed a purported class action complaint (the "Raniwala Complaint") against us,
on behalf of our former and current assistant store managers. The Raniwala
Complaint was filed in the Alameda County Superior Court, California and alleges
we violated various California laws by erroneously treating our assistant store
managers as "exempt" employees who are not entitled to overtime compensation.
Based on these allegations, the Raniwala Complaint asserts we: (1) violated
various California Wage Orders, (2) violated Section 17200 of the California
Business and Professions Code, and (3) engaged in conversion. The Raniwala
Complaint seeks back wages, interest, penalties, and attorneys' fees.
On July 20, 2000, Raniwala filed an amended complaint to correct various
deficiencies in the original Complaint (the "Amended Raniwala Complaint"). On
September 25, 2000, we filed our answer to the Amended Raniwala Complaint.
On June 6, 2001, we negotiated a tentative settlement of the purported class
action with Raniwala. Pursuant to the terms of the settlement, in exchange for a
full release of claims, we are obligated to pay a maximum of $3.0 million
covering all claims and attorneys' fees, plus estimated payroll taxes of
approximately $153,000. The specific terms of the settlement are currently being
finalized between the parties and must then be approved by the Alameda County
Superior Court. While we believe that it is likely that the settlement will be
approved, we can provide no assurance to that effect.
On April 14, 1999, Suzanne Collins, a former assistant manager of our
subsidiary, Aaron Brothers, Inc., filed a class action complaint (the "Collins
Complaint") against Aaron Brothers on behalf of Aaron Brothers' former store
managers, assistant store managers, and managers-in-training. The Collins
Complaint was filed in Los Angeles County Superior Court, California and alleges
that Aaron Brothers violated various California laws by erroneously treating its
store managers, assistant store managers, and managers-in-training as "exempt"
employees who are not entitled to overtime compensation. Based on these
allegations, the Collins Complaint asserts that Aaron Brothers: (1) violated
various California Labor Codes; (2) violated Section 17200 of the California
Business and Professions Code; and (3) engaged in conversion. The Collins
Complaint seeks back wages, interest, penalties, punitive damages and attorneys'
fees.
On June 25, 2001, Collins filed an amended Complaint which expanded the
purported class to include all current salaried store managers, assistant store
managers, and managers-in-training based in California; added a new plaintiff as
a class representative; and added two additional causes of action for injunctive
and declaratory relief.
The Court has set a hearing date during the fourth quarter of fiscal 2001 to
determine whether the case should proceed as a class action lawsuit. A trial
date has not yet been scheduled.
The case is currently in the discovery phase. There can be no assurance that
Aaron Brothers will be successful in defending this litigation or that future
operating results will not be materially adversely affected by the final
resolution of the lawsuit.
We are a defendant from time to time in lawsuits incidental to our business.
Based on currently available information, we believe that resolution of all
known contingencies, including the litigation described above, is uncertain, and
there can be no assurance that future costs of such litigation would not be
material to our financial position or results of operations.
39
MANAGEMENT
The following table lists our directors and executive officers, their ages,
and their positions as of July 31, 2001:
NAME AGE POSITION
---- -------------------- -------------------------------------------------
Charles J. Wyly, Jr................... 67 Chairman of the Board of Directors
Sam Wyly.............................. 66 Vice Chairman of the Board of Directors
Richard E. Hanlon..................... 53 Director
Richard C. Marcus..................... 62 Director
Elizabeth A. VanStory................. 39 Director
R. Michael Rouleau.................... 63 President and Chief Executive Officer
Bryan M. DeCordova.................... 45 Executive Vice President-Chief Financial Officer
Edward F. Sadler...................... 56 Executive Vice President-Store Operations
Robert M. Spencer..................... 61 Executive Vice President-Merchandising
Douglas B. Sullivan................... 50 Executive Vice President-Development
James F. Tucker....................... 56 Executive Vice President-Chief Information
Officer
Thomas C. DeCaro...................... 46 Senior Vice President-Merchandise Planning and
Control
Sue Elliott........................... 50 Senior Vice President-Human Resources
Stephen R. Gartner.................... 51 Senior Vice President-Supply Chain Management
Duane E. Hiemenz...................... 47 Senior Vice President-New Business Development
James C. Neustadt..................... 53 Senior Vice President-Advertising and Marketing
Mr. Charles J. Wyly, Jr. has served as Chairman of the Board since July 2001
and had served as Vice Chairman of the Board since 1985. He became a director in
1984. He co-founded Sterling Software, Inc. in 1981 and, until its acquisition
in 2000 by another company, had served as a director and since 1984 as Vice
Chairman of the Board. Mr. Wyly served as a director of Sterling Commerce, Inc.
from December 1995 until its acquisition in 2000 by another company. Mr. Wyly
was a director of Scottish Annuity & Life Holdings, Ltd. from October 1998 until
November 2000. Mr. Wyly served from 1964 to 1975 as an officer and director,
including serving as President from 1969 to 1973, of University Computing
Company. 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 of that company from 1968 to 1980. He was also a founding
partner of Maverick Capital, Ltd., a manager of equity hedge funds.
Mr. Sam Wyly has served as Vice Chairman of the Board since July 2001 and
had served as Chairman of the Board since 1984. Mr. Wyly is an entrepreneur who
has created and managed several public and private companies. He founded
University Computing Company, which became one of the first computer utility
networks and one of the first software products companies. He was a founder and,
until its acquisition in 2000 by another company, was Chairman and a director of
Sterling Software, Inc., a worldwide supplier of software products. He also was
Chairman of the Executive Committee and a director of Sterling Commerce, Inc.,
until its acquisition in 2000 by another company, and was Chairman and a
director of Scottish Annuity & Life Holdings, Ltd., a variable life insurance
and reinsurance company, from October 1998 until June 2000. He was a founding
partner of Maverick Capital, Ltd., a manager of equity hedge funds.
Mr. Hanlon became a director in April 1990. He has been Senior Vice
President--Investor Relations of AOL Time Warner Inc., the world's first
Internet-powered media and communications company, since its inception in
January 2001. From February 1995 until its inception as AOL Time Warner, Inc. in
January 2001, he held various executive positions at America Online, Inc., a
leading provider of Internet online services. From March 1993 until
February 1995, Mr. Hanlon was President
40
of Hanlon & Co., a consulting firm, and from 1988 until 1993 was Vice
President--Corporate Communications and Secretary of LEGENT Corporation.
Mr. Marcus became a director of Michaels in July 1999. Since January 1997,
Mr. Marcus has served as Senior Advisor to Peter J. Solomon Company, an
investment banking company. From December 1994 through December 1995,
Mr. Marcus served as Chief Executive Officer of Plaid Clothing Group, a
manufacturer of men's tailored clothing. He is currently on the boards of
directors of Zale Corporation, Lands' End, Inc., Fashionmall.com, and
GiftCertificates.com. Prior to these activities, Mr. Marcus was with Neiman
Marcus for 27 years and served as Chairman and Chief Executive Officer from 1979
through 1988.
Ms. VanStory became a director of Michaels in July 1999. Since
October 2000, she has been President of Thinkout, a consulting firm. From
June 1999 until October 2000, she served as President of iMotors.com. From 1997
to June 1999, Ms. VanStory was Vice President of OfficeDepot.com, a division of
Office Depot, Inc. From 1995 to 1997, she served as Vice President and General
Manager of New Media for The Weather Channel. Ms. VanStory began her career in
interactive media as Director of Marketing for Bell Atlantic Video Services,
where she served from 1992 to 1995. From 1988 to 1992, she held several
marketing positions with MCI Telecommunications Corporation. Ms. VanStory was
previously a director of shop.org, an online retailing association.
Mr. Rouleau has served as Chief Executive Officer since April 1996, and has
also served as President from April 1997 to June 1999 and again since
March 2001. Prior to joining us, Mr. Rouleau had served as Executive Vice
President of Store Operations for Lowe's Companies, Inc. from May 1992 until
April 1996 and in addition as President of Lowe's Contractor Yard Division from
February 1995 until April 1996. Prior to joining Lowe's, Mr. Rouleau was a
co-founder and President and Chief Executive Officer of Office Warehouse, which
subsequently merged into Office Max. Mr. Rouleau also served with the Target
Stores division of Dayton Hudson Corporation for 20 years.
Mr. DeCordova became Executive Vice President-Chief Financial Officer in
March 1997. From 1990 until joining us, he served as Vice President of Finance
and Chief Financial Officer, and from May 1991 also as Treasurer, for
Duckwall-ALCO Stores, Inc.
Mr. Sadler became Executive Vice President-Store Operations in
October 1999. From June 1995 until joining us, he was Regional Vice President
and subsequently Senior Vice President-Stores of Caldor. Prior to Caldor,
Mr. Sadler served with Target for 19 years, most recently as Vice President-
Store Operations.
Mr. Spencer became Executive Vice President-Merchandising in January 2001.
From January 1998 until January 2001, he served as Vice President-Northeast
Zone. Prior to joining us, Mr. Spencer held senior management positions at A.C.
Moore, where he was Executive Vice President and Chief Operating Officer from
March 1996 until December 1997, and at McCrory Stores, Target, and W.T. Grant.
Mr. Sullivan became Executive Vice President-Development in April 1997. He
joined Michaels in 1987 and has served in a variety of capacities, overseeing
the Company's store operations, distribution, store opening, real estate, legal,
and personnel functions, including serving as President from August 1995 to
April 1997. Prior to joining us, 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. From 1994 until joining us, Mr. Tucker held the positions of Vice
President of MIS and subsequently Senior Vice President and Chief Information
Officer for Shopko Stores, Inc. Prior to 1994, Mr. Tucker held the position of
Vice President-Management Information Services for Trans World Music Corp.
41
Mr. DeCaro became Senior Vice President-Merchandise Planning and Control in
August 2000. From 1998 until joining us, he was Vice President-Merchandise for
Disneyland Resort. Prior to this, he held the position of Senior Vice
President-Merchandise Planning and Allocation for Kohl's Department Stores from
February 1996 to April 1998. In addition, Mr. DeCaro has held various positions
in Merchandise Planning and Allocation and Finance for The Disney Store, The
Limited Stores, May Department Stores, and Sanger Harris Department Stores.
Ms. Elliott became Senior Vice President-Human Resources in October 2000.
From May 1998 until joining us, she was Senior Vice President-Human Resources
for Luby's, Inc. Prior to this, she held the positions of Vice President-Human
Resources and subsequently Senior Vice President-Italianni's Brand for Carlson
Restaurants Worldwide from January 1993 to May 1998. In addition, Ms. Elliott
has held various human resources and operations positions at PepsiCo (KFC
Restaurants).
Mr. Gartner joined us as Senior Vice President-Supply Chain Management in
May 2001. From 1998 until joining us, Mr. Gartner held the position of Executive
Vice President-Supply Chain Management for DSC Logistics. Prior to DSC
Logistics, Mr. Gartner served with The Pilsbury Company for 20 years, most
recently as Vice President-Distribution Operations.
Mr. Hiemenz became Senior Vice President-New Business Development in
October 1999, after joining us as a Zone Vice President in July 1996 and serving
as Executive Vice President-Store Operations from August 1996 to October 1999.
Prior to joining Michaels, Mr. Hiemenz had served with Lowe's for nine years,
most recently as a Regional Vice President.
Mr. Neustadt joined us as Senior Vice President-Advertising and Marketing in
May 1998. From 1994 until joining us, Mr. Neustadt was Vice
President-Advertising for Lowe's. Prior to Lowe's, he held a variety of
advertising and marketing positions with Montgomery Ward, Handy Andy, and
Payless Cashways, Inc.
DESCRIPTION OF OTHER INDEBTEDNESS
In May 2001, we completed a new senior unsecured bank credit facility with
Fleet National Bank, as administrative agent and lender, and other lending
institutions, which replaced our previous $100 million senior unsecured bank
credit facility. Our new credit agreement has an initial term of three years,
which may be extended for one additional year under specific conditions, and
provides for a $200 million revolving line of credit with a $25 million
competitive bid loan feature and a $70 million letter of credit sub-facility. In
addition, we have an uncommitted documentary letter of credit facility for an
additional $50.0 million and Aaron Brothers has a similar facility for
$2.5 million.
Our credit agreement contains various financial covenants, including:
- balance sheet leverage ratio, not to exceed 0.75 to 1.00. The balance
sheet leverage ratio is defined as (a) the sum of (i) the consolidated
funded debt (as defined in the credit agreement) plus (ii) six times the
consolidated rental expense (as defined in the credit agreement) for the
four most recent consecutive fiscal quarters to (b) the sum of (i) the
total capital (as defined in the credit agreement), plus (ii) six times
the consolidated rental expense for the most recent four consecutive
fiscal quarters,
- cash flow coverage ratio, not to be less than 1.90 to 1.00. The cash flow
coverage ratio is defined as the ratio of (a) the consolidated EBITDAR (as
defined in the credit agreement) to (b) the sum of (i) the consolidated
total interest expense (as defined in the credit agreement), plus
(ii) any scheduled amortization of principal on indebtedness (as defined
in the credit agreement) (including amortization relating to capital
leases), plus (iii) the consolidated rental expense,
42
- cash flow leverage ratio, not to exceed 1.5 to 1.0. The cash flow leverage
ratio is defined as the ratio of (a) the consolidated funded debt as of
the last day of the period to (b) the consolidated EBITDA (as defined in
the credit agreement) for the period, and
- capital expenditure limitation (in the aggregate, subject to certain
limitations, $200 million in 2001, $150 million in 2002, $190 million in
2003, $165 million in 2004, $200 million in 2005) with a permitted
carryover to the next fiscal year of 25% of any unutilized amounts,
and other covenants and events of default customary for bank facilities such as
our credit agreement. Negative covenants include, without limitation, certain
restrictions on indebtedness, liens, investments, distributions, mergers,
consolidations and dispositions of assets, sales of accounts, and negative
pledges. The credit agreement also contains a change of control provision.
Interest on all borrowings varies based upon the type of borrowing, the
fixed charge coverage ratio, and whether we elect to utilize the competitive bid
loan feature available under our credit agreement. If the competitive bid loan
feature is not utilized, the interest rate on borrowings under our credit
agreement is generally (i) the higher of (1) an annual rate of interest
announced from time to time by Fleet National Bank as its "base rate" or
(2) 0.5% above the Federal Funds Effective Rate or (ii) the Eurodollar Rate, as
defined by our credit agreement, plus an applicable margin from 0.55% to 1.15%
based on our fixed charge coverage ratio. If the competitive bid feature is
utilized, loans up to $25 million may be made under our credit agreement at
competitively bid interest rates offered by lending institutions participating
in the facility, which may have the effect of decreasing the amount of interest
we would otherwise be obligated to pay on such borrowings. We are required to
pay a facility fee from 0.20% to 0.35% per annum on the unused portion of the
revolving line of credit as well as letter of credit fees from 0.25% to 1.15%
that vary depending on the fixed charge coverage ratio and the type of letter of
credit.
Our wholly-owned subsidiary, Aaron Brothers, Inc., has guaranteed our
obligations under the credit agreement; if we acquire or create any additional
subsidiaries, the credit agreement may require those subsidiaries to likewise
guarantee our credit agreement obligations if those subsidiaries are
unrestricted subsidiaries as defined under the indenture for the notes. In
addition, the repayment of certain intercompany indebtedness relating to our
trademark and intellectual property licensing arrangements with affiliates,
5931, Inc. and 5931 Business Trust (which is not to exceed $1 billion pursuant
to covenants in the new bank facility), has been subordinated to our obligations
under the credit agreement.
We are in compliance with all terms and conditions of our credit agreement.
Borrowings outstanding under our credit agreement were $29.2 million as of
May 5, 2001. Borrowings available under the credit agreement are reduced by the
aggregate amount of letters of credit outstanding under the credit agreement
($8.7 million at May 5, 2001). Borrowings in the first quarter of fiscal 2001
were outstanding for 79 days, with an average outstanding borrowing of
$13.0 million and a weighted average interest rate of 7.33%.
Our wholly-owned subsidiary, Michaels of Canada, ULC, a Canadian unlimited
liability company, has a line of credit, which may not exceed the US dollar
equivalent of $2.0 million Canadian dollars. This facility has a $1.5 million
revolving line of credit and a $0.5 million third party payment line. We
guarantee this facility. Michaels of Canada pays a standby commitment fee of
1/8 of 1% on the unused portion of the revolving line of credit facility.
Interest on the revolving line of credit for Canadian dollar loans is at the
lender's prime rate for Canadian dollar loans made in Canada. As of May 5, 2001,
there were no outstanding borrowings on this facility.
43
THE EXCHANGE OFFER
PURPOSE AND EFFECT OF THE EXCHANGE OFFER
On July 6, 2001, we sold $200.0 million in principal amount at maturity of
the outstanding notes in a private placement through initial purchasers to a
limited number of "Qualified Institutional Buyers," as defined under the
Securities Act of 1933. In connection with the sale of the outstanding notes,
Michaels Stores and the initial purchasers entered into a registration rights
agreement, dated as of July 6, 2001. Under that agreement, Michaels Stores must,
among other things, use its commercially reasonable efforts to file with the SEC
a registration statement under the Securities Act covering the exchange offer
and to cause that registration statement to become effective under the
Securities Act. Upon the effectiveness of that registration statement, Michaels
Stores must also offer each holder of the outstanding notes the opportunity to
exchange its securities for an equal principal amount at maturity of exchange
notes. You are a holder with respect to the exchange offer if you are a person
in whose name any outstanding notes are registered on Michaels Stores' books or
any other person who has obtained a properly completed assignment of outstanding
notes from the registered holder.
Michaels Stores is making the exchange offer to comply with its obligations
under the registration rights agreement. A copy of the registration rights
agreement has been filed as an exhibit to the registration statement of which
this prospectus is a part.
In order to participate in the exchange offer, you must represent to
Michaels Stores, among other things, that:
- the exchange notes being acquired pursuant to the exchange offer are being
obtained in the ordinary course of business of the person receiving the
exchange notes,
- neither you nor any other person is engaging in or intends to engage in a
distribution of those exchange notes,
- neither you nor any other person has an arrangement or understanding with
any third person to participate in the distribution of the exchange notes,
and
- neither you nor any other person is an affiliate of Michaels Stores. An
affiliate is any person who "controls or is controlled by or is under
common control with" Michaels Stores.
RESALE OF THE EXCHANGE NOTES
Based on a previous interpretation by the Staff of the SEC set forth in
no-action letters issued to third parties, including Exxon Capital Holdings
Corporation (available May 13, 1988), Morgan Stanley & Co. Incorporated
(available June 5, 1991), Mary Kay Cosmetics, Inc. (available June 5, 1991),
Warnaco, Inc. (available October 11, 1991), and K-III Communications Corp.
(available May 14, 1993), Michaels Stores believes that the exchange notes
issued in the exchange offer may be offered for resale, resold, and otherwise
transferred by you, except if you are an affiliate of Michaels Stores, without
compliance with the registration and prospectus delivery provisions of the
Securities Act, provided that the representations set forth in "--Purpose and
Effect of the Exchange Offer" apply to you.
If you tender in the exchange offer with the intention of participating in a
distribution of the exchange notes, you cannot rely on the interpretation by the
Staff of the SEC as set forth in the Morgan Stanley & Co. Incorporated no-action
letter and other similar letters and you must comply with the registration and
prospectus delivery requirements of the Securities Act in connection with a
secondary resale transaction. In the event that Michaels Stores' belief
regarding resale is inaccurate, those who transfer exchange notes in violation
of the prospectus delivery provisions of the Securities Act and without an
exemption from registration under the federal securities laws may incur
liability under these laws. Michaels Stores does not assume or indemnify you
against this liability.
44
The exchange offer is not being made to, nor will Michaels Stores accept
surrenders for exchange from, holders of outstanding notes in any jurisdiction
in which the exchange offer or the acceptance thereof would not be in compliance
with the securities or blue sky laws of the particular jurisdiction. Each
broker-dealer that receives exchange notes for its own account in exchange for
outstanding notes, where the outstanding notes were acquired by that
broker-dealer as a result of market-making activities or other trading
activities, must acknowledge that it will deliver a prospectus in connection
with any resale of the exchange notes. In order to facilitate the disposition of
exchange notes by broker-dealers participating in the exchange offer, Michaels
Stores has agreed, subject to specific conditions, to make this prospectus, as
it may be amended or supplemented from time to time, available for delivery by
those broker-dealers to satisfy their prospectus delivery obligations under the
Securities Act. Any holder that is a broker-dealer participating in the exchange
offer must notify the exchange agent at the telephone number set forth in the
enclosed Letter of Transmittal and must comply with the procedures for
brokers-dealers participating in the exchange offer. Michaels Stores has not
entered into any arrangement or understanding with any person to distribute the
exchange notes to be received in the exchange offer. See "Plan of Distribution."
TERMS OF THE EXCHANGE OFFER
Upon the terms and subject to the conditions set forth in this prospectus
and in the Letter of Transmittal, Michaels Stores will accept any and all
outstanding notes validly tendered and not withdrawn prior to 5:00 p.m., New
York City time, on the day the exchange offer expires.
As of the date of this prospectus, $200.0 million in principal amount at
maturity of the notes are outstanding. This prospectus, together with the Letter
of Transmittal, is being sent to all registered holders of the outstanding notes
on this date. There will be no fixed record date for determining registered
holders of the outstanding notes entitled to participate in the exchange offer;
however, holders of the outstanding notes must tender their certificates
therefor or cause their outstanding notes to be tendered by book-entry transfer
prior to the expiration date of the exchange offer to participate.
The form and terms of the exchange notes will be the same as the form and
terms of the outstanding notes except that the exchange notes will be registered
under the Securities Act and therefore will not bear legends restricting their
transfer. Following consummation of the exchange offer, all rights under the
registration rights agreement accorded to holders of outstanding notes,
including the right to receive additional incremental interest on the
outstanding notes, to the extent and in the circumstances specified in the
registration rights agreement, will terminate.
Michaels Stores intends to conduct the exchange offer in accordance with the
provisions of the registration rights agreement and applicable federal
securities laws. Outstanding notes that are not tendered for exchange under the
exchange offer will remain outstanding and will be entitled to the rights under
the related indenture. Any outstanding notes not tendered for exchange will not
retain any rights under the registration rights agreement and will remain
subject to transfer restrictions. See "--Consequences of Failure to Exchange."
Michaels Stores will be deemed to have accepted validly tendered outstanding
notes when, as and if Michaels Stores will have given oral or written notice of
its acceptance to the exchange agent. The exchange agent will act as agent for
the tendering holders for the purposes of receiving the exchange notes from
Michaels Stores. If any tendered outstanding notes are not accepted for exchange
because of an invalid tender, the occurrence of other events set forth in this
prospectus, or otherwise, certificates for any unaccepted outstanding notes will
be returned, or, in the case of outstanding notes tendered by book-entry
transfer, those unaccepted outstanding notes will be credited to an account
maintained with The Depository Trust Company, without expense to the tendering
holder of those outstanding notes as promptly as practicable after the
expiration date of the exchange offer. See "--Procedures for Tendering."
45
Those who tender outstanding notes in the exchange offer will not be
required to pay brokerage commissions or fees or, subject to the instructions in
the Letter of Transmittal, transfer taxes with respect to the exchange pursuant
to the exchange offer. Michaels Stores will pay all charges and expenses, other
than applicable taxes described below, in connection with the exchange offer.
See "--Fees and Expenses."
EXPIRATION DATE; EXTENSIONS; AMENDMENTS
The expiration date is 5:00 p.m., New York City time on , 2001,
unless Michaels Stores, in its sole discretion, extends the exchange offer, in
which case, the expiration date will be the latest date and time to which the
exchange offer is extended. Michaels Stores may, in its sole discretion, extend
the expiration date of, or terminate, the exchange offer.
To extend the exchange offer, Michaels Stores must notify the exchange agent
by oral or written notice prior to 9:00 a.m., New York City time, on the next
business day after the previously scheduled expiration date and make a public
announcement of the extension.
Michaels Stores reserves the right:
- to delay accepting any outstanding notes, to extend the exchange offer or
to terminate the exchange offer if any of the conditions set forth below
under "--Conditions" are not satisfied by giving oral or written notice of
the delay, extension, or termination to the exchange agent; or
- to amend the terms of the exchange offer in any manner consistent with the
registration rights agreement.
Any delay in acceptances, extension, termination, or amendment will be
followed as promptly as practicable by oral or written notice of the delay to
the registered holders of the outstanding notes. If Michaels Stores amends the
exchange offer in a manner that constitutes a material change, Michaels Stores
will promptly disclose the amendment by means of a prospectus supplement that
will be distributed to the registered holders of the outstanding notes, and
Michaels Stores will extend the exchange offer for a period of five to ten
business days, depending upon the significance of the amendment and the manner
of disclosure to the registered holders of the outstanding notes, if the
exchange offer would otherwise expire during the five to ten business day
period.
Without limiting the manner in which Michaels Stores may choose to make a
public announcement of any delay, extension, amendment, or termination of the
exchange offer, Michaels Stores will have no obligation to publish, advertise,
or otherwise communicate that public announcement, other than by making a timely
release to an appropriate news agency.
Upon satisfaction or waiver of all the conditions to the exchange offer,
Michaels Stores will accept, promptly after the expiration date of the exchange
offer, all outstanding notes properly tendered and will issue the exchange notes
promptly after acceptance of the outstanding notes. See "--Conditions" below.
For purposes of the exchange offer, Michaels Stores will be deemed to have
accepted properly tendered outstanding notes for exchange when, as and if
Michaels Stores will have given oral or written notice of its acceptance to the
exchange agent.
In all cases, issuance of the exchange notes for outstanding notes that are
accepted for exchange pursuant to the exchange offer will be made only after
timely receipt by the exchange agent of certificates for those outstanding notes
or a timely confirmation of book-entry transfer of the outstanding notes into
the exchange agent's account at The Depository Trust Company, a properly
completed and duly executed Letter of Transmittal, and all other required
documents; provided, however, that Michaels Stores reserves the absolute right
to waive any defects or irregularities in the tender of outstanding notes or in
the satisfaction of conditions of the exchange offer by holders of the
outstanding notes. If any tendered outstanding notes are not accepted for any
reason set forth in the
46
terms and conditions of the exchange offer, if the holder withdraws such
previously tendered outstanding notes, or if outstanding notes are submitted for
a greater principal amount of outstanding notes than the holder desires to
exchange, then the unaccepted, withdrawn or portion of non-exchanged outstanding
notes, as appropriate, will be returned as promptly as practicable after the
expiration or termination of the exchange offer, or, in the case of outstanding
notes tendered by book-entry transfer, those unaccepted, withdrawn or portion of
non-exchanged outstanding notes, as appropriate, will be credited to an account
maintained with The Depository Trust Company, without expense to the tendering
holder thereof.
CONDITIONS
Without regard to other terms of the exchange offer, Michaels Stores will
not be required to exchange any exchange notes for any outstanding notes and may
terminate the exchange offer before the acceptance of any outstanding notes for
exchange, if:
- any action or proceeding is instituted or threatened in any court or by or
before any governmental agency with respect to the exchange offer which,
in Michaels Stores' reasonable judgment, might materially impair the
ability of Michaels Stores to proceed with the exchange offer;
- the Staff of the SEC proposes, adopts or enacts any law, statute, rule or
regulation or issues any interpretation of any existing law, statute, rule
or regulation, which, in Michaels Stores' reasonable judgment, might
materially impair the ability of Michaels Stores to proceed with the
exchange offer; or
- any governmental approval or approval by holders of the outstanding notes
has not been obtained, which approval Michaels Stores will, in its
reasonable judgment, deem necessary for the consummation of the exchange
offer.
If Michaels Stores determines that any of these conditions are not
satisfied, Michaels Stores may
- refuse to accept any outstanding notes and return all tendered outstanding
notes to the tendering holders, or, in the case of outstanding notes
tendered by book-entry transfer, credit those outstanding notes to an
account maintained with The Depository Trust Company,
- extend the exchange offer and retain all outstanding notes tendered prior
to the expiration of the exchange offer, subject, however, to the rights
of holders who tendered the outstanding notes to withdraw their tendered
outstanding notes, or
- waive unsatisfied conditions with respect to the exchange offer and accept
all properly tendered outstanding notes that have not been withdrawn. If
the waiver constitutes a material change to the exchange offer, Michaels
Stores will promptly disclose the waiver by means of a prospectus
supplement that will be distributed to the registered holders of the
outstanding notes, and Michaels Stores will extend the exchange offer for
a period of five to ten business days, depending upon the significance of
the waiver and the manner of disclosure to the registered holders of the
outstanding notes, if the exchange offer would otherwise expire during
this period.
PROCEDURES FOR TENDERING
To tender in the exchange offer, you must complete, sign and date an
original or facsimile Letter of Transmittal, have the signatures thereon
guaranteed if required by the Letter of Transmittal, and mail or otherwise
deliver the Letter of Transmittal to the exchange agent prior to the expiration
date of the exchange offer. In addition, either:
- certificates for the outstanding notes must be received by the exchange
agent, along with the Letter of Transmittal, or
47
- a timely confirmation of transfer by book-entry of those outstanding
notes, if the book-entry procedure is available, into the exchange agent's
account at The Depository Trust Company, as set forth in the procedure for
book-entry transfer described below, which the exchange agent must receive
prior to the expiration date of the exchange offer, or
you must comply with the guaranteed delivery procedures described below.
To be tendered effectively, the exchange agent must receive the Letter of
Transmittal and other required documents at the address set forth below under
"--Exchange Agent" prior to the expiration of the exchange offer.
If you tender your outstanding notes and do not withdraw them prior to the
expiration date of the exchange offer, you will be deemed to have an agreement
with Michaels Stores in accordance with the terms and subject to the conditions
set forth in this prospectus and in the Letter of Transmittal.
THE METHOD OF DELIVERY OF OUTSTANDING NOTES AND THE LETTER OF TRANSMITTAL
AND ALL OTHER REQUIRED DOCUMENTS TO THE EXCHANGE AGENT IS AT YOUR RISK. INSTEAD
OF DELIVERY BY MAIL, IT IS RECOMMENDED THAT YOU USE AN OVERNIGHT OR HAND
DELIVERY SERVICE, PROPERLY INSURED. IN ALL CASES, SUFFICIENT TIME SHOULD BE
ALLOWED TO ASSURE DELIVERY TO THE EXCHANGE AGENT BEFORE THE EXPIRATION DATE OF
THE EXCHANGE OFFER. NO LETTER OF TRANSMITTAL OR OUTSTANDING NOTES SHOULD BE SENT
TO MICHAELS STORES. YOU MAY REQUEST YOUR RESPECTIVE BROKERS, DEALERS, COMMERCIAL
BANKS, TRUST COMPANIES, OR NOMINEES TO EFFECT THE ABOVE TRANSACTIONS FOR YOU.
Any beneficial owner whose outstanding notes are registered in the name of a
broker, dealer, commercial bank, trust company, or other nominee and who wishes
to tender its outstanding notes should contact the registered holder promptly
and instruct that registered holder to tender the outstanding notes on the
beneficial owner's behalf. If the beneficial owner wishes to tender its
outstanding notes on the owner's own behalf, that owner must, prior to
completing and executing the Letter of Transmittal and delivering its
outstanding notes, either make appropriate arrangements to register ownership of
the outstanding notes in that owner's name or obtain a properly completed
assignment from the registered holder. The transfer of registered ownership of
outstanding notes may take considerable time.
Signatures on a Letter of Transmittal or a notice of withdrawal, as the case
may be, must be guaranteed by an eligible institution unless the outstanding
notes tendered pursuant thereto are tendered:
- by a registered holder who has not completed the box entitled "Special
Payment Instructions" or "Special Delivery Instructions" on the Letter of
Transmittal, or
- for the account of an eligible institution.
In the event that signatures on a Letter of Transmittal or a notice of
withdrawal, as the case may be, are required to be guaranteed, each of the
following is deemed an eligible institution:
- a member firm of a registered national securities exchange or of the
National Association of Securities Dealers, Inc.,
- commercial bank,
- trust company having an office or correspondent in the United States, or
- eligible guarantor institution as provided by Rule 17Ad-15 of the
Securities Exchange Act of 1934.
48
If the Letter of Transmittal is signed by a person other than the registered
holder of any outstanding notes, the outstanding notes must be endorsed or
accompanied by a properly completed bond power, signed by the registered holder
as his, her or its name appears on the outstanding notes.
If trustees, executors, administrators, guardians, attorneys-in-fact,
officers of corporations or others acting in a fiduciary or representative
capacity sign the Letter of Transmittal or any outstanding notes or bond power,
those persons should so indicate when signing, and unless Michaels Stores waives
evidence satisfactory to Michaels Stores of their authority to so act must be
submitted with the Letter of Transmittal.
Michaels Stores will determine all questions as to the validity, form,
eligibility, including time of receipt, acceptance of tendered outstanding
notes, and withdrawal of tendered outstanding notes, in its sole discretion. All
of these determinations by Michaels Stores will be final and binding. Michaels
Stores reserves the absolute right to reject any and all outstanding notes not
properly tendered or any outstanding notes Michaels Stores' acceptance of which
would, in the opinion of counsel for Michaels Stores, be unlawful. Michaels
Stores also reserves the right to waive any defects, irregularities or
conditions of tender as to particular outstanding notes. Michaels Stores'
interpretation of the terms and conditions of the exchange offer, including the
instructions in the Letter of Transmittal will be final and binding on all
parties. Unless waived, any defects or irregularities in connection with tenders
of outstanding notes must be cured within the time Michaels Stores determines.
Although Michaels Stores intends to notify holders of outstanding notes of
defects or irregularities with respect to tenders of outstanding notes, neither
Michaels Stores, nor the exchange agent, or any other person will incur any
liability for failure to give this notification. Tenders of outstanding notes
will not be deemed to have been made until defects or irregularities have been
cured or waived. Any outstanding notes received by the exchange agent that are
not properly tendered and as to which the defects or irregularities have not
been cured or waived will be returned by the exchange agent to the tendering
holders of outstanding notes, unless otherwise provided in the Letter of
Transmittal, as soon as practicable following the expiration date of the
exchange offer.
In addition, Michaels Stores reserves the right, in its sole discretion, to
purchase or make offers for any outstanding notes that remain outstanding
subsequent to the expiration date of the exchange offer or, as set forth above
under "--Conditions," to terminate the exchange offer and, to the extent
permitted by applicable law and the terms of its agreements relating to its
outstanding indebtedness, purchase outstanding notes in the open market, in
privately negotiated transactions or otherwise. The terms of any purchases or
offers could differ from the terms of the exchange offer.
If the holder of outstanding notes is a broker-dealer participating in the
exchange offer that will receive exchange notes for its own account in exchange
for outstanding notes that were acquired as a result of market-making activities
or other trading activities, that broker-dealer will be required to acknowledge
in the Letter of Transmittal that it will deliver a prospectus in connection
with any resale of the exchange notes and otherwise agree to comply with the
procedures described above under "--Resale of the Exchange Notes"; however, by
so acknowledging and delivering a prospectus, that broker-dealer will not be
deemed to admit that it is an "underwriter" within the meaning of the Securities
Act.
In all cases, issuance of exchange notes pursuant to the exchange offer will
be made only after timely receipt by the exchange agent of certificates for the
outstanding notes or a timely confirmation of book-entry transfer of outstanding
notes into the exchange agent's account at The Depository Trust Company, a
properly completed and duly executed Letter of Transmittal, and all other
required documents. If any tendered outstanding notes are not accepted for any
reason set forth in the terms and conditions of the exchange offer or if
outstanding notes are submitted for a greater principal amount of outstanding
notes than the holder of outstanding notes desires to exchange, the unaccepted
or portion of non-exchanged outstanding notes will be returned as promptly as
practicable after the
49
expiration or termination of the exchange offer, or, in the case of outstanding
notes tendered by book-entry transfer into the exchange agent's account at The
Depository Trust Company pursuant to the book-entry transfer procedures
described below, the unaccepted or portion of non-exchanged outstanding notes
will be credited to an account maintained with The Depository Trust Company,
without expense to the tendering holder of outstanding notes.
BOOK-ENTRY TRANSFER
The exchange agent will make a request to establish an account with respect
to the outstanding notes at The Depository Trust Company for the purposes of the
exchange offer within two business days after the date of this prospectus, and
any financial institution that is a participant in The Depository Trust
Company's systems may make book-entry delivery of outstanding notes by causing
The Depository Trust Company to transfer the outstanding notes into the exchange
agent's account at The Depository Trust Company in accordance with The
Depository Trust Company's procedures for transfer. However, although delivery
of outstanding notes may be effected through book-entry transfer at The
Depository Trust Company, the Letter of Transmittal or facsimile thereof, with
any required signature guarantees and any other required documents, must, in any
case, be transmitted to and received by the exchange agent at the address set
forth below under "--Exchange Agent" on or prior to the expiration date of the
exchange offer, unless the holder complies with the guaranteed delivery
procedures described below.
GUARANTEED DELIVERY PROCEDURES
Holders who wish to tender their outstanding notes and (1) whose outstanding
notes are not immediately available or (2) who cannot deliver their outstanding
notes, the Letter of Transmittal, or any other required documents to the
exchange agent prior to the expiration date, may effect a tender if:
- The tender is made through an eligible institution;
- Prior to the expiration date of the exchange offer, the exchange agent
receives from such eligible institution a properly completed and duly
executed Notice of Guaranteed Delivery, by facsimile transmission, mail or
hand delivery, setting forth the name and address of the holder, the
certificate number(s) of the outstanding notes and the principal amount of
outstanding notes tendered and stating that the tender is being made
thereby and guaranteeing that, within three Nasdaq National Market trading
days after the expiration date of the exchange offer, the Letter of
Transmittal, together with the certificate(s) representing the outstanding
notes in proper form for transfer or a confirmation of book-entry
transfer, as the case may be, and any other documents required by the
Letter of Transmittal will be deposited by the eligible institution with
the exchange agent; and
- The exchange agent receives the properly completed and executed Letter of
Transmittal, as well as the certificate(s) representing all tendered
outstanding notes in proper form for transfer and other documents required
by the Letter of Transmittal within three Nasdaq National Market trading
days after the expiration date of the exchange offer.
Upon request to the exchange agent, a Notice of Guaranteed Delivery will be
sent to holders who wish to tender their outstanding notes according to the
guaranteed delivery procedures set forth above.
WITHDRAWAL OF TENDERS
Except as otherwise provided, tenders of outstanding notes may be withdrawn
at any time prior to 5:00 p.m., New York City time, on the expiration date of
the exchange offer.
50
To withdraw a tender of outstanding notes in the exchange offer, a written
or facsimile transmission notice of withdrawal must be received by the exchange
agent at its address set forth herein prior to 5:00 p.m., New York City time, on
the expiration date of the exchange offer. Any such notice of withdrawal must
- specify the name of the person having deposited the outstanding notes to
be withdrawn,
- identify the outstanding notes to be withdrawn,
- be signed by the holder in the same manner as the original signature on
the Letter of Transmittal by which the outstanding notes were tendered or
be accompanied by documents of transfer sufficient to have the exchange
agent register the transfer of the outstanding notes in the name of the
person withdrawing the tender, and
- specify the name in which any outstanding notes are to be registered, if
different from that of the person who deposited the outstanding notes to
be withdrawn.
Michaels Stores will determine all questions as to the validity, form, and
eligibility of the notices, whose determination will be final and binding on all
parties. Any outstanding notes so withdrawn will be deemed not to have been
validly tendered for purposes of the exchange offer, and no exchange notes will
be issued with respect to those outstanding notes unless the outstanding notes
so withdrawn are validly retendered.
Any outstanding notes that have been tendered but that are not accepted for
payment will be returned to the holder of those outstanding notes, or in the
case of outstanding notes tendered by book-entry transfer, will be credited to
an account maintained with The Depository Trust Company, without cost to the
holder as soon as practicable after withdrawal, rejection of tender or
termination of the exchange offer. Properly withdrawn outstanding notes may be
retendered by following one of the procedures described above under
"--Procedures for Tendering" at any time prior to the expiration date of the
exchange offer.
TERMINATION OF CERTAIN RIGHTS
All rights given to holders of outstanding notes under the registration
rights agreement will terminate upon the consummation of the exchange offer
except with respect to Michaels Stores' duty:
- to keep the registration statement effective until the closing of the
exchange offer, and
- to provide copies of the latest version of this prospectus to any
broker-dealer that requests copies of this prospectus for use in
connection with any resale by that broker-dealer of exchange notes
received for its own account pursuant to the exchange offer in exchange
for outstanding notes acquired for its own account as a result of
market-making or other trading activities, subject to the conditions
described above under "--Resale of the Exchange Notes."
EXCHANGE AGENT
The Bank of New York has been appointed exchange agent for the exchange
offer. Questions and requests for assistance, requests for additional copies of
this prospectus or the Letter of Transmittal,
51
and requests for copies of the Notice of Guaranteed Delivery with respect to the
outstanding notes should be addressed to the exchange agent as follows:
By Hand or Overnight Courier: By Registered or Certified Mail:
101 Barclay Street 101 Barclay Street, 7E
New York, New York 10286 New York, New York 10286
Corporate Trust Services Window Attention: Diane Amorroso
Ground Level Reorganization Section
Attention: Diane Amorroso
Reorganization Section
By Telephone (to confirm receipt of facsimile): (202) 815-3738
By Facsimile (for Eligible Institutions only): (212) 815-6339
FEES AND EXPENSES
Michaels Stores will pay the expenses of soliciting tenders in connection
with the exchange offer. The principal solicitation is being made by mail;
however, additional solicitation may be made by telecopier, telephone, or in
person by officers and regular employees of Michaels Stores and its affiliates.
Michaels Stores has not retained any dealer-manager in connection with the
exchange offer and will not make any payments to broker-dealers or others
soliciting acceptances of the exchange offer. Michaels Stores, however, will pay
the exchange agent reasonable and customary fees for its services and will
reimburse the exchange agent for its reasonable out-of-pocket expenses in
connection with the exchange offer.
Michaels Stores estimates that its cash expenses in connection with the
exchange offer will be approximately $75,000. These expenses include
registration fees, fees and expenses of the exchange agent, accounting and legal
fees, and printing costs, among others.
Michaels Stores will pay all transfer taxes, if any, applicable to the
exchange of the outstanding notes for exchange notes. The tendering holder of
outstanding notes, however, will pay applicable taxes if certificates
representing outstanding notes not tendered or accepted for exchange are to be
delivered to, or are to be issued in the name of, any person other than the
registered holder of outstanding notes tendered, or
- if tendered, the certificates representing outstanding notes are
registered in the name of any person other than the person signing the
Letter of Transmittal, or
- if a transfer tax is imposed for any reason other than the exchange of the
outstanding notes in the exchange offer.
If satisfactory evidence of payment of the transfer taxes or exemption from
payment of transfer taxes is not submitted with the Letter of Transmittal, the
amount of the transfer taxes will be billed directly to the tendering holder and
the exchange notes need not be delivered until the transfer taxes are paid.
CONSEQUENCES OF FAILURE TO EXCHANGE
Participation in the exchange offer is voluntary. Holders of the outstanding
notes are urged to consult their financial and tax advisors in making their own
decisions on what action to take.
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Outstanding notes that are not exchanged for the exchange notes in the
exchange offer will not retain any rights under the registration rights
agreement and will remain restricted securities for purposes of the federal
securities laws. Accordingly, the outstanding notes may not be offered, sold,
pledged, or otherwise transferred except:
- to Michaels Stores or any subsidiary thereof;
- to a "Qualified Institutional Buyer" within the meaning of Rule 144A under
the Securities Act purchasing for its own account or for the account of a
qualified institutional buyer in a transaction meeting the requirements of
Rule 144A;
- pursuant to an exemption from registration under the Securities Act
provided by Rule 144 thereunder, if available; or
- pursuant to an effective registration statement under the Securities Act,
and, in each case, in accordance with all other applicable securities laws.
ACCOUNTING TREATMENT
For accounting purposes, Michaels Stores will recognize no gain or loss as a
result of the exchange offer. The exchange notes will be recorded at the same
carrying value as the outstanding notes, as reflected in Michaels Stores'
accounting records on the date of the exchange. The expenses of the exchange
offer will be amortized over the remaining term of the exchange notes.
53
DESCRIPTION OF THE NOTES
GENERAL
The outstanding notes were and the exchange notes will be issued under an
Indenture, dated as of July 6, 2001 (the "Indenture"), between Michaels
Stores, Inc. (the "Company") and The Bank of New York, as Trustee (the
"Trustee"). All references in this section to "the Company" do not include our
subsidiaries unless the context otherwise requires and all references to "the
Notes" include the outstanding notes and the exchange notes.
The following summary of certain provisions of the Indenture and the Notes
does not purport to be complete and is subject to, and is qualified in its
entirety by reference to, all the provisions of the Indenture, including the
definitions of certain terms therein and those terms made a part thereof by the
TIA. The summary provides an accurate description of all material terms of the
Notes. Capitalized terms used herein and not otherwise defined have the meanings
set forth under "--Certain Definitions."
Principal of, premium, if any, and interest on the Notes will be payable,
and the Notes may be exchanged or transferred, at the office or agency of the
Company in the Borough of Manhattan, The City of New York (which initially shall
be the corporate trust office of the Trustee, at 101 Barclay Street, New York,
New York 10286), except that, at the option of the Company, payment of interest
may be made by check mailed to the registered holders of the Notes at their
registered addresses.
The Notes will be issued only in fully registered form, without coupons, in
denominations of $1,000 and any integral multiple of $1,000. No service charge
will be made for any registration of transfer or exchange of Notes, but the
Company may require payment of a sum sufficient to cover any transfer tax or
other similar governmental charge payable in connection therewith.
The definition of "Restricted Subsidiary" in the Indenture will exclude any
"Unrestricted Subsidiary" and, as a result, Unrestricted Subsidiaries generally
will not be bound by the restrictive provisions of the Indenture. The Board of
Directors will have the ability, subject to the provisions of the Indenture, to
designate certain other Restricted Subsidiaries as Unrestricted Subsidiaries
after the Issue Date. Subject to the provisions of the Indenture, the Board of
Directors may also designate Unrestricted Subsidiaries to be Restricted
Subsidiaries. See the definitions of "Restricted Subsidiary" and "Unrestricted
Subsidiary" and "--Certain Covenants--Limitation on Restricted Payments" herein.
TERMS OF THE NOTES
The Notes are unsecured, senior obligations of the Company, are initially in
the aggregate principal amount of $200.0 million, subject to our ability to
issue additional notes which may be of the same series as these Notes and,
together with these Notes, will not exceed $250.0 million in the aggregate, as
described under "--Further Issues." The Notes mature on July 1, 2009.
Each Note bears interest at a rate per annum of 9 1/4% from July 6, 2001, or
from the most recent date to which interest has been paid or provided for,
payable semiannually to Holders of record at the close of business on the
June 15 or December 15 immediately preceding the interest payment date on
January 1 and July 1 of each year, commencing January 1, 2002. Interest on the
Notes will be computed on the basis of a 360-day year of twelve 30-day months.
OPTIONAL REDEMPTION
The Notes will be redeemable, at the Company's option, in whole or in part,
at any time on or after July 1, 2005, and prior to maturity, upon not less than
30 nor more than 60 days' prior notice mailed by first-class mail to each
Holder's registered address, at the following redemption prices (expressed as a
percentage of principal amount), plus accrued interest, if any, to the
redemption date
54
(subject to the right of Holders of record on the relevant record date to
receive interest due on the relevant interest payment date), if redeemed during
the 12-month period commencing on July 1 of the years set forth below:
REDEMPTION
PERIOD PRICE
------ -----------
2005........................................................ 104.625%
2006........................................................ 102.313%
2007 and thereafter......................................... 100%
In addition, at any time and from time to time prior to July 1, 2004, the
Company may redeem in the aggregate up to 35% of the aggregate principal amount
of the Notes with the proceeds of one or more Equity Offerings so long as there
is a Public Market at the time of such redemption at a redemption price
(expressed as a percentage of principal amount thereof) of 109.25% plus accrued
interest, if any, to the redemption date (subject to the right of Holders of
record on the relevant record date to receive interest due on the relevant
interest payment date); PROVIDED, HOWEVER, that at least 65% of the initial
aggregate principal amount of the Notes must remain outstanding after each such
redemption.
In the case of any partial redemption, selection of the Notes for redemption
will be made by the Trustee on a pro rata basis, by lot or by such other method
as the Trustee in its sole discretion shall deem to be fair and appropriate,
although no Note of $1,000 in original principal amount or less will be redeemed
in part. If any Note is to be redeemed in part only, the notice of redemption
relating to such Note shall state the portion of the principal amount thereof to
be redeemed. A new Note in principal amount equal to the unredeemed portion
thereof will be issued in the name of the Holder thereof upon cancellation of
the original Note.
RANKING
The indebtedness evidenced by the Notes is unsecured Senior Indebtedness of
the Company, will rank PARI PASSU in right of payment with all existing and
future Senior Indebtedness of the Company and will be senior in right of payment
to all existing and future Subordinated Obligations of the Company. The Notes
are effectively subordinated to all existing and future Secured Indebtedness of
the Company to the extent of the value of the assets securing such Indebtedness
and to all existing and future Indebtedness of any Subsidiary of the Company.
As of May 5, 2001, after giving effect to the offering of the notes and the
use of proceeds from the outstanding notes to redeem our 10 7/8% senior notes
due 2006, the Company would have had $200.6 million of senior indebtedness
outstanding and, except for the guarantee by Aaron Brothers, Inc. of the Credit
Agreement, the non-guarantor Subsidiaries would have had no indebtedness
outstanding. The Company has no Subordinated Obligations other than intercompany
Indebtedness. Although the Indenture contains limitations on the amount of
additional Indebtedness which the Company or any Restricted Subsidiary may
Incur, under certain circumstances the amount of such Indebtedness could be
substantial and such debt may be secured Indebtedness or Indebtedness of
Subsidiaries. See "Risk Factors--Secured Indebtedness and Borrowings by
Subsidiaries That Do Not Become Guarantors Will Be Effectively Senior to the
Notes" and "--Certain Covenants--Limitation on Indebtedness" and "--Limitation
on Liens."
CHANGE OF CONTROL
Upon the occurrence of any of the following events (each a "Change of
Control") with respect to the Company, each Holder will have the right to
require the Company to repurchase all or any part of such Holder's Notes at a
purchase price in cash equal to 101% of the principal amount thereof, plus
55
accrued and unpaid interest, if any, to the date of repurchase (subject to the
right of Holders of record on the relevant record date to receive interest due
on the related interest payment date):
(i) (A) any "person" (as such term is used in Sections 13(d) and 14(d)
of the Exchange Act), other than one or more Permitted Holders, is or
becomes the beneficial owner (as defined in Rules 13d-3 and 13d-5 under the
Exchange Act), directly or indirectly, of more than 35% of the total voting
power of the Voting Stock of the Company and (B) the Permitted Holders
"beneficially own" (as defined in Rules 13d-3 and 13d-5 under the Exchange
Act), directly or indirectly, in the aggregate a lesser percentage of the
total voting power of the Voting Stock of the Company than such other person
and do not have the right or ability by voting power, contract or otherwise
to elect or designate for election a majority of the Board of Directors of
the Company (for the purposes of this clause, such other person shall be
deemed to beneficially own any Voting Stock of a specified corporation held
by a parent corporation, if such other person "beneficially owns" (as
defined in Rules 13d-3 and 13d-5 under the Exchange Act), directly or
indirectly, more than 35% of the voting power of the Voting Stock of such
parent corporation and the Permitted Holders "beneficially own" (as defined
in Rules 13d-3 and 13d-5 under the Exchange Act), directly or indirectly, in
the aggregate a lesser percentage of the voting power of the Voting Stock of
such parent corporation and do not have the right or ability by voting
power, contract or otherwise to elect or designate for election a majority
of the board of directors of such parent corporation);
(ii) during any period of two consecutive years, individuals who at the
beginning of such period constituted the Board of Directors of the Company
(together with any new directors whose election by such Board of Directors
or whose nomination for election by the shareholders of the Company was
approved by a vote of 66 2/3% of the directors of the Company then still in
office who were either directors at the beginning of such period or whose
election or nomination for election was previously so approved) cease for
any reason to constitute a majority of the Board of Directors of the Company
then in office;
(iii) any sale, lease, exchange or other transfer (in one transaction or
a series of related transactions) of all, or substantially all, the assets
of the Company to any Person or group of Persons (other than to any Wholly
Owned Subsidiary of the Company); or
(iv) the merger or consolidation of the Company with or into another
corporation with the effect that either (A) immediately after such
transaction any person (as defined in clause (i) above) (other than a
Permitted Holder) shall have become the "beneficial owner" (as defined in
clause (i) above) of securities of the surviving corporation of such merger
or consolidation representing a majority of the voting power of the Voting
Stock of the surviving corporation or (B) the securities of the Company that
are outstanding immediately prior to such transaction and which represent
100% of the voting power of the Voting Stock of the Company are changed into
or exchanged for cash, securities or property, unless pursuant to such
transaction such securities are changed into or exchanged for, in addition
to any other consideration, (1) securities of the surviving corporation that
represent immediately after such transaction, at least a majority of the
voting power of the Voting Stock of the surviving corporation or
(2) securities that represent immediately after such transaction at least a
majority of the voting power of the Voting Stock of the corporation that
owns, directly or indirectly, 100% of the voting power of the Voting Stock
of the surviving corporation of that transaction.
Within 30 days following any Change of Control, or at the Company's option,
prior to any Change of Control but after the public announcement thereof, the
Company shall mail a notice to each Holder with a copy to the Trustee stating:
(1) that a Change of Control has or may have occurred and that such Holder has
the right to require the Company to purchase such Holder's Notes at a purchase
price in cash equal to 101% of the principal amount thereof, plus accrued and
unpaid interest, if any, to the date of repurchase (subject to the right of
Holders of record on a record date to receive interest on the
56
relevant interest payment date); (2) the circumstances and relevant facts and
pro forma financial information regarding such Change of Control; (3) the
repurchase date (which shall be no earlier than the consummation of the Change
of Control and no earlier than 30 days nor later than 60 days from the date such
notice is mailed); (4) that the Change of Control offer is conditioned on the
Change of Control occurring if the notice is mailed prior to the Change of
Control; and (5) the instructions determined by the Company, consistent with
this covenant, that a Holder must follow in order to have its Notes purchased.
Notwithstanding the occurrence of a Change of Control, the Company shall not be
obligated to repurchase the Notes upon a Change of Control if the Company has
irrevocably elected to redeem all of the Notes under the provisions described
under "--Optional Redemption" above, provided that the Company does not default
in its redemption obligations pursuant to such election.
Neither the Trustee nor the Board of Directors of the Company may waive the
covenant relating to the Holder's right to have its Notes repurchased upon a
Change of Control.
The phrase "all or substantially all," as used with respect to a sale of
assets in the definition in the Indenture of "Change of Control," varies
according to the facts and circumstances of the subject transaction, has no
clearly established meaning under New York law (the law governing the Indenture)
and is subject to judicial interpretation. Accordingly, in certain
circumstances, there may be a degree of uncertainty in ascertaining whether a
particular transaction would involve a disposition of "all or substantially all"
of the assets of a Person and therefore it may be unclear whether a Change of
Control has occurred.
The existence of a Holder's right to require the Company to repurchase such
Holder's Notes upon a Change of Control may deter a third party from acquiring
the Company in a transaction which constitutes a Change of Control.
The Company will comply, to the extent applicable, with the requirements of
Section 14(e) of the Exchange Act and any other securities laws or regulations
in connection with the repurchase of Notes pursuant to this covenant. To the
extent that the provisions of any securities laws or regulations conflict with
provisions of this covenant, the Company will comply with the applicable
securities laws and regulations and will not be deemed to have breached its
obligations under this paragraph by virtue thereof.
The Change of Control purchase feature is a result of negotiations between
the Company and the initial purchasers of the Notes. The Company has no present
intention to engage in a transaction involving a Change of Control, although it
is possible that the Company would decide to do so in the future. Subject to the
limitations discussed below, the Company could, in the future, enter into
certain transactions, including acquisitions, refinancings or other
recapitalizations, that would not constitute a Change of Control under the
Indenture, but that could increase the amount of indebtedness outstanding at
such time or otherwise affect the Company's capital structure or credit rating.
The Company will not be required to make a Change of Control offer upon a
Change of Control if a third party makes the Change of Control offer in the
manner, at the times and otherwise in compliance with the requirements described
in the Indenture applicable to a Change of Control offer made by the Company and
purchases all notes validly tendered and not withdrawn under such Change of
Control offer.
The occurrence of certain of the events that would constitute a Change of
Control would constitute a default under the Credit Agreement. Future
Indebtedness of the Company may contain prohibitions of certain events which
would constitute a Change of Control and may require such Indebtedness to be
repaid or repurchased upon a Change of Control. Moreover, the exercise by the
Holders of their right to require the Company to repurchase the Notes could
cause a default under such Indebtedness, even if the Change of Control itself
does not, due to the financial effect of such repurchase on the Company.
Finally, the Company's ability to pay cash to the Holders upon a
57
repurchase may be limited by the Company's then existing financial resources.
There can be no assurance that sufficient funds will be available when necessary
to make any required repurchases.
CERTAIN COVENANTS
The Indenture contains covenants including, among others, the following:
LIMITATION ON INDEBTEDNESS. (a) The Company will not Incur, and will not
permit any Restricted Subsidiary to Incur, any Indebtedness; PROVIDED, HOWEVER,
that the Company, any Guarantor and any Foreign Restricted Subsidiary may Incur
Indebtedness (including Acquired Indebtedness) if on the date thereof the
Consolidated Coverage Ratio would be equal to or greater than 2.5 to 1.0.
(b) Notwithstanding the foregoing paragraph (a), the Company and any
Restricted Subsidiaries (to the extent set forth below) may Incur the following
Indebtedness ("Permitted Indebtedness"):
(i) Indebtedness and letters of credit (with letters of credit being
deemed to have a principal amount equal to the maximum face amount
thereunder) of the Company, Aaron Brothers, Inc. (in the form of a guarantee
of the Company's obligations) as long as it is a Restricted Subsidiary that
is not a Significant Subsidiary or any Restricted Subsidiary which is a
Guarantor of the Notes under the Credit Agreement, Letter of Credit Facility
and any Refinancing Indebtedness in respect thereof in an aggregate
principal amount outstanding at any time not to exceed the greater of
(x) an amount equal to 50% of the book value of the inventory of the Company
and its Restricted Subsidiaries as of any date of Incurrence calculated on a
consolidated basis in accordance with GAAP and (y) $325 million; provided
that if Aaron Brothers, Inc. is at any time a Restricted Subsidiary that is
a Significant Subsidiary and an obligor (including as a guarantor) under the
Credit Agreement, Letter of Credit Facility or Refinancing Indebtedness in
respect thereof, such event will be deemed to constitute the incurrence of
Indebtedness guaranteed by Aaron Brothers, Inc. under the Credit Agreement,
Letter of Credit Facility or Refinancing Indebtedness in respect thereof, as
the case may be;
(ii) Indebtedness of the Company owing to and held by any Wholly Owned
Subsidiary or Indebtedness of a Restricted Subsidiary owing to and held by
the Company or any Wholly Owned Subsidiary; PROVIDED, HOWEVER, that any
subsequent issuance or transfer of any Capital Stock or any other event
which results in any such Wholly Owned Subsidiary ceasing to be a Wholly
Owned Subsidiary or any subsequent transfer of any such Indebtedness (except
to the Company or a Wholly Owned Subsidiary) will be deemed, in each case,
to constitute the Incurrence of such Indebtedness by the issuer thereof;
(iii) (x) Indebtedness represented by the Notes and any Guarantees of
the Notes by any of the Company's Subsidiaries in an amount not to exceed
the amount outstanding on the initial Issue Date, (y) any Indebtedness of
the Company or any Restricted Subsidiary (other than the Indebtedness
described in clauses (i)-(ii) above) outstanding on the Issue Date, provided
that the 10 7/8% Senior Notes shall only be deemed Permitted Indebtedness
until 60 days after the Issue Date and (z) any Refinancing Indebtedness
Incurred in respect of any Indebtedness described in this clause (iii) other
than the 10 7/8% Senior Notes or paragraph (a);
(iv) (A) Acquired Indebtedness of the Company or a Restricted
Subsidiary; PROVIDED, HOWEVER, that at the time such Restricted Subsidiary
or assets is acquired by the Company or a Restricted Subsidiary, the Company
would have been able to Incur $1.00 of additional Indebtedness pursuant to
paragraph (a) of this covenant after giving effect to the Incurrence of such
Indebtedness pursuant to this clause (iv) and such transaction or series of
related transactions and (B) Refinancing Indebtedness Incurred by a
Restricted Subsidiary in respect of Indebtedness Incurred by such Restricted
Subsidiary pursuant to this clause (iv);
58
(v) Indebtedness (A) in respect of performance bonds, bankers'
acceptances, letters of credit and surety or appeal bonds provided by the
Company or any Restricted Subsidiary in the ordinary course of its business
and which do not secure other Indebtedness and (B) under Currency
Agreements, Interest Rate Agreements and Commodity Price Protection
Agreements Incurred which, at the time of Incurrence, is in the ordinary
course of business; PROVIDED, HOWEVER, that, in the case of Currency
Agreements, Interest Rate Agreements and Commodity Price Protection
Agreements, such Currency Agreements, Interest Rate Agreements and Commodity
Price Protection Agreements do not increase the Indebtedness of the Company
outstanding at any time other than as a result of fluctuations in foreign
currency exchange rates, interest rates or commodity prices or by reason of
fees, indemnities and compensation payable thereunder;
(vi) Indebtedness (A) represented by Guarantees by the Company of
Indebtedness otherwise permitted to be Incurred pursuant to this covenant
and (B) represented by Guarantees by a Restricted Subsidiary of Indebtedness
of the Company or another Restricted Subsidiary otherwise permitted to be
Incurred pursuant to this covenant; PROVIDED that, in the case of
clause (B), if a Restricted Subsidiary Guarantees any such Indebtedness
other than any Guarantee by Aaron Brothers, Inc. of Indebtedness under the
Credit Agreement, Letter of Credit Facility and any Refinancing Indebtedness
in respect thereof, such Restricted Subsidiary executes and delivers to the
Trustee a supplemental indenture in form satisfactory to the Trustee
providing for the Guarantee on an equal basis of the Notes; provided,
however, if Aaron Brothers, Inc. is at any time a Restricted Subsidiary that
is a Significant Subsidiary while it has Guaranteed the Credit Agreement,
Letter of Credit Facility, or Refinancing Indebtedness in respect thereof,
Aaron Brothers, Inc. shall Guarantee the Notes on an equal basis as set
forth in this clause (vi);
(vii) Indebtedness of the Company or any Restricted Subsidiary
represented by Capitalized Lease Obligations, mortgage financings or
purchase money obligations, in each case Incurred for the purpose of
financing or refinancing all or any part of the purchase price or cost of
construction, repairs, renovation, remodeling, expansion or other
improvement of property, plant and equipment, including services and
equipment supporting such items, used in the Company's or any Restricted
Subsidiary's business or a Related Business (collectively, "Purchase Money
Debt") in an aggregate principal amount not to exceed 10% of Total Assets at
the time of any Incurrence thereof;
(viii) Indebtedness of the Company or any Restricted Subsidiary
represented by Capitalized Lease Obligations Incurred from time to time for
point-of-sale equipment and store systems, including services and equipment
supporting such equipment and systems, with the aggregate capitalized amount
of such obligation determined in accordance with GAAP outstanding at any one
time not to exceed $50 million;
(ix) Indebtedness of the Company or any Restricted Subsidiary Incurred
with respect to acquisitions of assets or a Person or consisting of
Guarantees of such Indebtedness, so long as such Indebtedness was not
created in anticipation of such acquisition and does not exceed, in the
aggregate, $10 million; and
(x) other Indebtedness of the Company or any Restricted Subsidiary in an
aggregate principal amount outstanding at any time not to exceed
$50 million, of which no more than $10 million may be borrowed by
non-Guarantor Restricted Subsidiaries.
(c) Notwithstanding the foregoing, the Company shall not Incur any
Indebtedness pursuant to the foregoing paragraph (b) if the proceeds thereof are
used, directly or indirectly, to Refinance any Subordinated Obligations unless
such new Indebtedness shall be subordinated to the Notes to at least the same
extent as such Subordinated Obligations being Refinanced. The Indenture further
provides that, notwithstanding any other provision of this "--Limitation on
Indebtedness" covenant, the
59
Company will not, and will not permit any Restricted Subsidiary to, Incur any
Guarantee of Indebtedness of any Unrestricted Subsidiary.
(d) Notwithstanding the foregoing, any Guarantee by a Restricted Subsidiary
of the Notes may be released (i) upon the sale, transfer or other disposition of
all of the Capital Stock of such Restricted Subsidiary held by the Company or
any Subsidiary to a Person other than the Company or a Subsidiary, (ii) if such
Restricted Subsidiary no longer guarantees any Indebtedness of the Company or
has outstanding any Indebtedness which it would not be able to incur without
guaranteeing the Notes pursuant to paragraph (b) of this "--Limitation on
Indebtedness" covenant if such Indebtedness was incurred on the date of such
release, or (iii) if such Subsidiary is designated an Unrestricted Subsidiary in
compliance with "--Limitation on Restricted Payments."
(e) For purposes of determining compliance with the foregoing covenant,
(i) in the event that an item of Indebtedness meets the criteria of more than
one of the types of Indebtedness described above, the Company may classify or
later reclassify such item of Indebtedness or any portion thereof and only be
required to include the amount and type of such Indebtedness in one of the above
clauses and (ii) an item of Indebtedness may be divided and classified in more
than one of the types of Indebtedness described above.
LIMITATION ON RESTRICTED PAYMENTS. (a) The Company will not, and will not
permit any Restricted Subsidiary to, directly or indirectly,
(i) declare or pay any dividend or make any distribution on or in
respect of its Capital Stock (including any payment in connection with any
merger or consolidation involving the Company), except (1) dividends or
distributions payable solely in its Capital Stock (other than Disqualified
Stock) or in options, warrants or other rights to purchase such Capital
Stock, and (2) dividends or distributions payable to the Company or another
Restricted Subsidiary (and, if such Restricted Subsidiary making such
dividend or distribution is not wholly owned, to its other shareholders on a
pro rata basis),
(ii) purchase, redeem, retire or otherwise acquire for value any Capital
Stock of the Company held by Persons other than the Company or another
Restricted Subsidiary,
(iii) purchase, repurchase, redeem, defease or otherwise acquire or
retire for value, prior to scheduled maturity, scheduled repayment or
scheduled sinking fund payment any Subordinated Obligations (other than
(A) the purchase, repurchase or other acquisition of Subordinated
Obligations in anticipation of satisfying a sinking fund obligation,
principal installment or final maturity, in each case due within one year of
the date of such purchase, repurchase or acquisition or (B) the repayment,
redemption or retirement for value of the Company's obligations owed to
5931, Inc. or 5931 Business Trust or successors thereto so long as it
remains a Wholly Owned Subsidiary) or
(iv) make any Investment (other than a Permitted Investment) in any
Person (any such dividend, distribution, purchase, redemption, repurchase,
defeasance, other acquisition, retirement, Investment or payment being
herein referred to as a "Restricted Payment") if at the time the Company or
such Restricted Subsidiary makes such Restricted Payment:
(1) a Default or Event of Default will have occurred and be
continuing (or would result therefrom);
(2) the Company could not Incur at least $1.00 of additional
Indebtedness under paragraph (a) of the covenant described under
"--Limitation on Indebtedness;" or
(3) the aggregate amount of such Restricted Payment and all other
Restricted Payments (the amount so expended, if other than in cash, to be
determined in good faith by the Board of Directors of the Company, whose
determination will be evidenced by a resolution of such
60
Board of Directors certified in an Officers' Certificate to the Trustee)
declared or made subsequent to the Issue Date would exceed the sum of:
(A) 50% of the Consolidated Net Income with respect to the period
(treated as one accounting period) from the end of the most recent
fiscal quarter ending prior to the Issue Date to the end of the most
recent fiscal quarter for which financial statements are available to
the Trustee (or, in case such Consolidated Net Income will be a
deficit, minus 100% of such deficit) plus $100 million;
(B) the aggregate Net Cash Proceeds received by the Company from
the issue or sale of Capital Stock (other than Disqualified Stock)
subsequent to the Issue Date (other than an issuance or sale to a
Subsidiary);
(C) the amount by which Indebtedness of the Company is reduced on
the Company's balance sheet upon the conversion or exchange (other
than by a Restricted Subsidiary) subsequent to the Issue Date of any
Indebtedness of the Company convertible or exchangeable for Capital
Stock (other than Disqualified Stock) of the Company (less the amount
of any cash or other property distributed by the Company upon such
conversion or exchange);
(D) in the case of designation of an Unrestricted Subsidiary as a
Restricted Subsidiary (as long as the designation of such Subsidiary
as an Unrestricted Subsidiary was deemed a Restricted Payment) the
value (as provided in the definition of "Investment") of the
Company's interest in such Subsidiary provided that such amount shall
not in any case exceed the aggregate amount of the Restricted
Payments deemed made at the time or after the Subsidiary was
designated as an Unrestricted Subsidiary; and
(E) in the case of the disposition, return, dividend or repayment
of any Investment constituting a Restricted Payment made after the
date of the Indenture an amount (to the extent not included in
Consolidated Net Income) equal to the lesser of payments made to the
Company or a Restricted Subsidiary with respect to such Investment
and the initial amount of such Investment, in either case, less the
cost of disposition of such Investment and net of taxes (to the
extent not reflected in Consolidated Net Income).
(b) The provisions of the foregoing paragraph (a) will not prohibit:
(i) any purchase, redemption, defeasance or other acquisition of Capital
Stock of the Company or Subordinated Obligations made by exchange for, or
out of the Net Cash Proceeds of the substantially concurrent sale of,
Capital Stock of the Company (other than Disqualified Stock and other than
Capital Stock issued or sold to a Subsidiary); PROVIDED, HOWEVER, that
(A) such purchase, redemption, defeasance or other acquisition will be
excluded in the calculation of the amount of Restricted Payments and
(B) the Net Cash Proceeds from such sale will be excluded from clause (3)
(B) of paragraph (a) above;
(ii) any purchase, redemption, defeasance or other acquisition of
Subordinated Obligations made by exchange for, or out of the net proceeds of
the substantially concurrent sale of, Subordinated Obligations of the
Company; PROVIDED, HOWEVER, that (A) the principal amount of such new
Indebtedness does not exceed the principal amount of the Subordinated
Obligations being so redeemed, purchased, defeased, acquired or retired for
value (plus the amount of any premium required to be paid under the terms of
the instrument governing the Subordinated Obligations being so redeemed,
purchased, defeased, acquired or retired), (B) such new Indebtedness is
subordinated to the Notes at least to the same extent as such Subordinated
Obligations so redeemed, purchased, defeased, acquired or retired for value,
(C) such new Indebtedness has a final scheduled maturity date later than the
final scheduled maturity date of
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the Notes and (D) such new Indebtedness has an Average Life equal to or
greater than the Average Life of the Notes; PROVIDED FURTHER, HOWEVER, that
such purchase, redemption, defeasance or other acquisition will be excluded
in the calculation of the amount of Restricted Payments;
(iii) any purchase, redemption, defeasance or other acquisition of
Subordinated Obligations (1) from Net Available Cash to the extent permitted
by the covenant described under "--Limitation on Sales of Assets and
Subsidiary Stock"; PROVIDED, HOWEVER, that such purchase or redemption will
be excluded in the calculation of the amount of Restricted Payments or
(2) pursuant to an offer to purchase which is then required to be made upon
a change of control of the Company pursuant to the terms of the instrument
governing such Subordinated Obligation; PROVIDED, HOWEVER, that such
purchase will be included in the calculation of the amount of Restricted
Payments;
(iv) dividends paid within 60 days after the date of declaration thereof
if at such date of declaration such dividend would have complied with this
covenant; PROVIDED, HOWEVER, that the amount of such dividend will be
included in the calculation of the amount of Restricted Payments; or
(v) repurchase, acquisitions or retirements of shares of Capital Stock
of the Company deemed to occur upon the exercise of stock options or similar
rights issued under employee benefit plans of the Company if such shares
represent all or a portion of the exercise price or are surrendered in
connection with satisfying any federal or state income tax obligation or are
repurchased or acquired to fulfill obligations of the Company or any
Restricted Subsidiary under employee compensation or other benefit
arrangements entered into or provided for in the ordinary course of
business; provided that cash payments pursuant to this clause (v) shall not
exceed $2 million in any fiscal year.
LIMITATION ON RESTRICTIONS ON DISTRIBUTIONS FROM RESTRICTED
SUBSIDIARIES. The Company will not, and will not permit any Restricted
Subsidiary to, create or otherwise cause or permit to exist or become effective
any consensual encumbrance or restriction on the ability of any Restricted
Subsidiary to
(i) pay dividends or make any other distributions on its Capital Stock
or pay any Indebtedness or other obligation owed to the Company,
(ii) make any Investments in the Company or
(iii) transfer any of its property or assets to the Company or any
Restricted Subsidiary, except:
(1) any encumbrance or restriction pursuant to an agreement in effect
at or entered into on the Issue Date;
(2) any encumbrance or restriction with respect to a Restricted
Subsidiary pursuant to an agreement in effect on or prior to the date on
which such Restricted Subsidiary was acquired by the Company or a
Restricted Subsidiary (other than encumbrances or restrictions Incurred
in connection with, or in contemplation of, the transaction or series of
related transactions pursuant to which such Restricted Subsidiary became
a Subsidiary or was acquired by the Company or a Restricted Subsidiary)
and outstanding on such date;
(3) any encumbrance or restriction pursuant to an agreement effecting
a refinancing of Indebtedness Incurred pursuant to an agreement referred
to in clause (1) or (2) of this covenant or contained in any amendment,
waiver, modification or renewal of an agreement referred to in
clause (1) or (2) of this covenant; PROVIDED, HOWEVER, that the
encumbrances and restrictions contained in any such refinancing agreement
or amendment, waiver, modification or renewal are no less favorable to
the Noteholders than the encumbrances and restrictions contained in such
agreements as determined in good faith by the Company;
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(4) in the case of clause (iii), any encumbrance or restriction
(A) that restricts in a customary manner the subletting, assignment or
transfer of any property or asset that is subject to a lease, license or
similar contract, (B) by virtue of any transfer of, agreement to
transfer, option or right with respect to, or Lien on, any property or
assets of the Company or any Restricted Subsidiary not otherwise
prohibited by the Indenture, (C) arising or agreed to in the ordinary
course of business and that does not individually or in the aggregate,
detract from the value of property or assets of the Company or any
Restricted Subsidiary in any manner material to the Company or such
Restricted Subsidiary or (D) contained in security agreements securing
Indebtedness of a Restricted Subsidiary to the extent such encumbrance or
restrictions restrict the transfer of the property subject to such
security agreements;
(5) any restriction with respect to a Restricted Subsidiary imposed
pursuant to an agreement entered into for the sale or disposition of all
or substantially all the Capital Stock or assets of such Restricted
Subsidiary pending the closing of such sale or disposition; and
(6) encumbrances or restrictions contained in any financing agreement
of a Foreign Restricted Subsidiary or arising or existing by reason of
applicable law, including any legal limitations restricting the ability
of Foreign Restricted Subsidiaries to pay as dividends or distribute or
otherwise pay or repatriate funds to the Company or its Subsidiaries.
LIMITATION ON SALES OF ASSETS AND SUBSIDIARY STOCK. (a) The Company will
not, and will not permit any Restricted Subsidiary to, make any Asset
Disposition unless
(i) the Company or such Restricted Subsidiary receives consideration at
the time of such Asset Disposition at least equal to the fair market value,
as determined in good faith by the Board of Directors of the Company
(including as to the value of all non-cash consideration), of the shares and
assets subject to such Asset Disposition,
(ii) at least 75% of the consideration thereof received by the Company
or such Restricted Subsidiary (other than Asset Swaps) is in the form of
cash or Temporary Cash Investments and
(iii) an amount equal to 100% of the Net Available Cash from such Asset
Disposition is applied by the Company or such Restricted Subsidiary, as the
case may be
(A) FIRST, to the extent the Company or any Restricted Subsidiary, as
the case may be, elects (or is required by the terms of any Senior
Indebtedness), to prepay, repay or purchase Senior Indebtedness or
Indebtedness (other than Disqualified Stock) of a Wholly Owned Subsidiary
(in each case other than Indebtedness owed to the Company or an Affiliate
of the Company) within 180 days from the later of the date of such Asset
Disposition or the receipt of such Net Available Cash;
(B) SECOND, to the extent of the balance of Net Available Cash after
application in accordance with clause (A), to the extent the Company or
such Restricted Subsidiary, as the case may be, elects, to the investment
by the Company or any Restricted Subsidiary in Additional Assets within
one year from the later of the date of such Asset Disposition or the
receipt of such Net Available Cash;
(C) THIRD, to the extent of the balance of such Net Available Cash
after application in accordance with clauses (A) and (B), to make an
Offer (as defined below) to purchase Notes pursuant to and subject to the
conditions set forth in paragraph (b) of this covenant within 45 days
after the date that is one year from the receipt of such Net Available
Cash; and
(D) FOURTH, to the extent of the balance of such Net Available Cash
after application in accordance with clauses (A), (B) and (C), to
(x) the acquisition by the Company or any Wholly Owned Subsidiary of
Additional Assets, (y) the prepayment, repayment, purchase or other
acquisition of Indebtedness of the Company (other than Indebtedness owed
to an
63
Affiliate of the Company and other than Disqualified Stock of the
Company) or Indebtedness of any Restricted Subsidiary (other than
Indebtedness owed to the Company or an Affiliate of the Company) or
(z) to general corporate purposes (other than to the payment of dividends
or distributions in respect of, or repurchases of, Capital Stock), in
each case within 45 days after the later of one year from the receipt of
such Net Available Cash and the date the Offer described in
paragraph (b) below is consummated; PROVIDED, HOWEVER that in connection
with any prepayment, repayment, purchase or other acquisition of
Indebtedness pursuant to clause (A), (C) or (D) above, the Company or
such Restricted Subsidiary will, to the extent such Indebtedness is not
revolving Indebtedness, retire such Indebtedness and, except as to
Indebtedness described in clause (i) of paragraph (b) under "--Limitation
on Indebtedness," will cause any related loan commitment or availability
(if any) to be permanently reduced in an amount equal to the principal
amount so prepaid, repaid or purchased.
Notwithstanding the foregoing provisions, the Company and its Restricted
Subsidiaries shall not be required to apply any Net Available Cash in accordance
herewith except to the extent that the aggregate Net Available Cash from all
Asset Dispositions which are not applied in accordance with this covenant
exceeds $10,000,000. The Company shall not be required to make an Offer for
Notes pursuant to this covenant if the Net Available Cash available therefor
(after application of the proceeds as provided in clauses (A) and (B)) are less
than $15,000,000 for any particular Asset Disposition (which lesser amounts
shall be carried forward for purposes of determining whether an Offer is
required with respect to the Net Available Cash from any subsequent Asset
Disposition).
For the purposes of this covenant, the following are deemed to be cash:
(x) the assumption by the transferee of Indebtedness of the Company (other than
Disqualified Stock of the Company) or any Restricted Subsidiary and the release
of the Company or such Restricted Subsidiary from all liability on such
Indebtedness in connection with such Asset Disposition, (y) any Designated
Noncash Consideration received by the Company or any of its Restricted
Subsidiaries in the Asset Sale and (z) securities received by the Company or any
Restricted Subsidiary from the transferee that are promptly converted by the
Company or such Restricted Subsidiary into cash.
With respect to an Asset Swap constituting an Asset Disposition, the Company
or any Restricted Subsidiary shall be required to receive in cash (as such term
is deemed to be defined for purposes of this paragraph (a)) or Temporary Cash
Investments in an amount equal to 75% of the proceeds of the Asset Disposition
which do not consist of in-kind assets acquired with the Asset Swap.
(b) In the event of an Asset Disposition that requires the purchase of
Notes pursuant to clause (a)(iii)(C) of this covenant, the Company will be
required to purchase Notes tendered pursuant to an offer by the Company for the
Notes (the "Offer") at a purchase price of 100% of their principal amount plus
accrued interest to the date of purchase in accordance with the procedures
(including prorating in the event of oversubscription) set forth in the
Indenture. If the aggregate purchase price of Notes tendered pursuant to the
Offer is less than the Net Available Cash allotted to the purchase of the Notes,
the Company will apply the remaining Net Available Cash in accordance with
clause (a)(iii)(D) above.
(c) The Company will comply, to the extent applicable, with the
requirements of Section 14(e) of the Exchange Act and any other securities laws
or regulations in connection with the repurchase of Notes pursuant to this
covenant. To the extent that the provisions of any securities laws or
regulations conflict with provisions of this covenant, the Company will comply
with the applicable securities laws and regulations and will not be deemed to
have breached its obligations under this covenant by virtue thereof.
LIMITATION ON TRANSACTIONS WITH AFFILIATES. (a) The Company will not, and
will not permit any Restricted Subsidiary to, directly or indirectly, enter into
any agreement or conduct any transaction or series of related transactions
(including the purchase, sale, lease or exchange of any property, or
64
rendering of any service) with any Affiliate of the Company (an "Affiliate
Transaction") unless (i) the terms of such transaction or agreement are no less
favorable to the Company or such Restricted Subsidiary, as the case may be, than
those that could be obtained at the time of such transaction in arm's-length
dealings with a Person who is not such an Affiliate; and (ii) in the event such
Affiliate Transaction involves an aggregate amount in excess of $5,000,000, the
terms of such transaction or agreement shall have been approved by a majority of
the members of the Board of Directors having no personal stake in such Affiliate
Transaction (and such majority determines that such Affiliate Transaction
satisfies the criteria in clause (i) above).
(b) The foregoing shall not apply to (i) any Restricted Payment permitted
to be made pursuant to "--Limitation on Restricted Payments," (ii) any issuance
of securities, or other payments, awards or grants in cash, securities or
otherwise pursuant to, or the funding of, employment arrangements, stock options
and stock ownership plans approved by the Board of Directors or the payment of
fees and indemnities to directors of the Company and its Restricted Subsidiaries
in the ordinary course of business, (iii) loans or advances to employees in the
ordinary course of business, (iv) any transaction between the Company and a
Wholly Owned Subsidiary or between Wholly Owned Subsidiaries, (v) transactions
pursuant to written agreements in existence on the Issue Date,
(vi) repurchases, acquisitions or retirements of shares of Capital Stock of the
Company deemed to occur upon the exercise of stock options or similar rights
issued under employee benefit plans of the Company if such shares represent all
or a portion of the exercise price or are surrendered in connection with
satisfying any federal or state income tax obligation or are repurchased or
acquired to fulfill obligations of the Company or any Restricted Subsidiary
under employee compensation or other benefit arrangements entered into or
provided for in the ordinary course of business; provided that cash payments
pursuant to this clause (vi) shall not exceed $2 million in any fiscal year, or
(vii) any transaction between the Company or any Wholly Owned Subsidiary, on the
one hand, and a Restricted Subsidiary, on the other hand, in the ordinary course
of business on terms that are customary in the industry or consistent with past
practice.
LIMITATION ON LIENS. The Company will not, and will not permit any
Restricted Subsidiary to, directly or indirectly, create or permit to exist any
Lien on any of its property or assets (including Capital Stock), whether owned
on the Issue Date or thereafter acquired, securing any obligation, other than
Permitted Liens, unless contemporaneously therewith effective provision is made
to secure the Notes equally and ratably with (or on a senior basis to, in the
case of Subordinated Obligations) such obligation for so long as such obligation
is so secured.
LIMITATION ON SALE/LEASEBACK TRANSACTIONS. The Company will not, and will
not permit any Restricted Subsidiary to, enter into any Sale/Leaseback
Transaction with respect to any property unless (i) the Company or such
Restricted Subsidiary would be entitled to (A) Incur Indebtedness in an amount
equal to the Attributable Indebtedness with respect to such Sale/Leaseback
Transaction pursuant to the covenant described under "--Limitation on
Indebtedness" and (B) create a Lien, if any, on such property securing such
Attributable Indebtedness without equally and ratably securing the Notes
pursuant to the covenant described under "--Limitation on Liens," (ii) the Net
Cash Proceeds received by the Company or any Restricted Subsidiary in connection
with such Sale/Leaseback Transaction are at least equal to the fair value (as
determined in good faith and certified in an Officers' Certificate to the
Trustee) of such property and (iii) the transfer of such property is permitted
by, and the Company or such Restricted Subsidiary applies the proceeds of such
transaction in compliance with, the covenant described under "--Limitation on
Sales of Assets and Subsidiary Stock."
LIMITATION ON SALE OF SUBSIDIARY PREFERRED STOCK. The Company (i) will not,
and will not permit any Restricted Subsidiary of the Company to, transfer,
convey, sell, lease or otherwise dispose of any Preferred Stock of any
Restricted Subsidiary to any Person (other than to the Company or a Wholly Owned
Subsidiary), unless (a) such transfer, conveyance, sale, lease or other
disposition is of all the
65
Capital Stock of such Restricted Subsidiary (or, in the case of a non-wholly
owned Restricted Subsidiary, all of the Capital Stock held by the Company or its
Restricted Subsidiaries) and (b) the net cash proceeds from such transfer,
conveyance, sale, lease or other disposition are applied in accordance with the
covenant described above under "--Limitation on Sales of Assets and Subsidiary
Stock" and (ii) will not permit any Restricted Subsidiary to issue any of its
Preferred Stock to any Person other than to the Company or a Wholly Owned
Subsidiary
SEC REPORTS. Notwithstanding that the Company may not be required to remain
subject to the reporting requirements of Section 13 or 15(d) of the Exchange
Act, the Company will file with the SEC and provide the Trustee and Noteholders
with the annual reports and such information, documents and other reports which
are specified in Sections 13 and 15(d) of the Exchange Act. The Company also
will comply with the other provisions of TIA Section 314(a).
MERGER AND CONSOLIDATION
The Company will not consolidate with or merge with or into, or convey,
transfer or lease all or substantially all its assets to, any Person, unless:
(i) the resulting, surviving or transferee Person (the "Successor Company") will
be a corporation organized and existing under the laws of the United States of
America, any State thereof or the District of Columbia and the Successor Company
(if not the Company) will expressly assume, by supplemental indenture, executed
and delivered to the Trustee, in form satisfactory to the Trustee, all the
obligations of the Company under the Notes and the Indenture; (ii) immediately
after giving effect to such transaction (and treating any Indebtedness which
becomes an obligation of the Successor Company or any Restricted Subsidiary as a
result of such transaction as having been Incurred by the Successor Company or
such Restricted Subsidiary at the time of such transaction), no Default or Event
of Default will have occurred and be continuing; (iii) immediately after giving
effect to such transaction, the Successor Company would be able to Incur an
additional $1.00 of Indebtedness under paragraph (a) of the covenant described
under "--Limitation on Indebtedness"; and (iv) the Company will have delivered
to the Trustee an Officers' Certificate and an Opinion of Counsel, each stating
that such consolidation, merger or transfer and such supplemental indenture, if
any, comply with the Indenture, as set forth in the Indenture.
The Successor Company will succeed to, and be substituted for, and may
exercise every right and power of, the Company under the Indenture, but the
predecessor Company in the case of a lease of all its assets or a conveyance,
transfer or lease of substantially all its assets will not be released from the
obligation to pay the principal of and interest on the Notes.
Notwithstanding the foregoing clauses (ii) and (iii), any Wholly Owned
Subsidiary may consolidate with, merge into or transfer all or part of its
properties and assets to the Company and the Company will not be required to
take any action under clause (iv) in connection therewith.
DEFAULTS
An Event of Default is defined in the Indenture as (i) a default in any
payment of interest on any Note when due, continued for 30 days, (ii) a default
in the payment of principal of any Note when due at its Stated Maturity, upon
optional redemption, upon required repurchase, upon declaration or otherwise,
(iii) the failure by the Company to comply with its obligations described under
"--Merger and Consolidation," "--Limitation on Sales of Assets and Subsidiary
Stock" or "--Change of Control," (iv) the failure by the Company to comply for
60 days after notice with its other agreements contained in the Indenture,
(v) the failure by the Company or any Significant Subsidiary of the Company to
pay any Indebtedness within any applicable grace period after final maturity or
the acceleration of any such Indebtedness by the holders thereof because of a
default if the total amount of such Indebtedness unpaid or accelerated exceeds
$10 million or its foreign currency equivalent (the "cross acceleration
provision"), (vi) certain events of bankruptcy, insolvency or reorganization of
the Company or any
66
Significant Subsidiary of the Company (the "bankruptcy provisions") or
(vii) any final, non-appealable judgment or decree for the payment of money in
excess of $10 million is rendered against the Company or any Significant
Subsidiary of the Company and either (A) an enforcement proceeding has been
commenced by any creditor upon such judgment or decree or (B) such judgment or
decree remains unpaid and outstanding for a period of 60 days following such
judgment and is not discharged, waived or stayed (the "judgment default
provision").
The foregoing will constitute Events of Default whatever the reason for any
such Event of Default and whether it is voluntary or involuntary or is effected
by operation of law or pursuant to any judgment, decree or order of any court or
any order, rule or regulation of any administrative or governmental body.
However, a default under clauses (iv) or (v) will not constitute an Event of
Default until the Trustee or the Holders of 25% in aggregate principal amount of
the outstanding Notes notify the Company as provided in the Indenture of the
default and the Company does not cure such default within the time specified in
clauses (iv) and (v) hereof after receipt of such notice.
If an Event of Default occurs and is continuing, the Trustee or the Holders
of at least 25% in aggregate principal amount of the then outstanding Notes by
notice to the Company may declare the principal of and accrued but unpaid
interest on all the Notes to be due and payable. Upon such a declaration, such
principal and interest will be due and payable immediately. If an Event of
Default relating to certain events of bankruptcy, insolvency or reorganization
of the Company occurs and is continuing, the principal of and accrued interest
on all the Notes will become immediately due and payable without any declaration
or other act on the part of the Trustee or any Holders. Under certain
circumstances, the Holders of a majority in aggregate principal amount of the
outstanding Notes may rescind any such acceleration with respect to the Notes
and its consequences.
Subject to the provisions of the Indenture relating to the duties of the
Trustee, in case an Event of Default occurs and is continuing, the Trustee will
be under no obligation to exercise any of the rights or powers under the
Indenture at the request or direction of any of the Holders unless such Holders
shall have offered to the Trustee reasonable indemnity or security against any
loss, liability or expense. Except to enforce the right to receive payment of
principal, premium, if any, or interest when due, no Holder may pursue any
remedy with respect to the Indenture or the Notes unless (i) such Holder shall
have previously given the Trustee notice that an Event of Default is continuing,
(ii) Holders of at least 25% in aggregate principal amount of the outstanding
Notes shall have requested the Trustee to pursue the remedy, (iii) such Holders
shall have offered the Trustee reasonable security or indemnity against any
loss, liability or expense, (iv) the Trustee shall not have complied with such
request within 60 days after the receipt of the request and the offer of
security or indemnity and (v) the Holders of a majority in principal amount of
the outstanding Notes shall not have given the Trustee a direction inconsistent
with such request within such 60-day period. Subject to certain restrictions,
the Holders of a majority in principal amount of the outstanding Notes are given
the right to direct the time, method and place of conducting any proceeding for
any remedy available to the Trustee or of exercising any trust or power
conferred on the Trustee. The Trustee, however, may refuse to follow any
direction that conflicts with law or the Indenture or that the Trustee
determines is unduly prejudicial to the rights of any other Holder or that would
involve the Trustee in personal liability. Prior to taking any action under the
Indenture, the Trustee will be entitled to indemnification from the Noteholders
satisfactory to it in its sole discretion against all losses and expenses caused
by taking or not taking such action.
The Indenture provides that if a Default occurs and is continuing and is
known to the Trustee, the Trustee must mail to each Holder notice of the Default
within the earlier of 90 days after it occurs or 30 days after it is known by a
Trust Officer or written notice of it is received by the Trustee. Except in the
case of a Default in the payment of principal of, premium, if any, or interest
on any Note, the Trustee may withhold notice if and so long as a committee of
its Trust Officers in good faith determines
67
that withholding notice is in the interests of the Noteholders. In addition, the
Company is required to deliver to the Trustee, within 120 days after the end of
each fiscal year, a certificate indicating whether the signers thereof know of
any Default that occurred during the previous year. The Company also is required
to deliver to the Trustee, within 30 days after the occurrence thereof, written
notice of any event which would constitute certain Defaults, their status and
what action the Company is taking or proposes to take in respect thereof.
SATISFACTION AND DISCHARGE
The Indenture will be discharged and will cease to be of further effect
(except as to surviving rights of registration of transfer or exchange of the
Notes as expressly provided for in the Indenture) as to all outstanding Notes
under the Indenture when (a) either (1) all such Notes theretofore authenticated
and delivered (except lost, stolen or destroyed Notes which have been replaced
or paid or Notes whose payment has been deposited in trust or segregated and
held in trust by the Company and thereafter repaid to the Company or discharged
from such trust as provided for in the Indenture) have been delivered to the
Trustee for cancellation or (2) all Notes not theretofore delivered to the
Trustee for cancellation (a) have become due and payable, (b) will become due
and payable at their Stated Maturity within 91 days or (c) are to be called for
redemption within 91 days under arrangements satisfactory to the Trustee for the
giving of notice of redemption by the Trustee in the name, and at the expense,
of the Company; (b) the Company or any other Person has irrevocably deposited or
caused to be deposited with the Trustee as trust funds in trust an amount in
United States dollars sufficient to pay and discharge the entire indebtedness on
the Notes not theretofore delivered to the Trustee for cancellation, including
principal of, premium, if any, and accrued interest at such maturity, Stated
Maturity or redemption date; and (c) the Company or any other Person has paid or
caused to be paid all other sums payable under the Indenture by the Company. The
Company may request the Trustee to acknowledge the discharge upon delivery to
the Trustee of an officers' certificate and an opinion of independent counsel
each stating that all conditions precedent under the Indenture relating to the
satisfaction and discharge of such Indenture have been complied with.
AMENDMENTS AND WAIVERS
Subject to certain exceptions, the Indenture may be amended with the consent
of the Holders of a majority in principal amount of the Notes then outstanding
and any past default or compliance with any provisions may be waived with the
consent of the Holders of a majority in principal amount of the Notes then
outstanding. However, without the consent of each Holder of an outstanding Note
affected, no amendment may, among other things, (i) reduce the amount of Notes
whose Holders must consent to an amendment, (ii) reduce the rate of or extend
the time for payment of interest on any Note, (iii) reduce the principal of or
extend the Stated Maturity of any Note, (iv) reduce the premium payable upon the
redemption of any Note or change the time at which any Note may be redeemed as
described under "--Optional Redemption," (v) make any Note payable in money
other than that stated in the Note, (vi) impair the right of any Holder to
receive payment of principal of and interest on such Holder's Notes on or after
the due dates therefor or to institute suit for the enforcement of any payment
on or with respect to such Holder's Notes or (vii) make any change in the
amendment provisions which require each Holder's consent or in the waiver
provisions.
Without the consent of any Holder, the Company and the Trustee may amend the
Indenture to cure any ambiguity, omission, defect or inconsistency, to provide
for the assumption by a successor corporation of the obligations the Company
under the Indenture, to provide for uncertificated Notes in addition to or in
place of certificated Notes (provided that the uncertificated Notes are issued
in registered form for purposes of Section 163(f) of the Code, or in a manner
such that the uncertificated Notes are as described in Section 163(f) (2) (B) of
the Code), to add Guarantees with respect to the Notes, to secure the Notes, to
add to the covenants of the Company for the benefit of the Noteholders
68
or to surrender any right or power conferred upon the Company, to make any
change that does not adversely affect the rights of any Holder and to comply
with any requirement of the SEC in connection with the qualification of the
Indenture under the TIA.
The consent of the Noteholders is not necessary under the Indenture to
approve the particular form of any proposed amendment. It is sufficient if such
consent approves the substance of the proposed amendment.
After an amendment under the Indenture becomes effective, the Company is
required to mail to Noteholders a notice briefly describing such amendment.
However, the failure to give such notice to all Noteholders, or any defect
therein, will not impair or affect the validity of the amendment.
TRANSFER AND EXCHANGE
A Noteholder may transfer or exchange Notes in accordance with the
Indenture. Upon any transfer or exchange, the registrar and the Trustee may
require a Noteholder, among other things, to furnish appropriate endorsements
and transfer documents and the Company may require a Noteholder to pay any taxes
required by law or permitted by the Indenture, including any transfer tax or
other similar governmental charge payable in connection therewith. The Company
is not required to transfer or exchange any Note selected for redemption or to
transfer or exchange any Note for a period of 15 days prior to a selection of
Notes to be redeemed or an interest payment date. The Notes will be issued in
registered form and the registered holder of a Note will be treated as the owner
of such Note for all purposes.
DEFEASANCE
The Company at any time may terminate all of its obligations under the Notes
and the Indenture ("legal defeasance"), except for certain obligations,
including those respecting the defeasance trust (as defined herein) and
obligations to register the transfer or exchange of the Notes, to replace
mutilated, destroyed, lost or stolen Notes and to maintain a registrar and
paying agent in respect of the Notes. The Company at any time may terminate its
obligations under the covenants described under "--Certain Covenants," the
operation of the cross acceleration provision, the bankruptcy provisions with
respect to Significant Subsidiaries and the judgment default provision described
under "--Defaults" and the limitations contained in clauses (iii) and
(iv) under "--Merger and Consolidation" ("covenant defeasance").
The Company may exercise its legal defeasance option notwithstanding its
prior exercise of its covenant defeasance option. If the Company exercises its
legal defeasance option, payment of the Notes may not be accelerated because of
an Event of Default with respect thereto. If the Company exercises its covenant
defeasance option, payment of the Notes may not be accelerated because of an
Event of Default specified in clause (iv), (v), (vi) (with respect only to
Significant Subsidiaries), or (vii) under "--Defaults" above or because of the
failure of the Company to comply with clauses (ii), (iii) or (iv) under
"--Merger and Consolidation."
In order to exercise either defeasance option, the Company must irrevocably
deposit or cause to be deposited in trust (the "defeasance trust") with the
Trustee money or U.S. Government Obligations which through the scheduled payment
of principal and interest in respect thereof in accordance with their terms will
provide cash at such times and in such amounts as will be sufficient to pay
principal and interest when due on all the Notes (except lost, stolen or
destroyed Notes which have been replaced or repaid) to maturity or redemption,
as the case may be, and must comply with certain other conditions, including
delivery to the Trustee of an Opinion of Counsel to the effect that Holders of
the Notes will not recognize income, gain or loss for federal income tax
purposes as a result of such deposit and defeasance and will be subject to
federal income tax on the same amount and in the same manner and at the same
times as would have been the case if such deposit and defeasance had not
69
occurred (and, in the case of legal defeasance only, such Opinion of Counsel
must be based on a ruling of the Internal Revenue Service or other change in
applicable federal income tax law).
CONCERNING THE TRUSTEE
The Bank of New York is the Trustee under the Indenture and has been
appointed by the Company as Registrar and Paying Agent with regard to the Notes.
FALL AWAY EVENT
In the event of the occurrence of a Fall Away Event, the covenants and
provisions described above under "--Change of Control," "--Certain
Covenants--Limitation on Indebtedness," "--Limitation on Restricted Payments,"
"--Limitation on Restrictions on Distributions from Restricted Subsidiaries,"
"--Limitation on Sales of Assets and Subsidiary Stock," "--Limitation on
Transactions with Affiliates," and "--Limitation on Sale of Subsidiary Preferred
Stock" shall each no longer be in effect for the remaining term of the Notes,
subject to the next paragraph; provided that after a Fall Away Event, so long as
the Notes retain an Investment Grade status the Company will become subject to a
new covenant that will provide that from and after the occurrence of a Fall Away
Event the non-Guarantor Subsidiaries of the Company (other than Foreign
Restricted Subsidiaries, and except that Aaron Brothers, Inc. may guarantee the
Credit Agreement, Letter of Credit Facility or Refinancing Indebtedness, so long
as it is not a Significant Subsidiary), may not Guarantee Indebtedness of the
Company or otherwise incur Indebtedness other than Indebtedness of the types
described under "--Certain Covenants--Limitation on Indebtedness" in clauses
(ii), (iii)(x), (iii)(y) of such covenant as in effect on the date of the
occurrence of the Fall Away Event with respect to Indebtedness outstanding on
the date of the occurrence of the Fall Away Event, in clause (iii)(z) of such
covenant as in effect on the date of the occurrence of the Fall Away Event with
respect to Indebtedness outstanding on the date of the occurrence of the Fall
Away Event, in clause (iv) of such covenant (except that the proviso contained
therein shall not be applicable); in clauses (v), (vii) and (viii) of such
covenant and Indebtedness in an aggregate principal amount not to exceed 5% of
the Company's Consolidated Tangible Net Worth at any one time outstanding. The
covenant will also contain a release provision that any guarantee by a
Subsidiary may be released (a) upon the sale, transfer or other disposition of
all of the Capital Stock of such Subsidiary held by the Company or any
Subsidiary to a Person other than the Company or a Subsidiary or (b) if such
Subsidiary no longer guarantees any Indebtedness of the Company or has any
Indebtedness outstanding which it would not be able to incur without
guaranteeing the Notes pursuant to this covenant if such Indebtedness was
incurred on the date of the release.
If, at any time, after the occurrence of a Fall Away Event, the Company
fails to maintain Investment Grade status or a Default or Event of Default has
occurred and is continuing, then the covenants which are no longer in effect
pursuant to the preceding paragraph will be immediately reinstated and be
applicable to the Company and its Restricted Subsidiaries and the new covenant
in the preceding paragraph shall be terminated although any actions taken during
the pendency of the Fall Away Event shall not be deemed a Default or Event of
Default under the Indenture whether or not they would have been permitted if the
covenants did not fall away.
FURTHER ISSUES
We may from time to time, without notice to or the consent of the Holders of
the Notes, create and issue further notes ranking equally with the Notes in all
respects (or in all respects other than the payment of interest accruing prior
to the issue date of such further notes or except for the first payment of
interest following the issue date of such further notes). Such further notes,
together with these Notes, will not exceed $250.0 million in the aggregate, may
be consolidated and form a single series with the Notes and have the same terms
as to status, redemption, voting or otherwise as to the
70
Notes. All references herein to the Notes will include any further notes once
issued, unless the context otherwise requires.
GOVERNING LAW
The Indenture provides that it and the Notes are governed by, and construed
in accordance with, the laws of the State of New York without giving effect to
applicable principles of conflicts of law to the extent that the application of
the law of another jurisdiction would be required thereby.
CERTAIN DEFINITIONS
"Acquired Indebtedness" means Indebtedness of a Person (i) existing at the
time such Person becomes a Restricted Subsidiary or (ii) assumed in connection
with the acquisition of assets from such Person, in each case, other than
Indebtedness incurred in connection with, or in contemplation of, such Person
becoming a Restricted Subsidiary or such acquisition, as the case may be.
Acquired Indebtedness shall be deemed to be incurred on the date of the related
acquisition of assets from any Person or the date the acquired Person becomes a
Restricted Subsidiary, as the case may be.
"Additional Assets" means (i) any property or assets (other than inventory
in the ordinary course of business and other than Indebtedness and Capital
Stock) in a Related Business; (ii) the Capital Stock of a Person that becomes a
Restricted Subsidiary as a result of the acquisition of such Capital Stock by
the Company or another Restricted Subsidiary; or (iii) Capital Stock
constituting a minority interest in any Person that at such time is a Restricted
Subsidiary; PROVIDED, HOWEVER, that, in the case of clauses (ii) and (iii), such
Restricted Subsidiary is primarily engaged in a Related Business.
"Affiliate" of any specified Person means any other Person, directly or
indirectly, controlling or controlled by or under direct or indirect common
control with such specified Person. For the purposes of this definition,
"control" when used with respect to any Person means the power to direct the
management and policies of such Person, directly or indirectly, whether through
the ownership of voting securities, by contract or otherwise; and the terms
"controlling" and "controlled" have meanings correlative to the foregoing. For
purposes of the covenants in the Indenture, "Affiliate" shall also mean any
beneficial owner of shares representing 10% or more of the total voting power of
the Voting Stock (on a fully diluted basis) of the Company or of rights or
warrants to purchase such Voting Stock (whether or not currently exercisable)
and any Person who would be an Affiliate of any such beneficial owner pursuant
to the first sentence hereof.
"Asset Disposition" means any sale, lease, transfer or other disposition (or
series of related sales, leases, transfers or dispositions) of shares of Capital
Stock of a Restricted Subsidiary (other than directors' qualifying shares),
property or other assets (each referred to for the purposes of this definition
as a "disposition") by the Company or any of its Restricted Subsidiaries
(including any disposition by means of a merger, consolidation or similar
transaction) other than (i) a disposition by a Restricted Subsidiary to the
Company or by the Company or a Restricted Subsidiary to a Wholly Owned
Subsidiary, (ii) a disposition of property, assets, inventory or Temporary Cash
Investments in the ordinary course of business, (iii) for purposes of the
"Limitation on Sales of Assets and Subsidiary Stock" covenant only, a
disposition that constitutes a Restricted Payment permitted by the "Limitation
on Restricted Payments" covenant, (iv) a disposition of duplicative or excessive
real property where less than 75% of the consideration received is in the form
of cash or Temporary Cash Investments, which disposition occurs within one year
of the acquisition thereof and (v) any disposition of assets or series of
related dispositions with an aggregate fair market value (as determined in good
faith) of less than $5 million.
"Asset Swap" means the exchange by the Company or a Restricted Subsidiary of
a portion of its property, business or assets, for property, businesses or
assets or Capital Stock of a Person, which all or substantially all of whose
assets are a type used in the business of the Company on the date of the
71
Indenture or in a Related Business, or a combination of any property, business
or assets or Capital Stock of such a Person and cash or Temporary Cash
Investments.
"Attributable Indebtedness" in respect of a Sale/Leaseback Transaction
means, as at the time of determination, the present value (discounted at the
interest rate borne by the Notes, compounded annually) of the total obligations
of the lessee for rental payments during the remaining term of the lease
included in such Sale/Leaseback Transaction (including any period for which such
lease has been extended); PROVIDED, HOWEVER, that "Attributable Indebtedness"
shall not include any such obligations to the extent they relate to the lease of
stores, warehouses, offices or distribution facilities, including without
limitation, the fixtures appertaining thereto, unless such obligations are
required to be recorded on the Company's balance sheet in accordance with GAAP.
"Average Life" means, as of the date of determination, with respect to any
Indebtedness or Preferred Stock, the quotient obtained by dividing (i) the sum
of the product of the numbers of years from the date of determination to the
dates of each successive scheduled principal payment of such Indebtedness or
redemption or similar payment with respect to such Preferred Stock multiplied by
the amount of such payment by (ii) the sum of all such payments.
"Board of Directors" means the Board of Directors or equivalent governing
body of a Person (or the general partner of such Person, as the case may be) or
any committee thereof duly authorized to act on behalf of such Board or
equivalent governing body.
"Business Day" means a day other than a Saturday, Sunday or other day on
which banking institutions in New York State are authorized or required by law
to close.
"Capitalized Lease Obligation" means an obligation that is required to be
classified and accounted for as a capitalized lease for financial reporting
purposes in accordance with GAAP, and the amount of Indebtedness represented by
such obligation shall be the capitalized amount of such obligation determined in
accordance with GAAP; and the Stated Maturity thereof shall be the date of the
last payment of rent or any other amount due under such lease.
"Capital Stock" of any Person means any and all shares, interests, rights to
purchase, warrants, options, participation or other equivalents of or interests
in (however designated) equity of such Person, including any Preferred Stock,
but excluding any debt securities convertible into such equity.
"Code" means the Internal Revenue Code of 1986, as amended.
"Commodity Price Protection Agreement" means any forward contract, commodity
swap, commodity option or other similar financial agreement or arrangement
relating to, or the value which is dependent upon, fluctuations in commodity
prices.
"Consolidated Coverage Ratio" as of any date of determination means the
ratio of (i) the aggregate amount of EBITDA for the period of the most recent
four consecutive fiscal quarters for which financial statements are available to
(ii) Consolidated Interest Expense for such period; PROVIDED, HOWEVER, that
(1) if the Company or any Restricted Subsidiary has Incurred any Indebtedness
since the beginning of such period that remains outstanding or if the
transaction giving rise to the need to calculate the Consolidated Coverage Ratio
is an Incurrence of Indebtedness, or both, EBITDA and Consolidated Interest
Expense for such period shall be calculated after giving effect on a pro forma
basis to such Indebtedness as if such Indebtedness had been Incurred on the
first day of such period and the discharge of any other Indebtedness repaid,
repurchased, defeased or otherwise discharged with the proceeds of such new
Indebtedness as if such discharge had occurred on the first day of such period,
(2) if since the beginning of such period the Company or any Restricted
Subsidiary shall have made any Asset Disposition or if the transaction giving
rise to the need to calculate the Consolidated Coverage Ratio is an Asset
Disposition, the EBITDA for such period shall be reduced by an amount equal to
the EBITDA (if positive) directly attributable to the assets which are the
subject of such Asset
72
Disposition for such period, or increased by an amount equal to the EBITDA (if
negative) directly attributable thereto for such period and Consolidated
Interest Expense for such period shall be reduced by an amount equal to the
Consolidated Interest Expense directly attributable to any Indebtedness of the
Company or any Restricted Subsidiary repaid, repurchased, defeased or otherwise
discharged with respect to the Company and its continuing Restricted
Subsidiaries in connection with such Asset Disposition for such period (or, if
the Capital Stock of any Restricted Subsidiary is sold, the Consolidated
Interest Expense for such period directly attributable to the Indebtedness of
such Restricted Subsidiary to the extent the Company and its continuing
Restricted Subsidiaries are no longer liable for such Indebtedness after such
sale), (3) if since the beginning of such period the Company or any Restricted
Subsidiary (by merger or otherwise) shall have made an Investment in any
Restricted Subsidiary (or any Person which becomes a Restricted Subsidiary) or
an acquisition of assets, including any acquisition of assets occurring in
connection with a transaction causing a calculation to be made hereunder, which
constitutes all or substantially all of an operating unit of a business, EBITDA
and Consolidated Interest Expense for such period shall be calculated after
giving pro forma effect thereto (including the Incurrence of any Indebtedness)
as if such Investment or acquisition occurred on the first day of such period
and (4) if since the beginning of such period any Person (that subsequently
became a Restricted Subsidiary or was merged with or into the Company or any
Restricted Subsidiary since the beginning of such period) shall have made any
Asset Disposition or any Investment that would have required an adjustment
pursuant to clause (2) or (3) above if made by the Company or a Restricted
Subsidiary during such period, EBITDA and Consolidated Interest Expense for such
period shall be calculated after giving pro forma effect thereto as if such
Asset Disposition or Investment occurred on the first day of such period. For
purposes of this definition, whenever pro forma effect is to be given to an
acquisition of assets, the amount of income or earnings relating thereto and the
amount of Consolidated Interest Expense associated with any Indebtedness
Incurred in connection therewith, the pro forma calculations shall be determined
in good faith by a responsible financial or accounting officer of the Company.
If any Indebtedness bears a floating rate of interest and is being given pro
forma effect, the interest expense on such Indebtedness shall be calculated as
if the rate in effect on the date of determination had been the applicable rate
for the entire period (taking into account any Interest Rate Agreement
applicable to such Indebtedness if such Interest Rate Agreement has a remaining
term in excess of 12 months).
"Consolidated Interest Expense" means, for any period, the total interest
expense of the Company and its consolidated Restricted Subsidiaries, plus, to
the extent not included in such interest expense, (i) interest expense
attributable to capital leases, (ii) amortization of debt discount and debt
issuance costs, (iii) non-cash interest expense, (iv) commissions, discounts and
other fees and charges owed with respect to letters of credit and bankers'
acceptance financing, (v) interest actually paid by the Company or any such
Restricted Subsidiary under any Guarantee of Indebtedness or other obligation of
any other Person, (vi) net costs associated with Hedging Obligations (including
amortization of fees), (vii) Preferred Stock dividends in respect of all
Preferred Stock of the Company and its Subsidiaries held by Persons other than
the Company or a Wholly Owned Subsidiary and (viii) the cash contributions to
any employee stock ownership plan or similar trust to the extent such
contributions are used by such plan or trust to pay interest or fees to any
Person (other than the Company) in connection with Indebtedness Incurred by such
plan or trust; PROVIDED, HOWEVER, that there shall be excluded therefrom any
such interest expense of any Unrestricted Subsidiary to the extent the related
Indebtedness is not Guaranteed or paid by the Company or any Restricted
Subsidiary.
"Consolidated Net Income" means, for any period, the net income (loss) of
the Company and its consolidated Subsidiaries in accordance with GAAP; PROVIDED,
HOWEVER, that there shall not be included in such Consolidated Net Income:
(i) any net income (loss) of any Person if such Person is not a
Restricted Subsidiary, except that (A) subject to the limitations contained
in (iv) below the Company's equity in the net income
73
of any such Person for such period shall be included in such Consolidated
Net Income up to the aggregate amount of cash actually distributed by such
Person during such period to the Company or a Restricted Subsidiary as a
dividend or other distribution (subject, in the case of a dividend or other
distribution to a Restricted Subsidiary, to the limitations contained in
clause (iii) below) and (B) the Company's equity in a net loss of any such
Person (other than an Unrestricted Subsidiary) for such period shall be
included in determining such Consolidated Net Income,
(ii) any net income (loss) of any Person acquired by the Company or a
Restricted Subsidiary in a pooling of interests transaction for any period
prior to the date of such acquisition,
(iii) any net income of any Restricted Subsidiary if such Restricted
Subsidiary is subject to restrictions, directly or indirectly, on the
payment of dividends or the making of distributions by such Restricted
Subsidiary, directly or indirectly, to the Company, except that (A) subject
to the limitations contained in (iv) below the Company's equity in the net
income of any such Restricted Subsidiary for such period shall only be
included in such Consolidated Net Income up to the aggregate amount of cash
that could have been distributed by such Restricted Subsidiary during such
period to the Company or another Restricted Subsidiary as a dividend
(subject, in the case of a dividend to another Restricted Subsidiary, to the
limitation contained in this clause) and (B) the Company's equity in a net
loss of any such Restricted Subsidiary for such period shall be included in
determining such Consolidated Net Income,
(iv) any gain (but not loss) realized upon the sale or other disposition
of any property, plant or equipment of the Company or its consolidated
Subsidiaries (including pursuant to any Sale/ Leaseback Transaction) which
is not sold or otherwise disposed of in the ordinary course of business and
any gain (but not loss) realized upon the acquisition or disposition of any
securities, of any Person,
(v) any extraordinary gain or loss net of taxes (less all fees and
expenses relating thereto),
(vi) the cumulative effect of a change in accounting principles,
(vii) any gain or loss, net of taxes, realized upon the termination of
any employee pension benefit plan, and
(viii) any net gain arising from the extinguishment, under GAAP, of any
Indebtedness of any Person.
"Consolidated Tangible Net Worth" of any Person means, at any time, for such
Person and its Restricted Subsidiaries on a consolidated basis, an amount
computed equal to (a) the consolidated stockholders' equity of the Person and
its Restricted Subsidiaries, minus, (b) all Intangible Assets of the Person and
its Restricted Subsidiaries, in each case as of such time.
"Credit Agreement" means the Revolving Credit Agreement, dated as of May 1,
2001, among the Company, Fleet National Bank and the lenders parties thereto, as
it may be amended, extended, renewed, refinanced, substituted or replaced from
time to time (including increases in principal amount thereof to the extent
permitted under the Notes, the addition of one or more lenders to an existing
facility or the replacement or inclusion of one or more lenders in a new
facility) in one or more agreements.
"Currency Agreement" means in respect of a Person any foreign exchange
contract, currency swap agreement or other similar agreement as to which such
Person is a party or a beneficiary.
"Default" means any event which is, or after notice or passage of time or
both would be, an Event of Default.
"Designated Noncash Consideration" means the fair market value of non-cash
consideration received by the Company or any of its Restricted Subsidiaries in
connection with an Asset Disposition
74
that is so designated pursuant to an officer's certificate, setting forth the
basis of the valuation. The aggregate fair market value of the Designated
Noncash Consideration, taken together with the fair market value at the time of
receipt of all other Designated Noncash Consideration then held by the Company
or any Restricted Subsidiary, may not exceed 5% of the Company's Consolidated
Tangible Net Worth, at the time of the receipt of the Designated Noncash
Consideration (with the fair market value being measured at the time received
and without giving effect to subsequent changes in value).
"Disqualified Stock" means, with respect to any Person, any Capital Stock
which by its terms (or by the terms of any security into which it is convertible
or for which it is exchangeable) or upon the happening of any event (i) matures
or is mandatorily redeemable pursuant to a sinking fund obligation or otherwise,
(ii) is convertible or exchangeable for Indebtedness or Disqualified Stock or
(iii) is redeemable at the option of the holder thereof, in whole or in part, in
each case on or prior to the first anniversary of the Stated Maturity of the
Notes (other than upon a change of control or sale of assets by the Company in
circumstances where the holders of the Notes would have similar rights).
"EBITDA" for any period means the sum of Consolidated Net Income for such
period, plus the following to the extent deducted in calculating such
Consolidated Net Income: (i) income tax expense, (ii) Consolidated Interest
Expense, (iii) depreciation expense, (iv) amortization expense, and (v) all
other non-cash items reducing Consolidated Net Income (excluding any non-cash
items to the extent they represent an accrual of, or reserve for, cash
disbursements for any subsequent period), less all non-cash items increasing
such Consolidated Net Income, in each case for such period. Notwithstanding the
foregoing, the income tax expense, depreciation expense and amortization expense
of a Restricted Subsidiary of the Company shall be included in EBITDA only to
the extent (and in the same proportion) that the net income of such Subsidiary
was included in calculating Consolidated Net Income and only if a corresponding
amount would be permitted at the date of determination to be distributable to
the Company by such Subsidiary as a dividend.
"Equity Offering" means an offering for cash of common stock of the Company.
"Exchange Act" means the Securities Exchange Act of 1934, as amended.
"Fall Away Event" means the Notes shall have achieved Investment Grade
status and the Company delivers to the Trustee an officer's certificate
certifying that the foregoing condition has been satisfied.
"Foreign Restricted Subsidiary" means a Restricted Subsidiary that is
organized and existing under the laws of any country or other jurisdiction other
than the United States of America, any State thereof or the District of Columbia
and substantially all of the assets of which are located outside the United
States of America.
"GAAP" means generally accepted accounting principles in the United States
of America as in effect as of the date of the Indenture, including those set
forth in the opinions and pronouncements of the Accounting Principles Board of
the American Institute of Certified Public Accountants and statements and
pronouncements of the Financial Accounting Standards Board or in such other
statements by such other entity as approved by a significant segment of the
accounting profession. All ratios and computations based on GAAP contained in
the Indenture shall be computed in conformity with GAAP.
"Guarantee" means any obligation, contingent or otherwise, of any Person
directly or indirectly guaranteeing any Indebtedness or other obligation of any
other Person and any obligation, direct or indirect, contingent or otherwise, of
such Person (i) to purchase or pay (or advance or supply funds for the purchase
or payment of) such Indebtedness or other obligation of such other Person
(whether arising by virtue of partnership arrangements, or by agreement to
keep-well, to purchase assets, goods, securities or services, to take-or-pay, or
to maintain financial statement conditions or otherwise) or (ii) entered into
for purposes of assuring in any other manner the obligee of such Indebtedness or
75
other obligation of the payment thereof or to protect such obligee against loss
in respect thereof (in whole or in part); PROVIDED, HOWEVER, that the term
"Guarantee" shall not include endorsements for collection or deposit in the
ordinary course of business. The term "Guarantee" used as a verb has a
corresponding meaning.
"Guarantor" means any guarantor of the Notes.
"Hedging Obligations" of any Person means the obligations of such Person
pursuant to any Interest Rate Agreement, Currency Agreement, or Commodity Price
Protection Agreement.
"Holder" or "Noteholder" means the Person in whose name a Note is registered
on the Registrar's books.
"Incur" means issue, assume, Guarantee, incur or otherwise become liable
for; PROVIDED, HOWEVER, that any Indebtedness or Capital Stock of a Person
existing at the time such Person becomes a Subsidiary (whether by merger,
consolidation, acquisition or otherwise) shall be deemed to be incurred by such
Subsidiary at the time it becomes a Subsidiary.
"Indebtedness" means, with respect to any Person on any date of
determination (without duplication),
(i) the principal of and premium, if any, in respect of indebtedness of
such Person for borrowed money,
(ii) the principal of and premium, if any, in respect of obligations of
such Person evidenced by bonds, debentures, notes or other similar
instruments,
(iii) all obligations of such Person in respect of letters of credit or
other similar instruments (including reimbursement obligations with respect
thereto),
(iv) all obligations of such Person to pay the deferred and unpaid
purchase price of property or services (except Trade Payables), which
purchase price is due more than six months after the date of placing such
property in service or taking delivery and title thereto or the completion
of such services,
(v) all Capitalized Lease Obligations and all Attributable Indebtedness
of such Person,
(vi) the amount of all obligations of such Person with respect to the
redemption, repayment or other repurchase of any Disqualified Stock or, with
respect to any Restricted Subsidiary, any Preferred Stock (but excluding, in
each case, any accrued dividends),
(vii) all Indebtedness of other Persons secured by a Lien on any asset of
such Person, whether or not such Indebtedness is assumed by such Person;
PROVIDED, HOWEVER, that the amount of such Indebtedness shall be the lesser
of (A) the fair market value of such asset at such date of determination and
(B) the amount of such Indebtedness of such other Person,
(viii) all Indebtedness of other Persons to the extent Guaranteed by such
Person, and
(ix) to the extent not otherwise included in this definition, Hedging
Obligations.
The amount of Indebtedness of any Person at any date shall be the
outstanding balance at such date of all unconditional obligations as described
above and the maximum liability, upon the occurrence of the contingency giving
rise to the obligation, of any contingent obligations at such date.
"Intangible Assets" means intellectual property, goodwill and other
intangible assets, in each case determined in accordance with GAAP.
"Interest Rate Agreement" means with respect to any Person any interest rate
protection agreement, interest rate future agreement, interest rate option
agreement, interest rate swap
76
agreement, interest rate cap agreement, interest rate collar agreement, interest
rate hedge agreement or other similar agreement or arrangement as to which such
Person is party or a beneficiary.
"Investment" in any Person means any direct or indirect advance, loan (other
than advances to customers in the ordinary course of business that are recorded
as accounts receivable on the balance sheet of such Person) or other extension
of credit (including by way of Guarantee or similar arrangement) or capital
contribution to (by means of any transfer of cash or other property to others or
any payment for property or services for the account or use of others), or any
purchase or acquisition of Capital Stock, Indebtedness or other similar
instruments issued or owned by such Person and all other items that would be
classified as investments on a balance sheet prepared in accordance with GAAP.
For purposes of the definition of "Unrestricted Subsidiary" and the "Limitation
on Restricted Payments" covenant, (i)"Investment" shall include the portion
(proportionate to the Company's equity interest in such Subsidiary) of the fair
market value of the net assets of any Subsidiary of the Company at the time that
such Subsidiary is designated an Unrestricted Subsidiary; PROVIDED, HOWEVER,
that upon a redesignation of such Subsidiary as a Restricted Subsidiary, the
Company shall be deemed to continue to have a permanent "Investment" in an
Unrestricted Subsidiary in an amount (if positive) equal to (x) the Company's
"Investment" in such Subsidiary at the time of such redesignation less (y) the
portion (proportionate to the Company's equity interest in such Subsidiary) of
the fair market value of the net assets of such Subsidiary at the time that such
Subsidiary is so redesignated a Restricted Subsidiary; and (ii) any property
transferred to or from an Unrestricted Subsidiary shall be valued at its fair
market value at the time of such transfer, in each case as determined in good
faith by the Board of Directors and evidenced by a resolution of such Board of
Directors certified in an Officers' Certificate to the Trustee.
"Investment Grade" means BBB- or higher by Standard & Poor's Ratings Group
and its successors and Baa3 or higher by Moody's Investors Service, Inc. and its
successors.
"Issue Date" means the date on which the Notes are originally issued.
"Letter of Credit Facility" means the Master Commercial Letter of Credit
Reimbursement Agreement, dated as of May 1, 2001, among the Company and Fleet
National Bank, as it may be amended, extended, renewed, refinanced, substituted,
or replaced from time to time (including increases in principal or notional
amount thereof to the extent permitted under the Notes, or the addition of one
or more lenders to an existing facility or the replacement or inclusion of one
or more lenders in a new facility) in one or more agreements.
"Lien" means any mortgage, pledge, security interest, encumbrance, lien or
charge of any kind (including any conditional sale or other title retention
agreement or lease in the nature thereof).
"Net Available Cash" from an Asset Disposition means cash payments received
(including any cash payments received by way of deferred payment of principal
pursuant to a note or installment receivable or otherwise, but only as and when
received, but excluding any other consideration received in the form of
assumption by the acquiring Person of Indebtedness or other obligations relating
to such properties or assets or received in any other non-cash form and
excluding Designated Non Cash Consideration and Asset Swaps except to the extent
they are converted into cash) therefrom, in each case net of (i) all legal,
title and recording tax expenses, commissions and other fees and expenses
incurred, and all Federal, state, provincial, foreign and local taxes required
to be paid or accrued as a liability under GAAP, as a consequence of such Asset
Disposition, (ii) all payments made on any Indebtedness which is secured by any
assets subject to such Asset Disposition, in accordance with the terms of any
Lien upon such assets, or which must by its terms, or in order to obtain a
necessary consent to such Asset Disposition, or by applicable law be repaid out
of the proceeds from such Asset Disposition, (iii) all distributions and other
payments required to be made to minority interest holders in Subsidiaries or
joint ventures as a result of such Asset Disposition, (iv) the deduction of
appropriate amounts to be provided by the seller as a reserve, in accordance
with GAAP, against any liabilities associated with the
77
assets disposed of in such Asset Disposition and retained by the Company or any
Restricted Subsidiary after such Asset Disposition and (v) in the case of an
Asset Disposition by a Foreign Restricted Subsidiary, any amount which, as a
result of applicable law, may not be legally paid as a dividend, or distributed
or otherwise paid or repatriated to the Company or its Subsidiaries.
"Net Cash Proceeds," with respect to any issuance or sale of Capital Stock,
means the cash proceeds of such issuance or sale net of attorneys' fees,
accountants' fees, underwriters' or placement agents' fees, discounts or
commissions and brokerage, consultant and other fees and expenses actually
incurred in connection with such issuance or sale and net of taxes paid or
payable as a result thereof.
"Permitted Holders" means Sam Wyly, Charles J. Wyly, Jr., Evan A. Wyly,
trusts established by or for the benefit of any such Persons or any of their
lineal descendants, entities controlled by any such trusts, and their respective
Affiliates.
"Permitted Investment" means an Investment by the Company or any Restricted
Subsidiary in
(i) the Company, a Restricted Subsidiary or a Person which will, upon
the making of such Investment, become a Restricted Subsidiary; PROVIDED,
HOWEVER, that the primary business of such Restricted Subsidiary is a
Related Business;
(ii) another Person if as a result of such Investment such other Person
is merged or consolidated with or into, or transfers or conveys all or
substantially all its assets to, the Company or a Restricted Subsidiary;
PROVIDED, HOWEVER, that such Person's primary business is a Related
Business;
(iii) Temporary Cash Investments;
(iv) receivables owing to the Company or any Restricted Subsidiary, if
created or acquired in the ordinary course of business and payable or
dischargeable in accordance with customary trade terms; PROVIDED, HOWEVER,
that such trade terms may include such concessionary trade terms as the
Company or any such Restricted Subsidiary deems reasonable under the
circumstances;
(v) payroll, travel and similar advances to cover matters that are
expected at the time of such advances ultimately to be treated as expenses
for accounting purposes and that are made in the ordinary course of
business;
(vi) loans or advances to employees made in the ordinary course of
business consistent with past practice of the Company or such Restricted
Subsidiary;
(vii) stock, obligations or securities received in settlement of debts
created in the ordinary course of business and owing to the Company or any
Restricted Subsidiary or in satisfaction of judgments;
(viii) any Investment to the extent the consideration therefore consists
of Qualified Capital Stock of the Company;
(ix) advances to vendors in the ordinary course of business in an
aggregate principal amount at any one time outstanding not to exceed
$5 million;
(x) in the form of payment pursuant to deferred compensation plans for
former and current directors, officers, consultants and employees; and
(xi) in addition to items (i)-(x) above, an amount not to exceed 2.5% of
the Company's Consolidated Tangible Net Worth in the aggregate at any one
time outstanding.
"Permitted Liens" means, with respect to any Person,
(a) pledges or deposits by such Person under workmen's compensation
laws, unemployment insurance laws or similar legislation, or good faith
deposits in connection with bids, tenders,
78
contracts (other than for the payment of Indebtedness) or leases to which
such Person is a party, or deposits to secure public or statutory
obligations of such Person or deposits of cash or United States government
bonds to secure surety or appeal bonds to which such Person is a party, or
deposits as security for contested taxes or import duties or for the payment
of rent, in each case incurred in the ordinary course of business;
(b) Liens imposed by law, such as carriers', warehousemen's and
mechanics' Liens, in each case for sums not yet due or being contested in
good faith by appropriate proceedings or other Liens arising out of
judgments or awards against such Person with respect to which such Person
shall then be proceeding with an appeal or other proceedings for review and
landlords' Liens;
(c) Liens for property taxes not yet due or payable or subject to
penalties for non-payment or which are being contested in good faith by
appropriate proceedings;
(d) Liens in favor of issuers of surety bonds or letters of credit
issued pursuant to the request of and for the account of such Person in the
ordinary course of its business;
(e) minor survey exceptions, minor encumbrances, easements or
reservations of, or rights of others for, licenses, rights-of-way, sewers,
electric lines, telegraph and telephone lines and other similar purposes, or
zoning or other restrictions as to the use of real properties or Liens
incidental to the conduct of the business of such Person or to the ownership
of its properties which were not incurred in connection with Indebtedness
and which do not in the aggregate materially adversely affect the value of
said properties or materially impair their use in the operation of the
business of such Person;
(f) Liens securing Hedging Obligations so long as the related
Indebtedness is, and is permitted to be under the Indenture, secured by a
Lien on the same property securing such Hedging Obligations;
(g) leases and subleases of real property which do not interfere with
the ordinary conduct of the business of the Company or any of its Restricted
Subsidiaries, and which are made on customary and usual terms applicable to
similar properties;
(h) Liens existing as of the date of the Indenture and Liens created by
the Indenture;
(i) Liens created solely for the purpose of securing Purchase Money Debt
Incurred after the date on which the Notes are originally issued; PROVIDED,
HOWEVER, that (A) the aggregate principal amount of Indebtedness secured by
such Liens shall not exceed the lesser of cost or fair market value of the
assets or property so acquired or constructed, (B) the Indebtedness secured
by such Liens shall have otherwise been permitted to be issued under the
Indenture and (C) such Liens shall not encumber any other assets or property
of the Company or any of its Restricted Subsidiaries and shall attach to
such assets or property within 90 days of the construction, acquisition or
improvement of such assets or property;
(j) Liens on the assets or property of a Restricted Subsidiary of the
Company existing at the time such Restricted Subsidiary became a Subsidiary
of the Company and not incurred as a result of (or in connection with or in
anticipation of) such Restricted Subsidiary becoming a Subsidiary of the
Company; PROVIDED, HOWEVER, that (A) any such Lien does not by its terms
cover any property or assets after the time such Restricted Subsidiary
becomes a Subsidiary which were not covered immediately prior to such time,
(B) the incurrence of the Indebtedness secured by such Lien shall have
otherwise been permitted to be Incurred under the Indenture, and (C) such
Liens do not extend to or cover any other property or assets of the Company
or any of its Restricted Subsidiaries;
(k) Liens to secure Capitalized Lease Obligations permitted to be
Incurred under the Indenture;
79
(l) Liens to secure Indebtedness permitted to be Incurred under the
Indenture which is recourse solely to the assets securing such Indebtedness;
PROVIDED that (i) the fair market value, as determined in good faith, of the
assets subject to such Liens (determined at the time such Liens are granted)
does not exceed an amount equal to 125% of the amount of such Indebtedness
and (ii) the aggregate principal amount outstanding of all Indebtedness
secured by such Liens at the time when such additional Indebtedness is
Incurred shall not exceed 5% of the Company's Consolidated Tangible Net
Worth; and
(m) Liens extending, renewing or replacing in whole or in part a Lien
permitted by the Indenture; PROVIDED, HOWEVER, that (A) such Liens do not
extend beyond the property subject to the existing Lien and improvements and
construction on such property and (B) the Indebtedness secured by the Lien
may not exceed the Indebtedness secured at the time by the existing Lien.
"Person" means any individual, corporation, limited liability company,
partnership, joint venture, association, joint-stock company, trust,
unincorporated organization, government or any agency or political subdivision
thereof or any other entity.
"Preferred Stock," as applied to any Person, means Capital Stock of any
class or classes (however designated) which is preferred as to the payment of
dividends or distribution, or as to the distribution of assets upon any
voluntary or involuntary liquidation or dissolution of such Person, over shares
of Capital Stock of any other class of such Person.
"Public Market" means any time after (x) the common stock of the Company is
then registered with the SEC pursuant to Section 12(b) or 12(g) of the Exchange
Act and traded either on a national securities exchange or in the National
Association of Securities Dealers Automated Quotation System and (y) at least
20% of the total issued and outstanding Voting Stock of the Company has been
distributed by means of an effective registration statement under the Securities
Act.
"Qualified Capital Stock" of any Person means any and all Capital Stock of
such Person other than Disqualified Stock.
"Refinancing Indebtedness" means Indebtedness that refunds, refinances,
replaces, renews, repays or extends (including pursuant to any defeasance or
discharge mechanism) (collectively, "refinances," and "refinanced" shall have a
correlative meaning) any Indebtedness existing on the Issue Date or Incurred in
compliance with the Indenture (including Indebtedness of the Company that
refinances Indebtedness of any Restricted Subsidiary and Indebtedness of any
Restricted Subsidiary that refinances Indebtedness of another Restricted
Subsidiary) including Indebtedness that refinances Refinancing Indebtedness;
PROVIDED, HOWEVER, that (i) the Refinancing Indebtedness has a Stated Maturity
no earlier than the Stated Maturity of the Indebtedness being refinanced,
(ii) the Refinancing Indebtedness has an Average Life at the time such
Refinancing Indebtedness is Incurred that is equal to or greater than the
Average Life of the Indebtedness being refinanced and (iii) such Refinancing
Indebtedness is Incurred in an aggregate principal amount (or if issued with
original issue discount, an aggregate issue price) that is equal to (or, to the
extent of any applicable premium in connection with a refinancing, greater than)
or less than the sum of the aggregate principal amount (or if issued with
original issue discount, the aggregate accreted value) then outstanding of the
Indebtedness being refinanced; PROVIDED FURTHER, HOWEVER, that Refinancing
Indebtedness shall not include (x) Indebtedness of a Restricted Subsidiary that
refinances Indebtedness of the Company other than Indebtedness owed to such
Restricted Subsidiary by the Company, (y) Indebtedness of a non-Guarantor
Restricted Subsidiary that refinances Indebtedness of a Guarantor or
(z) Indebtedness of the Company or a Restricted Subsidiary that refinances
Indebtedness of an Unrestricted Subsidiary.
"Related Business" means any business related, ancillary or complementary to
the businesses of the Company and the Restricted Subsidiaries on the applicable
date.
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"Restricted Subsidiary" means any Subsidiary of the Company other than an
Unrestricted Subsidiary.
"Sale/Leaseback Transaction" means an arrangement relating to property now
owned or hereafter acquired whereby the Company or a Restricted Subsidiary
transfers such property to a Person and the Company or a Restricted Subsidiary
leases it from such Person.
"SEC" means the Securities and Exchange Commission, as from time to time
constituted, created under the Exchange Act, or if at any time after the
execution of the Indenture the SEC is not existing and performing the duties now
assigned to it under the TIA, then the body performing such duties at such time.
"Secured Indebtedness" means any Indebtedness of the Company secured by a
Lien.
"Senior Indebtedness" means all Indebtedness of the Company (including,
without limitation, Indebtedness under the Credit Agreement, and fees, costs and
expenses incurred thereunder), including interest thereon, whether outstanding
on the Issue Date or thereafter Incurred, unless in the instrument creating or
evidencing the same or pursuant to which the same is outstanding it is provided
that such obligations are subordinated in right of payment to the Notes;
PROVIDED, HOWEVER, that Senior Indebtedness shall not include (1) any obligation
of the Company to any Subsidiary, (2) any liability for federal, state, local or
other taxes owed or owing by the Company, (3) any accounts payable or other
liability to trade creditors arising in the ordinary course of business
(including Guarantees thereof or instruments evidencing such liabilities),
(4) any Indebtedness, Guarantee or obligation of the Company which is
subordinate or junior expressly by its written terms in any respect to any other
Indebtedness, Guarantee or obligation of the Company, including any Subordinated
Obligations, (5) any obligations with respect to any Capital Stock,
(6) Indebtedness which, when Incurred and without respect to any election under
Section 1111(b) of Title II, United States Code, is without recourse to the
Company, or (7) any Indebtedness Incurred in violation of the Indenture.
"Significant Subsidiary" means any Restricted Subsidiary that would be a
"Significant Subsidiary" of the Company within the meaning of Rule 1-02 under
Regulation S-X promulgated by the SEC as of the Issue Date.
"Stated Maturity" means, with respect to any security, the date specified in
such security as the fixed date on which the payment of principal of such
security is due and payable, including pursuant to any mandatory redemption
provision (but excluding any provision providing for the repurchase of such
security at the option of the holder thereof upon the happening of any
contingency beyond the control of the issuer unless such contingency has
occurred).
"Subordinated Obligation" means any Indebtedness of the Company (whether
outstanding on the Issue Date or thereafter Incurred) which is subordinate or
junior in right of payment to the Notes pursuant to a written agreement.
"Subsidiary" of any Person means any corporation, association, partnership
or other business entity of which more than 50% of the total voting power of
shares of Capital Stock or other interests (including partnership interests)
entitled (without regard to the occurrence of any contingency) to vote in the
election of directors, managers or trustees thereof is at the time owned or
controlled, directly or indirectly, by (i) such Person, (ii) such Person and one
or more Subsidiaries of such Person or (iii) one or more Subsidiaries of such
Person.
"Temporary Cash Investments" means any of the following: (i) any investment
in direct obligations of the United States of America or any agency thereof or
obligations Guaranteed by the United States of America or any agency thereof,
(ii) investments in time deposit accounts, certificates of deposit and money
market deposits maturing within 180 days of the date of acquisition thereof
issued by a bank or trust company which is organized under the laws of the
United States of America, any state thereof or
81
any foreign country recognized by the United States of America having capital,
surplus and undivided profits aggregating in excess of $250,000,000 (or the
foreign currency equivalent thereof) and whose long-term debt is rated "A" (or
such similar equivalent rating) or higher by at least one nationally recognized
statistical rating organization (as defined in Rule 436 under the Securities
Act), (iii) repurchase obligations with a term of not more than 30 days for
underlying securities of the types described in clause (i) above entered into
with a bank or trust company meeting the qualifications described in
clause (ii) above, (iv) investments in commercial paper, maturing not more than
365 days after the date of acquisition, issued by a Person (other than an
Affiliate of the Company) organized and in existence under the laws of the
United States of America, any State thereof or any foreign country recognized by
the United States of America with a rating at the time as of which any
investment therein is made of "P-1" (or higher) according to Moody's Investors
Service, Inc. or "A-1" (or higher) according to Standard & Poor's Ratings Group,
(v) investments in securities with maturities of six months or less from the
date of acquisition issued or fully guaranteed by any state, commonwealth or
territory of the United States of America, or by any political subdivision or
taxing authority thereof, and rated at least "A" by Standard & Poor's Ratings
Group or "A" by Moody's Investors Service, Inc., and (vi) investments in mutual
funds whose investment guidelines restrict such funds' investments to
investments which are substantially similar to those described in clauses
(i)-(v) above.
"10 7/8% Senior Notes" means the Company's 10 7/8% Senior Notes due 2006.
"TIA" means the Trust Indenture Act of 1939, as amended, or any successor
statute.
"Total Assets" means, as of any date, the Company's total consolidated
assets as of such date, as determined in accordance with GAAP.
"Trade Payables" means, with respect to any Person, any accounts payable or
any indebtedness or monetary obligation to trade creditors created, assumed or
Guaranteed by such Person arising in the ordinary course of business in
connection with the acquisition of goods or services.
"Unrestricted Subsidiary" means (i) any Subsidiary of the Company that at
the time of determination shall be designated an Unrestricted Subsidiary by the
Board of Directors in the manner provided below, and (ii) any Subsidiary of an
Unrestricted Subsidiary. The Board of Directors may designate any Subsidiary of
the Company (including any newly acquired or newly formed Subsidiary of the
Company) to be an Unrestricted Subsidiary unless such Subsidiary or any of its
Subsidiaries owns any Capital Stock or Indebtedness of, or owns or holds any
Lien on any property of, the Company or any other Subsidiary of the Company that
is not a Subsidiary of the Subsidiary to be so designated; PROVIDED, HOWEVER,
that (i) either (A) the Subsidiary to be so designated has total consolidated
assets of $1,000 or less or (B) if such Subsidiary has total consolidated assets
greater than $1,000, then such designation would be permitted under "Limitation
on Restricted Payments" and (ii) the holders of any Indebtedness of such
Subsidiary do not have direct or indirect recourse against the Company or any
Restricted Subsidiary of the Company and neither the Company nor any Restricted
Subsidiary of the Company otherwise has any liability for any payment
obligations in respect of such Indebtedness except as permitted under "--Certain
Covenants--Limitation on Indebtedness." The Board of Directors may designate any
Unrestricted Subsidiary to be a Restricted Subsidiary; PROVIDED, HOWEVER, that
immediately after giving effect to such designation (x) the Company could Incur
$1.00 of additional Indebtedness under clause (a) of "--Certain
Covenants--Limitation on Indebtedness" and (y) no Default shall have occurred
and be continuing. Any such designation by the Board of Directors shall be
evidenced to the Trustee by promptly filing with the Trustee a copy of the Board
Resolution giving effect to such designation and an Officers' Certificate
certifying that such designation complied with the foregoing provisions.
Notwithstanding the foregoing, any Unrestricted Subsidiary (as determined in
accordance with clauses (i) through (ii) of the first sentence of this
definition) may but is not obligated to provide a Guarantee for the Notes.
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"U.S. Government Obligations" means direct obligations (or certificates
representing an ownership interest in such obligations) of the United States of
America (including any agency or instrumentality thereof) for the payment of
which the full faith and credit of the United States of America is pledged and
which are not callable or redeemable at the issuer's option.
"Voting Stock" of a corporation means all classes of Capital Stock of such
corporation then outstanding and normally entitled to vote in the election of
directors.
"Wholly Owned Subsidiary" means a Restricted Subsidiary of the Company all
the Capital Stock of which (other than directors' qualifying shares) is owned by
the Company or another Wholly Owned Subsidiary.
BOOK-ENTRY DELIVERY AND FORM
The exchange notes will be issued only in fully registered form, without
interest coupons, in denominations of $1,000 and integral multiples thereof. The
exchange notes will not be issued in bearer form.
GLOBAL NOTES. The exchange notes will be represented by one or more Notes
in registered, global form without interest coupons (collectively, the "Global
Note"). The Global Note will be deposited upon issuance with the Trustee as
custodian for DTC, in New York, New York, and registered in the name of DTC or
its nominee, or will remain in the custody of the Trustee pursuant to a
customary custodian arrangement.
Interests in the Global Note may only be exchanged for certificated notes in
the limited circumstances specified under "--Exchange of Book-Entry Notes for
Certificated Notes." Except as set forth below, the Global Note may be
transferred, in whole and not in part, only to another nominee of DTC or to a
successor of DTC or its nominee. In addition, transfer of beneficial interests
in the Global Note will be subject to the applicable rules and procedures of DTC
and its direct or indirect participants, which may change from time to time.
EXCHANGE OF BOOK-ENTRY NOTES FOR CERTIFICATED NOTES. A beneficial interest
in a Global Note may not be exchanged for a Note in certificated form unless
(1) DTC (a) notifies the Company that it is unwilling or unable to continue
as Depositary for the Global Note or (b) has ceased to be a clearing
agency registered under the Exchange Act, and in either case the Company
thereupon fails to appoint a successor Depositary for 90 days,
(2) the Company, at its option, notifies the Trustee in writing that it
elects to cause the issuance of the Notes in certificated form, or
(3) there shall have occurred and be continuing an Event of Default or any
event which after notice or lapse of time or both would be an Event of
Default with respect to the Notes.
In all cases, certificated Notes delivered in exchange for any Global Note or
beneficial interests therein will be registered in the names, and issued in any
approved denominations, requested by or on behalf of the Depositary (in
accordance with its customary procedures). Any certificated Note issued in
exchange for an interest in a Global Note will bear the legend restricting
transfers that is borne by such Global Note. Any such exchange will be effected
through the DWAC system and an appropriate adjustment will be made in the
records of the security registrar to reflect a decrease in the principal amount
of the relevant Global Note.
CERTAIN BOOK-ENTRY PROCEDURES FOR GLOBAL NOTES. The descriptions of the
operations and procedures of DTC that follow are provided solely as a matter of
convenience. These operations and procedures are solely within the control of
the respective settlement systems and are subject to change by them
83
from time to time. The Company takes no responsibility for these operations and
procedures and urges investors to contact the system or their participants
directly to discuss these matters.
DTC has advised the Company that it is:
- a limited purpose trust company organized under the laws of the State of
New York,
- a "banking organization" within the meaning of the New York Banking Law,
- a member of the Federal Reserve System, and
- a "clearing corporation" within the meaning of the Uniform Commercial Code
and a "Clearing Agency" registered pursuant to the provisions of
Section 17A of the Exchange Act.
DTC was created to hold securities for its participants ("participants") and
facilitate the clearance and settlement of securities transactions between
participants through electronic book-entry changes in accounts of its
participants, thereby eliminating the need for physical transfer and delivery of
certificates. Participants include securities brokers and dealers, banks, trust
companies and clearing corporations and may include certain other organizations.
Indirect access to the DTC system is available to other entities such as banks,
brokers, dealers and trust companies that clear through or maintain a custodial
relationship with a participant, either directly or indirectly ("indirect
participants").
DTC has advised the Company that its current practice, upon the issuance of
the Global Note, is to credit, on its internal system, the respective principal
amount of the individual beneficial interests represented by such Global Note to
the accounts with DTC of the participants through which such interests are to be
held. Ownership of beneficial interest in the Global Note will be shown on, and
the transfer of that ownership will be effected only through, records maintained
by DTC or its nominees (with respect to interest of participants) and the
records of participants and indirect participants (with respect to interests of
persons other than participants).
As long as DTC, or its nominee, is the registered holder of a Global Note,
DTC or such nominee, as the case may be, will be considered the sole owner and
holder of the Notes represented by such Global Note for all purposes under the
Indenture and the Notes. Except in the limited circumstances described above
under "--Exchange of Book-Entry Notes for Certificated Notes," owners of
beneficial interests in a Global Note will not be entitled to have any portions
of such Global Note registered in their names, and will not receive or be
entitled to receive physical delivery of Notes in definitive form and will not
be considered the owners or Holders of the Global Note (or any Notes represented
thereby) under the Indenture or the Notes.
Investors may hold their interests in the Global Note directly through DTC,
if they are participants in such system, or indirectly through organizations
which are participants in such system. All interests in a Global Note will be
subject to the procedures and requirements of DTC.
The laws of some states require that certain persons take physical delivery
in definitive form of securities that they own. Consequently, the ability to
transfer beneficial interests in a Global Note to such persons may be limited to
that extent. Because DTC can act only on behalf of its participants, which in
turn act on behalf of indirect participants and certain banks, the ability of a
person having beneficial interests in a Global Note to pledge such interest to
persons or entities that do not participate in the DTC system, or otherwise take
actions in respect of such interests, may be affected by the lack of a physical
certificate evidencing such interests.
Payments of the principal of, premium, if any, and interest on the Global
Note will be made to DTC or its nominee as the registered owner thereof. Neither
the Company, the Trustee nor any of their respective agents will have any
responsibility or liability for any aspect of the records relating to or
payments made on account of beneficial ownership interest in the Global Note or
for maintaining, supervising or reviewing any records relating to such
beneficial ownership interests.
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The Company expects that DTC or its nominee, upon receipt of any payment of
principal of, premium, if any, or interest in respect of a Global Note
representing any Notes held by it or its nominee, will credit participants'
accounts with payments in amounts proportionate to their respective beneficial
interests in the principal amount of such Global Note for such Notes as shown on
the records of DTC or its nominee. The Company also expects that payments by
participants to owners of beneficial interests in such Global Note held through
such participants will be governed by standing instructions and customary
practices, as is now the case with securities held for the accounts of customers
registered in "street name." Such payments will be the responsibility of such
participants. None of the Company or the Trustee will be liable for any delay by
DTC or any of its participants in identifying the beneficial owners of the
Notes, and the Company and the Trustee may conclusively rely on and will be
protected in relying on instructions from DTC or its nominee as the registered
owner of the Notes for all purposes.
DTC has advised the Company that it will take any action permitted to be
taken by a holder of Notes only at the direction of one or more participants to
whose accounts with DTC interests in the Global Note are credited and only in
respect of such portion of the aggregate principal amount of the Notes as to
which such participant or participants has or have given such direction.
However, if there is an Event of Default under the Notes, DTC reserves the right
to exchange the Global Note for legended Notes in certificated form, and to
distribute such Notes to its participants.
Although DTC has agreed to the foregoing procedures in order to facilitate
transfer of beneficial ownership interests in the Global Notes among
participants of DTC, they are under no obligation to perform or continue to
perform such procedures, and such procedures may be discontinued or changed at
any time. None of the Company, the Trustee nor any of their respective agents
will have any responsibility for the performance by DTC or its participants or
indirect participants of their respective obligations under the rules and
procedures governing their operations, including maintaining, supervising or
reviewing the records relating to or payments made on account of, beneficial
ownership interests in Global Notes.
SAME DAY SETTLEMENT. Interests in the Global Note will trade in DTC's
Same-Day Funds Settlement System and secondary market trading activity in such
interests will therefore settle in immediately available funds, subject in all
cases to the rules and procedures of DTC and its participants. Transfers between
participants in DTC will be effected in accordance with DTC's procedures, and
will be settled in same-day funds.
85
PLAN OF DISTRIBUTION
Except as described below, a broker-dealer may not participate in the
exchange offer in connection with a distribution of the exchange notes. Each
broker-dealer that receives exchange notes for its own account pursuant to the
exchange offer must acknowledge that it will deliver a prospectus in connection
with any resale of the exchange notes. This prospectus, as it may be amended or
supplemented from time to time, may be used by a broker-dealer in connection
with resales of exchange notes received for its own account in exchange for
outstanding notes where those outstanding notes were acquired as a result of
market-making activities or other trading activities. Michaels Stores has agreed
that it will make this prospectus, as amended or supplemented, available to any
broker-dealer for use in connection with any resale subject to the conditions
described under "The Exchange Offer--Resale of the Exchange Notes."
Michaels Stores will not receive any proceeds from any sale of exchange
notes by broker-dealers. Exchange notes received by broker-dealers for their own
account pursuant to the exchange offer may be sold from time to time in one or
more transactions in the over-the-counter market, in negotiated transactions,
through the writing of options on the exchange notes or a combination of those
methods of resale, at market prices prevailing at the time of resale, at prices
related to the prevailing market prices, or negotiated prices. Any resale may be
made directly to purchasers or through brokers or dealers who may receive
compensation in the form of commissions or concessions from any broker-dealer
and/or the purchasers of any exchange notes. Any broker or dealer that
participates in a distribution of the exchange notes may be deemed to be an
"underwriter" within the meaning of the Securities Act of 1933, and any profit
on the resale of exchange notes and any commissions or concessions received by
those persons may be deemed to be underwriting compensation under the Securities
Act of 1933. The Letter of Transmittal states that by acknowledging that it will
deliver and by delivering a prospectus a broker-dealer will not be deemed to
admit that it is an "underwriter" within the meaning of the Securities Act of
1933.
Michaels Stores has agreed to pay all expenses incident to the exchange
offer other than commissions or concessions of any brokers or dealers and
expenses of counsel for the holders of the exchange notes and will indemnify the
holders of the exchange notes, including any broker-dealers, against some
liabilities, including some liabilities under the Securities Act of 1933.
LEGAL MATTERS
Jones, Day, Reavis & Pogue will pass upon the validity of the exchange notes
for Michaels Stores, Inc.
EXPERTS
Ernst & Young LLP, independent auditors, have audited our consolidated
financial statements at February 3, 2001 and January 29, 2000, and for each of
the three years in the period ended February 3, 2001, as set forth in their
report. We've included our financial statements in the prospectus and elsewhere
in the registration statement in reliance on Ernst & Young LLP's report, given
on their authority as experts in accounting and auditing.
86
MICHAELS STORES, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
PAGE
--------
Audited Financial Statements:
Report of Independent Auditors............................ F-2
Consolidated Balance Sheets at February 3, 2001 and
January 29, 2000.......................................... F-3
Consolidated Statements of Income for the fiscal years
ended February 3, 2001, January 29, 2000, and January
30, 1999................................................ F-4
Consolidated Statements of Cash Flows for the fiscal years
ended February 3, 2001, January 29, 2000, and January
30, 1999................................................ F-5
Consolidated Statements of Stockholders' Equity for the
fiscal years ended February 3, 2001, January 29, 2000,
and January 30, 1999.................................... F-6
Notes to Consolidated Financial Statements for the fiscal
years ended February 3, 2001, January 29, 2000, and
January 30, 1999........................................ F-7
Unaudited Supplemental Quarterly Financial Data for the
fiscal years ended February 3, 2001 and January 29,
2000.................................................... F-20
Unaudited Financial Statements:
Consolidated Balance Sheets at May 5, 2001 and February 3,
2001...................................................... F-21
Consolidated Statements of Income for the three months
ended May 5, 2001 and April 29, 2000.................... F-22
Consolidated Statements of Cash Flows for the three months
ended May 5, 2001 and April 29, 2000.................... F-23
Notes to Consolidated Financial Statements for the three
months ended May 5, 2001.................................. F-24
F-1
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Michaels Stores, Inc.
We have audited the accompanying consolidated balance sheets of Michaels
Stores, Inc. and subsidiaries (the "Company") as of February 3, 2001 and
January 29, 2000, and the related consolidated statements of income, cash flows,
and stockholders' equity for each of the three years in the period ended
February 3, 2001. 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 auditing standards generally
accepted in the United States. 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. and subsidiaries at February 3, 2001 and January 29, 2000,
and the consolidated results of their operations and their cash flows for each
of the three years in the period ended February 3, 2001, in conformity with
accounting principles generally accepted in the United States.
As discussed in Note 2 to the consolidated financial statements, in fiscal
2000 the Company changed its method of accounting for revenue recognition on
custom frame sales.
/s/ Ernst & Young LLP
Dallas, Texas
March 5, 2001
F-2
MICHAELS STORES, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS EXCEPT SHARE DATA)
FEBRUARY 3, JANUARY 29,
2001 2000
----------- -----------
ASSETS
CURRENT ASSETS:
Cash and equivalents...................................... $ 28,191 $ 77,398
Merchandise inventories................................... 663,700 615,065
Prepaid expenses and other................................ 24,572 19,026
Deferred income taxes and income taxes receivable......... 13,353 11,498
---------- ----------
Total current assets.................................... 729,816 722,987
---------- ----------
PROPERTY AND EQUIPMENT, AT COST............................. 543,312 455,285
Less accumulated depreciation............................... (242,307) (209,552)
---------- ----------
301,005 245,733
---------- ----------
COSTS IN EXCESS OF NET ASSETS OF ACQUIRED OPERATIONS, NET... 121,256 124,766
OTHER ASSETS................................................ 6,359 3,217
---------- ----------
127,615 127,983
---------- ----------
Total assets................................................ $1,158,436 $1,096,703
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable.......................................... $ 143,224 $ 124,828
Accrued liabilities and other............................. 144,121 136,375
Income taxes payable...................................... 1,663 9,773
---------- ----------
Total current liabilities............................... 289,008 270,976
---------- ----------
SENIOR NOTES................................................ 125,000 125,000
CONVERTIBLE SUBORDINATED NOTES.............................. -- 96,940
DEFERRED INCOME TAXES....................................... 18,269 17,990
OTHER LONG-TERM LIABILITIES................................. 21,513 18,999
---------- ----------
Total long-term liabilities............................. 164,782 258,929
---------- ----------
453,790 529,905
---------- ----------
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; shares issued of 31,836,840 at February 3,
2001 and 31,573,113 at January 29, 2000................. 3,184 3,157
Additional paid-in capital................................ 429,688 401,414
Retained earnings......................................... 271,774 194,138
Treasury stock, at cost, no shares and 1,509,000 shares,
respectively............................................ -- (31,911)
---------- ----------
Total stockholders' equity.............................. 704,646 566,798
---------- ----------
Total liabilities and stockholders' equity.................. $1,158,436 $1,096,703
========== ==========
See accompanying notes to consolidated financial statements.
F-3
MICHAELS STORES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS EXCEPT PER SHARE DATA)
FISCAL YEAR
------------------------------------
2000 1999 1998
---------- ---------- ----------
NET SALES................................................ $2,249,440 $1,882,522 $1,573,965
Cost of sales and occupancy expense...................... 1,494,304 1,244,204 1,051,266
---------- ---------- ----------
GROSS PROFIT............................................. 755,136 638,318 522,699
Selling, general, and administrative expense............. 596,522 503,069 425,690
Store pre-opening costs.................................. 10,197 11,077 7,897
Litigation settlement.................................... -- 1,500 --
---------- ---------- ----------
OPERATING INCOME......................................... 148,417 122,672 89,112
Interest expense......................................... 18,026 22,654 22,678
Other (income) and expense, net.......................... (3,678) (2,373) (3,890)
---------- ---------- ----------
INCOME BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF
ACCOUNTING CHANGE...................................... 134,069 102,391 70,324
Provision for income taxes............................... 53,628 40,090 26,723
---------- ---------- ----------
INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE..... 80,441 62,301 43,601
Cumulative effect of accounting change for revenue
recognition, net of tax of $1,235...................... 1,852 -- --
---------- ---------- ----------
NET INCOME............................................... $ 78,589 $ 62,301 $ 43,601
========== ========== ==========
EARNINGS PER COMMON SHARE EXCLUDING THE CUMULATIVE EFFECT
OF ACCOUNTING CHANGE:
Basic.................................................. $ 2.42 $ 2.15 $ 1.49
========== ========== ==========
Diluted................................................ $ 2.35 $ 2.01 $ 1.43
========== ========== ==========
EARNINGS PER COMMON SHARE INCLUDING THE CUMULATIVE EFFECT
OF ACCOUNTING CHANGE:
Basic.................................................. $ 2.37 $ 2.15 $ 1.49
========== ========== ==========
Diluted................................................ $ 2.29 $ 2.01 $ 1.43
========== ========== ==========
See accompanying notes to consolidated financial statements.
F-4
MICHAELS STORES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
FISCAL YEAR
---------------------------------
2000 1999 1998
--------- --------- ---------
OPERATING ACTIVITIES:
Net income................................................ $ 78,589 $ 62,301 $ 43,601
Adjustments:
Depreciation............................................ 61,841 55,085 45,972
Amortization............................................ 4,106 4,121 4,281
Other................................................... 1,070 969 1,017
Change in assets and liabilities, excluding
acquisitions:
Merchandise inventories............................... (47,609) (113,826) (115,659)
Prepaid expenses and other............................ (5,546) (4,115) (882)
Deferred income taxes and other....................... (3,723) 10,508 10,464
Accounts payable...................................... 18,396 18,655 (3,283)
Income taxes payable.................................. 21,634 2,540 15,854
Accrued liabilities and other......................... 18,000 24,532 4,673
--------- --------- ---------
Net change in assets and liabilities................ 1,152 (61,706) (88,833)
--------- --------- ---------
Net cash provided by operating activities........... 146,758 60,770 6,038
--------- --------- ---------
INVESTING ACTIVITIES:
Additions to property and equipment....................... (118,010) (90,860) (77,994)
Net proceeds from sales of property and equipment......... 108 101 18,427
Acquisitions.............................................. (2,182) -- --
--------- --------- ---------
Net cash used in investing activities............... (120,084) (90,759) (59,567)
--------- --------- ---------
FINANCING ACTIVITIES:
Payment of other long-term liabilities.................... (5,567) (6,100) (5,378)
Redemption of convertible subordinated notes.............. (4,206) -- --
Acquisition of treasury stock............................. (156,507) (11,539) (20,372)
Proceeds from stock options exercised..................... 89,465 28,760 7,060
Proceeds from issuance of common stock and other.......... 934 142 6,060
--------- --------- ---------
Net cash (used in) provided by financing
activities........................................ (75,881) 11,263 (12,630)
--------- --------- ---------
NET DECREASE IN CASH AND EQUIVALENTS........................ (49,207) (18,726) (66,159)
CASH AND EQUIVALENTS AT BEGINNING OF PERIOD................. 77,398 96,124 162,283
--------- --------- ---------
CASH AND EQUIVALENTS AT END OF PERIOD....................... $ 28,191 $ 77,398 $ 96,124
========= ========= =========
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest.................................... $ 14,335 $ 21,271 $ 20,708
========= ========= =========
Cash paid (refunds received) for income taxes............. $ 31,495 $ 24,463 $ (1,618)
========= ========= =========
See accompanying notes to consolidated financial statements.
F-5
MICHAELS STORES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE THREE YEARS ENDED FEBRUARY 3, 2001
(IN THOUSANDS EXCEPT SHARE DATA)
ADDITIONAL TREASURY
NUMBER OF COMMON PAID-IN RETAINED STOCK,
SHARES STOCK CAPITAL EARNINGS AT COST TOTAL
---------- -------- ---------- -------- --------- ---------
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
Exercise of stock options and
other............................ 1,866,353 186 28,716 765 -- 29,667
Tax benefit from exercise of stock
options.......................... -- -- 5,390 -- -- 5,390
Acquisition of treasury stock...... (364,000) -- -- -- (11,539) (11,539)
Net income......................... -- -- -- 62,301 -- 62,301
---------- ------ --------- -------- --------- ---------
BALANCE AT JANUARY 29, 2000.......... 30,064,113 3,157 401,414 194,138 (31,911) 566,798
Exercise of stock options and
other............................ 4,488,031 449 89,953 (953) -- 89,449
Conversion of Subordinated Notes... 2,445,696 245 96,328 -- -- 96,573
Tax benefit from exercise of stock
options.......................... -- -- 29,744 -- -- 29,744
Acquisition of treasury stock...... (5,161,000) -- -- -- (156,507) (156,507)
Retirement of treasury stock....... -- (667) (187,751) -- 188,418 --
Net income......................... -- -- -- 78,589 -- 78,589
---------- ------ --------- -------- --------- ---------
BALANCE AT FEBRUARY 3, 2001.......... 31,836,840 $3,184 $ 429,688 $271,774 $ -- $ 704,646
========== ====== ========= ======== ========= =========
See accompanying notes to consolidated financial statements.
F-6
MICHAELS STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
Michaels Stores, Inc. (together with its subsidiaries, unless the text
otherwise requires, the "Company") owns and operates a chain of 628 specialty
retail stores in 48 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
approximately 40,000 items. The Company's wholly-owned subsidiary, Aaron
Brothers, Inc., operates a chain of 119 framing and art supply stores. Aaron
Brothers stores are located primarily on the West Coast. The Company also owns
and operates Star Decorators' Wholesale Warehouse ("Star Wholesale"), a single
wholesale operation located in Dallas, Texas, offering merchandise primarily to
interior decorators/designers, wedding/event planners, florists, hotels,
restaurants, and commercial display companies.
FISCAL YEAR
The Company reports on the basis of a 52 or 53-week fiscal year, which ends
on the Saturday closest to January 31. Fiscal 2000 ended February 3, 2001 and
contained 53 weeks. Fiscal 1999 ended January 29, 2000 and fiscal 1998 ended
January 30, 1999, and each contained 52 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. The Company records interest income
earned from its cash and equivalents as a component of other (income) and
expense, net, in its financial statements. Interest income was $3,866,000,
$2,374,000, and $3,942,000 for fiscal 2000, 1999, and 1998, respectively.
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.
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
F-7
MICHAELS STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 $29,003,000
and $25,317,000 as of the end of fiscal 2000 and 1999, respectively.
IMPAIRMENT OF LONG-LIVED ASSETS
The Company periodically reviews long-lived assets for impairment by
comparing the carrying value of the assets with their estimated future
undiscounted cash flows. If it is determined that an impairment loss has
occurred, the loss would be recognized during that period. The impairment loss
is calculated as the difference between asset carrying values and the present
value of estimated net cash flows or comparable market values, giving
consideration to recent operating performance and pricing trends. In fiscal
2000, 1999, and 1998, the Company had no significant impairment losses related
to long-lived assets.
ESTIMATING FAIR VALUE OF FINANCIAL INSTRUMENTS
The $125 million of Senior Notes due June 2006 are estimated at fair market
value based on dealer quotes at each balance sheet date.
RESERVE FOR CLOSED FACILITIES
The Company maintains a reserve for future rental obligations, carrying
costs, and other closing costs related to closed facilities, primarily closed
and relocated stores. The following is a detail of account activity (in
thousands):
FISCAL YEAR
------------------------------
2000 1999 1998
-------- -------- --------
Balance at beginning of fiscal year......................... $8,765 $8,557 $7,278
Additions charged to costs and expenses..................... 6,302 4,076 4,840
Payment of rental obligations and other..................... (7,068) (3,868) (3,561)
------ ------ ------
Balance at end of fiscal year............................... $7,999 $8,765 $8,557
====== ====== ======
ADVERTISING COSTS
Advertising costs are expensed in the period in which the advertising first
occurs. Co-op advertising funds are recognized when the Company has performed
its obligations under the co-op advertising agreements. Advertising expense, net
of co-op advertising funds, was $82,519,000, $69,745,000, and $58,928,000 for
fiscal 2000, 1999, and 1998, respectively, and is included in selling, general,
and administrative expense.
F-8
MICHAELS STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
STORE PRE-OPENING COSTS
The Company expenses all start-up activity costs as incurred, which
primarily include store pre-opening costs.
REVENUE RECOGNITION
Revenue from sales of the Company's merchandise is recognized at the time of
the merchandise sale, excluding revenue from the sale of custom frames. The
Company allows for merchandise to be returned under most circumstances. The
Company does not provide a reserve for estimated returns, as the amount does not
have a material impact on the financial statements.
In fiscal 2000, the Company recorded the cumulative effect of a change in
accounting principle related to revenue recognition from the sale of custom
frames. The Company now recognizes the sale of custom frames at the time the
frame is picked up by the customer. For a detailed description, see Note 2 of
Notes to Consolidated Financial Statements.
RECLASSIFICATIONS
Certain reclassifications have been made to prior periods to conform to
current presentations.
F-9
MICHAELS STORES, INC.
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
------------------------------
2000 1999 1998
-------- -------- --------
(IN THOUSANDS EXCEPT PER SHARE
DATA)
NUMERATOR:
Net income (1).............................................. $78,589 $62,301 $43,601
Assumed add-back of interest on convertible subordinated
debt less tax benefit of $2,386........................... -- 3,893 --
------- ------- -------
Net income per diluted share computation.................... $78,589 $66,194 $43,601
======= ======= =======
DENOMINATOR:
Denominator for basic earnings per common share--weighted
average shares............................................ 33,209 29,006 29,218
Effect of dilutive securities:
Convertible subordinated debt............................. -- 2,551 --
Employee stock options.................................... 1,069 1,428 1,360
------- ------- -------
Denominator for diluted earnings per common share--weighted
average shares adjusted for dilutive securities........... 34,278 32,985 30,578
======= ======= =======
BASIC EARNINGS PER COMMON SHARE:
Before cumulative effect of accounting change............. $ 2.42 $ 2.15 $ 1.49
Cumulative effect of accounting change.................... (0.05) -- --
------- ------- -------
Net income................................................ $ 2.37 $ 2.15 $ 1.49
======= ======= =======
DILUTED EARNINGS PER COMMON SHARE:
Before cumulative effect of accounting change............. $ 2.35 $ 2.01 $ 1.43
Cumulative effect of accounting change.................... (0.06) -- --
------- ------- -------
Net income................................................ $ 2.29 $ 2.01 $ 1.43
======= ======= =======
------------------------
(1) Fiscal 2000 net income includes the cumulative effect of a change in
accounting principle, net of tax, in the amount of $1,852,000. See Note 2 of
Notes to Consolidated Financial Statements.
The Company's purchase and subsequent retirement of 5,161,000 shares of its
common stock ("Common Stock") in fiscal 2000 reduced the number of weighted
average shares outstanding by approximately 1,426,000 shares for fiscal 2000.
For fiscal 2000, approximately 1.6 million shares related to the Company's
outstanding employee stock options were excluded from the calculation of diluted
earnings per share since their exercise prices exceeded the fair market value of
the Common Stock. In addition, the convertible subordinated notes were not
included in the diluted earnings per share calculation for fiscal 1998 because
they were anti-dilutive.
F-10
MICHAELS STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which requires all derivatives to be
recorded on the balance sheet at fair value and establishes accounting treatment
for certain types of hedging activities. The Company will adopt the requirements
of SFAS No. 133 in its fiscal year beginning February 4, 2001. The adoption of
SFAS No. 133 will have no material impact on the Company's operating results or
financial position.
NOTE 2. CHANGE IN ACCOUNTING PRINCIPLE
Effective October 29, 2000, the Company changed its method of accounting for
custom frame sales in accordance with guidance provided in the Securities and
Exchange Commission's Staff Accounting Bulletin No. 101, "Revenue Recognition in
Financial Statements." Historically, the Company has recognized sales for custom
frame orders at the time that the order was placed by the customer. Under the
new accounting method adopted retroactive to January 30, 2000, the Company now
effectively recognizes revenue for custom frame orders at the time of delivery.
The cumulative effect of the change on prior years resulted in a charge to
income of $1.9 million (after reduction for income taxes of $1.2 million) which
is included in the results of operations for the first quarter of fiscal 2000.
The effect of the change on fiscal 2000 was to recognize $2.6 million in revenue
and increase income before the cumulative effect of the accounting change by
$685,000. No pro forma disclosures of net income and earnings per share for
prior fiscal years, assuming the accounting change was applied retroactively,
are provided as the amounts are not materially different from previously
reported amounts.
NOTE 3. DETAIL OF CERTAIN BALANCE SHEET ACCOUNTS
FEBRUARY 3, JANUARY 29,
2001 2000
------------ ------------
(IN THOUSANDS)
PROPERTY AND EQUIPMENT:
Land and buildings........................................ $ 28,868 $ 3,119
Fixtures and equipment.................................... 383,410 312,599
Leasehold improvements.................................... 125,187 112,715
Capital leases............................................ 5,847 26,852
-------- --------
$543,312 $455,285
======== ========
ACCRUED LIABILITIES AND OTHER:
Salaries, bonuses, and other payroll-related costs........ $ 54,722 $ 42,960
Taxes, other than income and payroll...................... 21,116 21,538
Rent...................................................... 7,678 10,233
Deferred revenue.......................................... 4,374 --
Current portion of capital lease obligations.............. 731 6,353
Other..................................................... 55,500 55,291
-------- --------
$144,121 $136,375
======== ========
F-11
MICHAELS STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4. DEBT
The Company completed a public offering of $125 million of Senior Notes (the
"Notes") in June 1996. 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. 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 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 fair value, based on dealer quotes, of the outstanding Notes as of
February 3, 2001 and January 29, 2000 was $130.6 million and $130.1 million,
respectively.
In January 1993, the Company issued $97.75 million of convertible
subordinated notes ("Subordinated Notes") due January 15, 2003. On June 9, 2000,
the Company called for the redemption of the Subordinated Notes on June 29,
2000. The aggregate principal amount of the Subordinated Notes outstanding was
$96,935,000. The holders had the option to convert their Subordinated Notes into
shares of Common Stock prior to 5:00 p.m., Eastern Time, on June 22, 2000, at a
price of $38.00 per share. Alternatively, holders could have their Subordinated
Notes redeemed on June 29, 2000 at a total redemption price of $1,051.25 per
$1,000 principal amount of Subordinated Notes, which included a premium for
early redemption and accrued interest. As a result, the majority of the
Subordinated Notes was surrendered by the June 22, 2000 conversion date and was
converted into 2,445,565 shares of Common Stock. The remaining Subordinated
Notes were redeemed at a total redemption price of $4,206,051 on June 29, 2000.
The loss from the redemption was not material.
The Company's bank credit facility with Fleet National Bank (formerly
BankBoston, N.A.) and other lending institutions (the "Credit Agreement")
provides for an unsecured revolving line of credit of $100 million with a
$25 million competitive bid feature and a $50 million letter of credit
sub-facility, which line of credit may be increased to $125 million under
specific conditions. The Credit Agreement contains certain financial covenants,
including those related to the ratio of funded debt to total capital, a fixed
charge coverage ratio, and a capital expenditure limitation. Interest on all
borrowings varies based upon the type of borrowing, our fixed charge coverage
ratio, and whether the Company elects to utilize the competitive bid feature
available under the Credit Agreement. If the competitive bid procedure is not
employed, 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 the lending
institution as its "base rate" 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 plus an applicable margin based on our fixed charge coverage ratio. If
the competitive bid feature is utilized, loans up to $25 million may be made
under the Credit Agreement at competitively bid interest rates offered by
lending institutions participating in the facility, which may have the effect of
decreasing the amount of interest the Company would otherwise be obligated to
pay on such borrowings. The Company is required to pay a facility fee from 0.2%
to 0.3% per annum on the unused portion of the revolving line of credit as well
as letter of credit fees that vary depending on the fixed charge coverage ratio.
We are in compliance with all terms and conditions of the Credit Agreement. No
borrowings were outstanding under the Credit Agreement at February 3, 2001 or
January 29, 2000. Borrowings available under the Credit Agreement are reduced by
the aggregate amount of letters of credit outstanding ($15,094,000 at
February 3, 2001). Borrowings in
F-12
MICHAELS STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4. DEBT (CONTINUED)
fiscal 2000 and fiscal 1999 were outstanding under the Credit Agreement for
47 days and 121 days, respectively, in connection with the inventory buildup for
peak selling seasons (with average outstanding borrowings of $25 million and
$40 million, respectively, and a weighted average interest rate of 7.80% and
6.29%, respectively). The Credit Agreement expires on August 28, 2001.
NOTE 5. 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:
FEBRUARY 3, JANUARY 29,
2001 2000
----------- -----------
(IN THOUSANDS)
DEFERRED TAX ASSETS:
Net operating loss, general business credit, and
alternative minimum tax credit carryforwards............ $11,734 $17,920
Accrued expenses.......................................... 21,332 17,675
Other..................................................... 6,693 4,311
------- -------
Deferred tax assets..................................... 39,759 39,906
Valuation allowance....................................... (5,408) (5,454)
------- -------
Total deferred tax assets............................... 34,351 34,452
------- -------
DEFERRED TAX LIABILITIES:
Depreciation and amortization............................. 23,672 23,033
Other..................................................... 15,595 17,655
------- -------
Total deferred tax liabilities.......................... 39,267 40,688
------- -------
Net deferred tax liabilities................................ $(4,916) $(6,236)
======= =======
F-13
MICHAELS STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5. INCOME TAXES (CONTINUED)
The federal and state income tax provision is as follows:
FISCAL YEAR
------------------------------
2000(1) 1999 1998
-------- -------- --------
(IN THOUSANDS)
FEDERAL:
Current................................................... $44,877 $24,393 $16,015
Deferred.................................................. 840 11,487 10,620
------- ------- -------
Total federal income tax provision.......................... 45,717 35,880 26,635
STATE:
Current................................................... 7,753 2,921 463
Deferred.................................................. (1,077) 1,289 (375)
------- ------- -------
Total state income tax provision............................ 6,676 4,210 88
------- ------- -------
Total income tax provision.................................. $52,393 $40,090 $26,723
======= ======= =======
------------------------
(1) The total income tax provision for fiscal 2000 includes a provision on
income before the cumulative effect of a change in accounting principle of
$53,628,000 and a tax benefit of $1,235,000 resulting from the cumulative
effect of a change in accounting principle.
Reconciliation between the actual income tax provision and the income tax
provision calculated by applying the federal statutory rate is as follows:
FISCAL YEAR
------------------------------
2000(1) 1999 1998
-------- -------- --------
(IN THOUSANDS)
Income tax provision at statutory rate...................... $45,844 $35,837 $24,613
Decrease in federal valuation allowance..................... (46) -- (1,075)
Decrease in valuation allowance for state net operating
losses, net of federal income tax effect.................. -- (1,571) (2,497)
State income taxes, net of federal income tax effect........ 4,339 4,308 2,554
Utilization of net operating losses previously not
benefited................................................. -- -- (1,439)
Amortization of intangibles................................. 1,290 1,279 1,331
Other....................................................... 966 237 3,236
------- ------- -------
Total income tax provision.................................. $52,393 $40,090 $26,723
======= ======= =======
At February 3, 2001, the Company had state net operating loss carryforwards
to reduce future taxable income of approximately $82 million expiring at various
dates between fiscal 2001 and fiscal 2018. The Company also has tax credit
carryforwards of approximately $500,000 available to offset future income taxes.
During fiscal 1999, the Company reduced its valuation allowance by $2.4 million
for state net operating losses because it was more likely than not that the
assets would be realized.
F-14
MICHAELS STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6. STOCKHOLDERS' EQUITY
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 fiscal 2000, 1999, and 1998, the Company issued 411, 982, and 178,730
shares, respectively, through the Stock Purchase Plan, generating $14,000,
$27,000, and $6,218,000, respectively, in new equity.
In October 1999, we began issuing Common Stock through our Employees Stock
Purchase Plan. The plan provides our employees with a convenient and economical
means of purchasing Common Stock. The plan also provides us with an additional
way to raise equity capital. During fiscal 2000 and 1999, we issued 33,288 and
8,035 shares, respectively, through the plan, generating approximately $922,000
and $208,000, respectively, in proceeds. Prior to October 1999, shares for the
Employees Stock Purchase Plan were acquired through open market purchases.
In fiscal 1998, the Company repurchased and placed into treasury 1,145,000
shares of Common Stock for an aggregate purchase price of $20.4 million. On
July 14, 1999, the Board of Directors authorized the repurchase of up to
5,000,000 shares of Common Stock. Pursuant to this plan, in fiscal 1999, the
Company repurchased and placed in treasury 364,000 shares of Common Stock for an
aggregate purchase price of $11.5 million. In the first quarter of fiscal 2000,
the Company retired all of the Common Stock held in treasury. Subsequent to the
first quarter of fiscal 2000, through December 14, 2000, the Company repurchased
4,636,000 shares of Common Stock for an aggregate purchase price of
$139.4 million (average of $30.06 per share) of which all shares have been
retired. On December 14, 2000, the Company announced the completion of the
July 1999 stock repurchase plan.
On December 14, 2000, the Board of Directors authorized the repurchase of an
additional 1,000,000 shares of outstanding Common Stock. During fiscal 2000, the
Company repurchased and retired 525,000 shares under this plan at an aggregate
purchase price of $17.2 million (average of $32.67 per share). The Company is
restricted by regulations of the Securities and Exchange Commission from making
repurchases during specified time periods. In addition, under the agreements
governing the Company's outstanding indebtedness, the Company can only
repurchase shares if specified financial ratios are maintained.
Select employees and key advisors of the Company, including directors, may
participate in the 1997 Stock Option Plan (the "Plan"), with an aggregate of
approximately 807,000 shares of Common Stock remaining for issuance thereunder.
Options issued to employees under the Plan have a five year term and vest over a
three year period following the date of grant, while options issued to directors
under the Plan have a five year term and vest immediately.
The Company has elected to follow the Accounting Principles Board Opinion
No. 25, "Accounting For Stock Issued To Employees," and related guidance 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.
F-15
MICHAELS STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6. STOCKHOLDERS' EQUITY (CONTINUED)
Pro forma information regarding net income and earnings per share, as
required by the provisions of SFAS No. 123, "Accounting For Stock-Based
Compensation," 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:
FISCAL YEAR
----------------------------------
2000 1999 1998
-------- -------- --------
Risk-free interest rates.................................... 6.24% 5.43% 4.93%
Dividend yield.............................................. 0% 0% 0%
Expected volatility rates of the Common Stock............... 73.8% 57.2% 58.4%
Weighted average expected life of the options (in years).... 2.55 3.20 2.14
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 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 over the options' vesting periods. 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 1995. The Company's
pro forma information is as follows:
FISCAL YEAR
------------------------------
2000 1999 1998
-------- -------- --------
(IN THOUSANDS EXCEPT PER SHARE
DATA)
Pro forma net income(1)..................................... $68,213 $50,188 $36,661
Pro forma earnings per common share:
Basic..................................................... 2.05 1.73 1.25
Diluted................................................... 2.01 1.55 1.21
------------------------
(1) The fiscal 2000 pro forma net income amount includes the cumulative effect
of the change in accounting principle, net of tax. See Note 2 of Notes to
Consolidated Financial Statements.
F-16
MICHAELS STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6. STOCKHOLDERS' EQUITY (CONTINUED)
For fiscal 2000, 1999, and 1998, the Company's stock option activity is
summarized below:
FISCAL YEAR
---------------------------------------------------------------
2000 1999 1998
------------------- ------------------- -------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
-------- -------- -------- -------- -------- --------
(IN THOUSANDS EXCEPT PRICE PER SHARE DATA)
Outstanding at beginning of year............... 7,403 $21.77 6,986 $19.54 6,627 $18.10
Granted........................................ 1,506 39.12 2,587 24.05 1,150 25.89
Exercised...................................... (4,454) 20.08 (1,857) 15.58 (494) 14.79
Forfeited/Expired.............................. (302) 31.77 (313) 27.68 (297) 19.96
------- ------- ------- ------- ------ -------
Outstanding at end of year..................... 4,153 $29.12 7,403 $21.77 6,986 $19.54
======= ======= ======= ======= ====== =======
Exercisable at end of year..................... 1,836 $23.71 5,335 $19.86 5,313 $18.39
Weighted average fair value of options granted
during the year.............................. $19.14 $10.69 $11.95
The following table summarizes information about stock options outstanding
at February 3, 2001:
STOCK OPTIONS
STOCK OPTIONS OUTSTANDING EXERCISABLE
---------------------------------- -------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
REMAINING EXERCISE EXERCISE
RANGE OF EXERCISE PRICES SHARES LIFE (YEARS) PRICE SHARES PRICE
------------------------ -------- ------------ -------- -------- --------
(IN THOUSANDS EXCEPT REMAINING LIFE AND PRICE PER SHARE DATA)
$13.74 - 18.32.......... 829 3.1 $17.91 814 $17.91
18.33 - 22.90.......... 747 3.0 22.19 327 22.11
22.91 - 27.48.......... 164 4.3 25.63 14 26.45
27.49 - 32.06.......... 1,087 3.2 29.45 467 29.67
32.07 - 36.65.......... 264 4.2 34.68 203 34.83
36.66 - 41.23.......... 140 4.3 39.93 8 37.38
41.24 - 45.81.......... 922 4.5 41.80 3 41.75
----- --- ------- ----- -------
4,153.. 3.6 $29.12 1,836 $23.71
===== === ======= ===== =======
NOTE 7. RETIREMENT PLANS
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 $1,808,000, $1,475,000, and
$1,293,000 for fiscal 2000, 1999, and 1998, respectively.
F-17
MICHAELS STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7. RETIREMENT PLANS (CONTINUED)
Effective August 1, 1999, the Company adopted the Michaels Stores, Inc.
Deferred Compensation Plan (the "Deferred Plan") to provide eligible employees,
directors, and certain consultants (plan "participants") the opportunity to
defer receipt of current compensation. The amount of compensation deferred by
each participant electing to participate in the Deferred Plan will be determined
in accordance with the terms of the Deferred Plan, based on elections by the
plan participants and paid in accordance with the terms of the Deferred Plan.
The Company provides matching contributions equal to 50% of the first 6% of
compensation deferred under the Deferred Plan, reduced by the matching
contributions credited to the participant under the Company's 401(k) Plan. The
participants who are employees will be eligible for a matching contribution only
if they participate in the 401(k) Plan and they are deferring to the 401(k) Plan
the maximum amount permitted for the Plan Year. The Company's matching
contribution expense was $298,000 and $84,000 for fiscal 2000 and 1999,
respectively. Deferred amounts and matching contributions are deposited each pay
period in a trust that qualifies as a grantor trust under the Internal Revenue
Code of 1986, as amended. The funds are invested in individual participant life
insurance contracts. The Company is the owner of these contracts and the Company
and the participant's designee are beneficiaries. Participants must elect
investments for their deferrals and matching contributions from a variety of
hypothetical benchmark funds. The return on the underlying investments
determines the amount of earnings and losses that are credited or debited to the
participant's account. Amounts deferred, matching contributions, and earnings
and losses are 100% vested. The Company's obligations under the Deferred Plan
are unsecured general obligations of the Company and will rank equally with
other unsecured general creditors of the Company.
NOTE 8. COMMITMENTS AND CONTINGENCIES
COMMITMENTS
The Company operates stores and uses distribution centers, office
facilities, and equipment that are generally leased under non-cancelable
operating leases, the majority of which provide for renewal options. Future
minimum annual rental commitments for all non-cancelable operating leases as of
February 3, 2001 are as follows (in thousands):
For the Fiscal Year:
2001...................................................... $ 172,171
2002...................................................... 171,109
2003...................................................... 158,432
2004...................................................... 140,670
2005...................................................... 123,946
Thereafter................................................ 455,148
----------
Total minimum rental commitments............................ $1,221,476
==========
Rental expense applicable to non-cancelable operating leases was
$149,630,000, $122,962,000, and $103,735,000 in fiscal 2000, 1999, and 1998,
respectively.
F-18
MICHAELS STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 8. COMMITMENTS AND CONTINGENCIES (CONTINUED)
CONTINGENCIES
On May 2, 2000, Taiyeb Raniwala, a former assistant manager of the Company,
filed a purported class action complaint (the "Raniwala Complaint") against the
Company, on behalf of the Company's former and current assistant store managers.
The Raniwala Complaint was filed in the Alameda County Superior Court,
California and alleges the Company violated certain California laws by
erroneously treating its assistant store managers as "exempt" employees who are
not entitled to overtime compensation. The Raniwala Complaint seeks back wages,
interest, penalties, and attorneys' fees. A hearing for class certification is
currently scheduled for June 29, 2001, and a trial is tentatively scheduled for
February 25, 2002. The case is in the early phase of discovery. Although the
Company believes it has certain meritorious defenses and intends to defend this
lawsuit vigorously, there can be no assurance that it will be successful in such
defense or that there will not be a materially adverse impact on its future
operating results by the final resolution of the lawsuit.
On April 14, 1999, Suzanne Collins, a former assistant manager of the
Company's subsidiary, Aaron Brothers, Inc., filed a class action complaint (the
"Collins Complaint") against Aaron Brothers on behalf of Aaron Brothers' former
store managers, assistant store managers, and managers-in-training. The Collins
Complaint was filed in Los Angeles County Superior Court, California and alleges
that Aaron Brothers violated certain California laws by erroneously treating its
store managers, assistant store managers, and managers-in-training as "exempt"
employees who are not entitled to overtime compensation. The Collins Complaint
seeks back wages, interest, penalties, and attorneys' fees. The hearing for
class certification and trial dates has been vacated, pending the appointment of
a new judge in the case. The case is currently in the discovery phase. Although
Aaron Brothers believes it has certain meritorious defenses and intends to
defend this lawsuit vigorously, there can be no assurance that it will be
successful in such defense or that there will not be a materially adverse impact
on its future operating results by the final resolution of the lawsuit.
On January 15, 1999, MJDesigns, Inc. ("MJDesigns"), a competitor, filed a
complaint alleging that representatives of the Company disseminated negative
information about the financial stability of MJDesigns, which, it was contended,
contributed to MJDesigns' bankruptcy filing. On August 5, 1999, the parties
reached a settlement, whereby the Company paid $1.5 million to MJDesigns and
both parties executed mutual releases.
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.
F-19
MICHAELS STORES, INC.
UNAUDITED SUPPLEMENTAL QUARTERLY FINANCIAL DATA
(IN THOUSANDS EXCEPT PER SHARE DATA)
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
-------- -------- -------- --------
FISCAL 2000:
AS RESTATED(1):
Net sales........................................... $474,152 $434,059 $525,735 $815,494
Cost of sales and occupancy expense................. 313,333 292,263 344,506 544,202
Operating income.................................... 21,338 11,600 29,328 86,151
Income before cumulative effect of accounting
change(1)......................................... 10,082 4,554 15,694 50,111
Net income.......................................... 8,230 4,554 15,694 50,111
Earnings per common share excluding the cumulative
effect of accounting change:
Basic............................................... $ 0.33 $ 0.13 $ 0.44 $ 1.54
Diluted............................................. $ 0.31 $ 0.13 $ 0.43 $ 1.52
Common shares used in per share calculations:
Basic............................................... 30,597 34,035 35,673 32,531
Diluted............................................. 32,317 35,417 36,483 32,896
AS PREVIOUSLY REPORTED:
Net sales........................................... $472,548 $438,392 $526,504 $809,408
Cost of sales and occupancy expense................. 312,394 294,721 344,831 540,912
Operating income.................................... 20,673 13,475 29,772 83,355
Net income.......................................... 9,684 5,679 15,960 48,433
Earnings per common share:
Basic............................................... $ 0.32 $ 0.17 $ 0.45 $ 1.49
Diluted............................................. $ 0.30 $ 0.16 $ 0.44 $ 1.47
FISCAL 1999:
Net sales........................................... $388,544 $359,124 $463,034 $671,820
Cost of sales and occupancy expense................. 262,547 244,859 307,270 429,528
Operating income.................................... 12,851 5,126 22,589 82,106
Net income.......................................... 5,193 28 10,436 46,644
Earnings per common share:
Basic............................................... $ 0.18 $ 0.00 $ 0.36 $ 1.58
Diluted............................................. $ 0.18 $ 0.00 $ 0.34 $ 1.41
Common shares used in per share calculations:
Basic............................................... 28,584 28,748 29,183 29,511
Diluted(2).......................................... 29,239 30,447 30,933 33,669
------------------------
(1) As more fully described in Note 2 of Notes to Consolidated Financial
Statements, the Company changed its accounting policy with respect to
revenue recognition related to the sale of custom frames effective
retroactively as of the beginning of fiscal 2000. As a result, the Company
has restated its previously published fiscal 2000 quarterly financial data
and recorded a charge of $1.9 million, net of tax, in the first quarter of
fiscal 2000 for the cumulative effect of the change on prior years.
(2) The convertible subordinated notes were not included in the diluted earnings
per common share calculation for the first, second, and third quarters of
fiscal 1999 because they were anti-dilutive. The convertible subordinated
notes were included in the diluted earnings per common share in the fourth
quarter of fiscal 1999.
F-20
MICHAELS STORES, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
MAY 5, FEBRUARY 3,
2001 2001
----------- -----------
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash and equivalents...................................... $ 21,365 $ 28,191
Merchandise inventories................................... 744,701 663,700
Prepaid expenses and other................................ 21,744 24,572
Deferred income taxes..................................... 13,345 13,353
---------- ----------
Total current assets.................................... 801,155 729,816
---------- ----------
PROPERTY AND EQUIPMENT, AT COST............................. 561,214 543,312
Less accumulated depreciation............................... (256,315) (242,307)
---------- ----------
304,899 301,005
---------- ----------
COSTS IN EXCESS OF NET ASSETS OF ACQUIRED OPERATIONS, NET... 120,313 121,256
OTHER ASSETS................................................ 8,351 6,359
---------- ----------
128,664 127,615
---------- ----------
Total assets................................................ $1,234,718 $1,158,436
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable.......................................... $ 169,314 $ 143,224
Accrued liabilities and other............................. 146,640 144,121
Borrowings under line of credit........................... 29,200 --
Income taxes payable...................................... 2,621 1,663
---------- ----------
Total current liabilities............................... 347,775 289,008
---------- ----------
SENIOR NOTES................................................ 125,000 125,000
DEFERRED INCOME TAXES....................................... 18,269 18,269
OTHER LONG-TERM LIABILITIES................................. 23,283 21,513
---------- ----------
Total long-term liabilities............................. 166,552 164,782
---------- ----------
514,327 453,790
---------- ----------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock, $.10 par value, 150,000,000 shares
authorized; shares issued and outstanding of 32,172,812
at May 5, 2001 and 31,836,840 at February 3, 2001....... 3,217 3,184
Additional paid-in capital................................ 438,768 429,688
Retained earnings......................................... 278,406 271,774
---------- ----------
Total stockholders' equity.............................. 720,391 704,646
---------- ----------
Total liabilities and stockholders' equity.................. $1,234,718 $1,158,436
========== ==========
See accompanying notes to consolidated financial statements.
F-21
MICHAELS STORES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED
--------------------
MAY 5, APRIL 29,
2001 2000
-------- ---------
NET SALES................................................... $524,720 $474,152
Cost of sales and occupancy expense......................... 347,439 313,333
-------- --------
GROSS PROFIT................................................ 177,281 160,819
Selling, general, and administrative expense................ 156,428 136,758
Store pre-opening costs..................................... 1,616 2,723
Litigation settlement....................................... 3,153 --
-------- --------
OPERATING INCOME............................................ 16,084 21,338
Interest expense............................................ 3,778 5,520
Other (income) and expense, net............................. (48) (989)
-------- --------
INCOME BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF
ACCOUNTING CHANGE......................................... 12,354 16,807
Provision for income taxes.................................. 5,065 6,725
-------- --------
INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE........ 7,289 10,082
Cumulative effect of accounting change for revenue
recognition, net of tax of $1,235......................... -- 1,852
-------- --------
NET INCOME.................................................. $ 7,289 $ 8,230
======== ========
EARNINGS PER COMMON SHARE EXCLUDING THE CUMULATIVE EFFECT OF
ACCOUNTING CHANGE:
Basic..................................................... $ 0.23 $ 0.33
======== ========
Diluted................................................... $ 0.22 $ 0.31
======== ========
EARNINGS PER COMMON SHARE INCLUDING THE CUMULATIVE EFFECT OF
ACCOUNTING CHANGE:
Basic..................................................... $ 0.23 $ 0.27
======== ========
Diluted................................................... $ 0.22 $ 0.25
======== ========
See accompanying notes to consolidated financial statements.
F-22
MICHAELS STORES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
--------------------
MAY 5, APRIL 29,
2001 2000
-------- ---------
OPERATING ACTIVITIES:
Net income................................................ $ 7,289 $ 8,230
Adjustments:
Depreciation............................................ 15,466 15,456
Amortization............................................ 1,032 1,027
Other................................................... 102 433
Change in assets and liabilities:
Merchandise inventories............................... (81,001) (26,792)
Prepaid expenses and other............................ 2,828 (685)
Deferred income taxes and other....................... (267) 21
Accounts payable...................................... 26,090 22,575
Income taxes payable.................................. 1,998 (4,066)
Accrued liabilities and other......................... 1,638 (7,108)
-------- --------
Net change in assets and liabilities................ (48,714) (16,055)
-------- --------
Net cash (used in) provided by operating
activities........................................ (24,825) 9,091
-------- --------
INVESTING ACTIVITIES:
Additions to property and equipment....................... (19,040) (17,220)
Net proceeds from sales of property and equipment......... 13 24
-------- --------
Net cash used in investing activities............... (19,027) (17,196)
-------- --------
FINANCING ACTIVITIES:
Net borrowings under bank credit facilities............... 29,200 --
Payment of other long-term liabilities.................... (247) (1,473)
Proceeds from stock options exercised..................... 7,777 31,285
Proceeds from issuance of common stock and other.......... 296 195
-------- --------
Net cash provided by financing activities........... 37,026 30,007
-------- --------
NET (DECREASE) INCREASE IN CASH AND EQUIVALENTS............. (6,826) 21,902
CASH AND EQUIVALENTS AT BEGINNING OF PERIOD................. 28,191 77,398
-------- --------
CASH AND EQUIVALENTS AT END OF PERIOD....................... $ 21,365 $ 99,300
======== ========
See accompanying notes to consolidated financial statements.
F-23
MICHAELS STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MAY 5, 2001
(UNAUDITED)
NOTE 1. BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Michaels
Stores, Inc. and its wholly-owned subsidiaries (collectively, the "Company").
All significant intercompany accounts and transactions have been eliminated.
The accompanying consolidated financial statements are unaudited (except for
the Consolidated Balance Sheet as of February 3, 2001) and have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals and other items, as disclosed) considered necessary
for a fair presentation have been included. Because of the seasonal nature of
the Company's business, the results of operations for the three months ended
May 5, 2001 are not indicative of the results to be expected for the entire
year. These interim financial statements should be read in conjunction with the
consolidated financial statements and footnotes thereto included in the
Company's Annual Report on Form 10-K for the fiscal year ended February 3, 2001.
All references herein to "fiscal 2001" relate to the 52 weeks ending
February 2, 2002, and all references to "fiscal 2000" relate to the 53 weeks
ended February 3, 2001. In addition, all references herein to "the first quarter
of fiscal 2001" relate to the 13 weeks ended May 5, 2001, and all references to
"the first quarter of fiscal 2000" relate to the 13 weeks ended April 29, 2000.
NOTE 2. CHANGE IN ACCOUNTING PRINCIPLE
Effective October 29, 2000, the Company changed its method of accounting for
custom frame sales in accordance with guidance provided in the SEC's Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements."
Historically, the Company has recognized sales for custom frame orders at the
time the customer placed the order. Under the new accounting method adopted
retroactive to January 30, 2000, the Company now effectively recognizes revenue
for custom frame orders at the time of delivery. The cumulative effect of the
change on fiscal years prior to fiscal 2000 resulted in a non-cash charge to
income of $1.9 million (after reduction for income taxes of $1.2 million), which
is included in the results of operations for the first quarter of fiscal 2000.
In addition, the Company has given retroactive effect to this change in
accounting principle by restatement of the Company's previously published
financial statements for the first quarter of fiscal 2000. The effect of the
change on the first quarter of fiscal 2000 was to recognize $1.6 million in
revenue and increase income before the cumulative effect of the accounting
change by $398,000.
F-24
MICHAELS STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE THREE MONTHS ENDED MAY 5, 2001
(UNAUDITED)
NOTE 3. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings
per common share:
THREE MONTHS
ENDED
--------------------
MAY 5, APRIL 29,
2001 2000
-------- ---------
(IN THOUSANDS,
EXCEPT PER SHARE
DATA)
NUMERATOR:
Income before cumulative effect of accounting change...... $7,289 $10,082
Cumulative effect of accounting change, net of tax........ -- 1,852
------ -------
Net income................................................ $7,289 $ 8,230
====== =======
DENOMINATOR:
Denominator for basic earnings per share-weighted average
shares.................................................. 31,872 30,597
Effect of dilutive securities:
Employee stock options.................................. 655 1,720
------ -------
Denominator for diluted earnings per share-weighted
average shares adjusted for dilutive securities......... 32,527 32,317
====== =======
BASIC EARNINGS PER COMMON SHARE:
Income before cumulative effect of accounting change...... $ 0.23 $ 0.33
Cumulative effect of accounting change, net of tax........ -- (0.06)
------ -------
Net income................................................ $ 0.23 $ 0.27
====== =======
DILUTED EARNINGS PER COMMON SHARE:
Income before cumulative effect of accounting change...... $ 0.22 $ 0.31
Cumulative effect of accounting change, net of tax........ -- (0.06)
------ -------
Net income................................................ $ 0.22 $ 0.25
====== =======
NOTE 4. CREDIT AGREEMENT
Effective May 1, 2001, the Company completed a new $200 million unsecured
bank credit facility with Fleet National Bank and other lending institutions
(the "Credit Agreement"), which replaced the previous $100 million unsecured
bank credit facility. The Credit Agreement has a term of three years (with a
maturity extension for one additional year available under certain conditions)
and contains a $25 million competitive bid feature and a $70 million letter of
credit sub-facility.
The Credit Agreement contains certain financial covenants, including a
balance sheet leverage ratio, a cash flow coverage ratio, a cash flow leverage
ratio, and a capital expenditure limitation. Interest on all borrowings varies
based upon the type of borrowing, the fixed charge coverage ratio, and whether
the Company elects to utilize the competitive bid feature available under the
Credit Agreement. If the competitive bid feature is not utilized, the interest
rate on borrowings under the
F-25
MICHAELS STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE THREE MONTHS ENDED MAY 5, 2001
(UNAUDITED)
NOTE 4. CREDIT AGREEMENT (CONTINUED)
Credit Agreement is generally (a) the higher of (i) an annual rate of interest
announced from time to time by Fleet National Bank, as agent, as its "base rate"
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, plus an
applicable margin based on our fixed charge coverage ratio. If the competitive
bid feature is utilized, loans up to $25 million may be made under the Credit
Agreement at competitively bid interest rates offered by lending institutions
participating in the facility, which may have the effect of decreasing the
amount of interest the Company would otherwise be obligated to pay on such
borrowings. The Company is required to pay a facility fee from 0.2% to 0.35% per
annum on the unused portion of the revolving line of credit as well as letter of
credit fees that vary depending on the fixed charge coverage ratio.
The Company is in compliance with all terms and conditions of the Credit
Agreement. Borrowings outstanding under the Credit Agreement were $29.2 million
as of May 5, 2001. Borrowings available under the Credit Agreement are reduced
by the aggregate amount of letters of credit outstanding under the Credit
Agreement ($8.7 million at May 5, 2001). Borrowings in the first quarter of
fiscal 2001 were outstanding for 79 days, with average outstanding borrowings of
$13.0 million and a weighted average interest rate of 7.33%.
NOTE 5. LEGAL PROCEEDINGS
On May 2, 2000, Taiyeb Raniwala ("Raniwala"), a former assistant manager of
the Company, filed a purported class action complaint (the "Raniwala Complaint")
against us, on behalf of our former and current assistant store managers. The
Raniwala Complaint was filed in the Alameda County Superior Court, California
and alleges we violated certain California laws by erroneously treating our
assistant store managers as "exempt" employees who are not entitled to overtime
compensation. Based on these allegations, the Raniwala Complaint asserts we:
(1) violated certain California Wage Orders; (2) violated Section 17200 of the
California Business and Professions Code; and (3) engaged in conversion. The
Raniwala Complaint seeks back wages, interest, penalties, and attorneys' fees.
On July 20, 2000, Raniwala filed an amended complaint to correct certain
deficiencies in the original Complaint (the "Amended Raniwala Complaint"). On
September 25, 2000, we filed our answer to the Amended Raniwala Complaint.
On June 6, 2001, we negotiated a tentative settlement with Raniwala.
Pursuant to the terms of the settlement, in exchange for a full release of
claims, we are obligated to pay a maximum of $3.0 million covering all claims
and attorneys' fees, plus estimated payroll taxes of approximately $153,000,
which amounts were accrued in the first quarter of fiscal 2001. The specific
terms of the settlement are currently being finalized between the parties and
must then be approved by the Alameda County Superior Court. While we believe
that it is likely that the settlement will be approved, we can provide no
assurance to that effect.
On April 14, 1999, Suzanne Collins ("Collins"), a former assistant manager
of our subsidiary, Aaron Brothers, Inc. ("Aaron Brothers"), filed a class action
complaint (the "Collins Complaint") against Aaron Brothers on behalf of Aaron
Brothers' former store managers, assistant store managers, and
managers-in-training. The Collins Complaint was filed in the Los Angeles County
Superior Court,
F-26
MICHAELS STORES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE THREE MONTHS ENDED MAY 5, 2001
(UNAUDITED)
NOTE 5. LEGAL PROCEEDINGS (CONTINUED)
California and alleges that Aaron Brothers violated certain California laws by
erroneously treating its store managers, assistant store managers, and
managers-in-training as "exempt" employees who are not entitled to overtime
compensation. Based on these allegations, the Collins Complaint asserts that
Aaron Brothers: (1) violated certain California Labor Codes; (2) violated
Section 17200 of the California Business and Professions Code; and (3) engaged
in conversion. The Collins Complaint seeks back wages, interest, penalties,
punitive damages, and attorneys' fees.
On May 30, 2001, Collins filed a motion to amend the Collins Complaint (the
"Amended Collins Complaint"), which is scheduled for a hearing on June 25, 2001.
If granted, the Amended Collins Complaint would: (1) expand the purported class
to include all current Aaron Brothers salaried store managers, assistant store
managers, and managers-in-training based in California; (2) add a new plaintiff
as a class representative; and (3) add two additional causes of action for
injunctive and declaratory relief.
The Court has set a status conference in the case for July 11, 2001. At the
July 11, 2001 status conference, it is anticipated that the Court will set a
hearing date to determine whether the case should proceed as a class action
lawsuit. A trial date has not yet been scheduled.
The case is currently in the discovery phase. There can be no assurance that
Aaron Brothers will be successful in defending this litigation or that future
operating results will not be materially adversely affected by the final
resolution of the lawsuit.
We are a defendant from time to time in lawsuits incidental to our business.
Based on currently available information, we believe that resolution of all
known contingencies, including the litigation described above, is uncertain, and
there can be no assurance that future costs of such litigation would not be
material to our financial position or results of operations.
NOTE 6. RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which requires all derivatives to be
recorded on the balance sheet at fair value and establishes accounting treatment
for certain types of hedging activities. The Company adopted the requirements of
SFAS No. 133 beginning in fiscal 2001. The adoption of SFAS No. 133 had no
material impact on the Company's operating results or financial position for the
first quarter of fiscal 2001.
F-27
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$200,000,000
[LOGO]
9 1/4% SENIOR NOTES DUE 2009
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PROSPECTUS
--------------
AUGUST , 2001
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PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 20. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Michaels' certificate of incorporation limits the liability of Michaels'
directors to the maximum extent permitted by Delaware law. Delaware law provides
that a director of a corporation will not be personally liable for monetary
damages for breach of that individual's fiduciary duties as a director except
for liability for (1) a breach of the director's duty of loyalty to the
corporation or its stockholders, (2) any act or omission not in good faith or
that involves intentional misconduct or a knowing violation of the law,
(3) unlawful payments of dividends or unlawful stock repurchases or redemptions,
or (4) any transaction from which the director derived an improper personal
benefit.
This limitation of liability does not apply to liabilities arising under
federal securities laws and does not affect the availability of equitable
remedies such as injunctive relief or rescission.
Section 145 of the Delaware General Corporation Law provides that a
corporation may indemnify directors and officers, as well as other employees and
individuals, against attorneys' fees and other expenses, judgments, fines and
amounts paid in settlement actually and reasonably incurred by such person in
connection with any threatened, pending or completed actions, suits or
proceedings in which such person was or is a party or is threatened to be made a
party by reason of such person being or having been a director, officer,
employee or agent of the corporation. The Delaware General Corporation Law
provides that Section 145 is not exclusive of other rights to which those
seeking indemnification may be entitled under any bylaw, agreement, vote of
stockholders or disinterested directors, or otherwise.
Michaels' certificate of incorporation requires that Michaels indemnify its
directors and officers, and any other person who is or was serving at the
request of Michaels as a director, officer, employee or agent of another
corporation or of a partnership, joint venture, trust or other enterprise, to
the fullest extent permitted by Delaware law. Michaels' certificate of
incorporation also requires that Michaels advance expenses incurred by such a
person in connection with the defense of any action or proceeding arising out of
that person's status or service to Michaels. The bylaws of Michaels require that
it indemnify its directors to the fullest extent permitted by Delaware law and
may, if and to the extent authorized by Michaels' board of directors, so
indemnify its officers and any other person whom it has the power to indemnify
against any liability, expense or other matter whatsoever.
As authorized by its certificate of incorporation, Michaels has procured
insurance that purports (a) to insure it against certain costs of
indemnification that may be incurred by it pursuant to the provisions referred
to above or otherwise and (b) to insure the directors and officers of Michaels
against certain liabilities incurred by them in the discharge of their functions
as directors and officers except for liabilities arising from their own
malfeasance.
ITEM 21. EXHIBITS
The following is a list of all exhibits filed as a part of this registration
statement on Form S-4, including those incorporated by reference.
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
--------------------- -----------------------
3.1(ii) Amended and Restated Bylaws of Michaels Stores, Inc.
4.1 Form of Common Stock Certificate (previously filed as
Exhibit 4.1 to Michaels' Annual Report on Form 10-K for
the year ended January 30, 1994, Commission File
No. 000-11822, filed April 29, 1994, and incorporated
herein by reference)
II-1
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
--------------------- -----------------------
4.2 Indenture, dated as of June 26, 1996, by and between
Michaels Stores, Inc. and The Bank of New York (previously
filed as Exhibit 4 to Form 10-Q for the quarter ended
July 28, 1996, filed by Registrant on September 30, 1996)
(File No. 000-11822)
4.3 Indenture, dated as of July 6, 2001, by and between Michaels
Stores, Inc. and The Bank of New York, as Trustee
4.4 Registration Rights Agreement, dated as of July 6, 2001, by
and among Michaels Stores, Inc. and Merrill Lynch, Pierce,
Fenner & Smith Incorporated, Credit Suisse First Boston
Corporation, Deutsche Banc Alex. Brown Inc., Fleet
Securities, Inc. and Wells Fargo Brokerage Services, LLC
5.1 Opinion of Jones, Day, Reavis & Pogue
12.1 Ratio of Earnings to Fixed Charges
23.1 Consent of Ernst & Young LLP
23.2 Consent of Jones, Day, Reavis & Pogue (included in
Exhibit 5.1)
24.1 Power of attorney
25.1 Statement of Eligibility under the Trust Indenture Act of
1939 on Form T-1.
99.1 Letter of Transmittal
99.2 Notice of Guaranteed Delivery
99.3 Letter regarding Exchange Offer
99.4 Letter to Depository Trust Company Participants
ITEM 22. UNDERTAKINGS
(a) The undersigned registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being made,
a post-effective amendment to this registration statement:
(i) To include any prospectus required by Section 10(a)(3) of the
Securities Act of 1933;
(ii) To reflect in the prospectus any facts or events arising after
the effective date of the registration statement (or the most recent
post-effective amendment thereof) which, individually or in the
aggregate, represent a fundamental change in the information set forth in
the registration statement. Notwithstanding the foregoing, any increase
or decrease in volume of securities offered (if the total dollar value of
securities offered would not exceed that which was registered) and any
deviation from the low or high end of the estimated maximum offering
range may be reflected in the form of prospectus filed with the
Commission pursuant to Rule 424(b) if, in the aggregate, the changes in
volume and price represent no more than a 20% change in the maximum
aggregate offering price set forth in the "Calculation of Registration
Fee" table in the effective registration statement; and
(iii) To include any material information with respect to the plan of
distribution not previously disclosed in the registration statement or
any material change to such information in the registration statement;
provided, however, that paragraphs (1)(i) and (1)(ii) do not apply if the
registration statement is on Form S-3 or Form S-8, and the information
required to be included in a post-effective amendment by those paragraphs
is contained in periodic reports filed with or furnished to the
Commission by the registrant pursuant to Sections 13 or
II-2
15(d) of the Securities Exchange Act of 1934 that are incorporated by
reference in the registration statement.
(2) That, for the purpose of determining any liability under the Securities
Act of 1933, each such post-effective amendment shall be deemed to be a new
registration statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be the initial bona
fide offering thereof.
(3) To remove from registration by means of a post-effective amendment any
of the securities being registered which remain unsold at the termination of the
offering.
(b) The undersigned registrant hereby undertakes that, for purposes of
determining any liability under the Securities Act of 1933, each filing of
the registrant's annual report pursuant to Section 13(a) or Section 15(d) of
the Securities Exchange Act of 1934 (and, where applicable, each filing of
an employee benefit plan's annual report pursuant to Section 15(d) of the
Securities Exchange Act of 1934) that is incorporated by reference in the
registration statement shall be deemed to be a new registration statement
relating to the securities offered therein, and the offering of such
securities at that time shall be deemed to be the initial bona fide offering
thereof.
(c) Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers and controlling persons of
the registrant pursuant to the foregoing provisions, or otherwise, the
registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the Act
and is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the registrant of expenses
incurred or paid by a director, officer or controlling person of the registrant
in the successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Act and will be governed by the final adjudication of
such issue.
(d) The undersigned registrant hereby undertakes to respond to requests for
information that is incorporated by reference into the prospectus pursuant to
Items 4, 10(b), 11, or 13 of this form, within one business day of receipt of
such request, and to send the incorporated documents by first class mail or
other equally prompt means. This includes information contained in documents
filed subsequent to the effective date of the registration statement through the
date of responding to the request.
(e) The undersigned registrant hereby undertakes to supply by means of a
post-effective amendment all information concerning a transaction, and the
company being acquired involved therein, that was not the subject of and
included in the registration statement when it became effective.
II-3
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Irving, State of Texas,
on August 1, 2001.
MICHAELS STORES, INC.
By: /s/ BRYAN M. DECORDOVA
-----------------------------------------
Bryan M. DeCordova
EXECUTIVE VICE PRESIDENT-CHIEF FINANCIAL
OFFICER
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed below by the following persons in the
capacities indicated as of August 1, 2001.
SIGNATURES TITLE
---------- -----
* Chairman of the Board of Directors
--------------------------------------------
Charles J. Wyly, Jr.
* Vice Chairman of the Board of Directors
--------------------------------------------
Sam Wyly
* President and Chief Executive Officer
-------------------------------------------- (Principal Executive Officer)
R. Michael Rouleau
/s/ BRYAN M. DECORDOVA Executive Vice President-Chief Financial
-------------------------------------------- Officer (Principal Financial and Accounting
Bryan M. DeCordova Officer)
Director
--------------------------------------------
Richard E. Hanlon
* Director
--------------------------------------------
Richard Marcus
Director
--------------------------------------------
Elizabeth A. VanStory
* The undersigned by signing his name hereto does sign and execute this
Registration Statement pursuant to the Powers of Attorney executed by the
above-named directors and officers of the Registrant, which are being filed
herewith the SEC on behalf of such directors and officers.
By: /s/ BRYAN M. DECORDOVA
--------------------------------------
Bryan M. DeCordova
ATTORNEY-IN-FACT
II-4
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
--------------------- ----------------------
3.1(ii) Amended and Restated Bylaws of Michaels Stores, Inc.
4.1 Form of Common Stock Certificate (previously filed as
Exhibit 4.1 to Michaels' Annual Report on Form 10-K for
the year ended January 30, 1994, Commission File
No. 000-11822, filed April 29, 1994, and incorporated
herein by reference)
4.2 Indenture, dated as of June 26, 1996, by and between
Michaels Stores, Inc. and The Bank of New York (previously
filed as Exhibit 4 to Form 10-Q for the quarter ended
July 28, 1996, filed by Registrant on September 30, 1996)
(File No. 000-11822)
4.3 Indenture, dated as of July 6, 2001, by and between Michaels
Stores, Inc. and The Bank of New York, as Trustee
4.4 Registration Rights Agreement, dated as of July 6, 2001, by
and among Michaels Stores, Inc. and Merrill Lynch, Pierce,
Fenner & Smith Incorporated, Credit Suisse First Boston
Corporation, Deutsche Banc Alex. Brown Inc., Fleet
Securities, Inc. and Wells Fargo Brokerage Services, LLC
5.1 Opinion of Jones, Day, Reavis & Pogue
12.1 Ratio of Earnings to Fixed Charges
23.1 Consent of Ernst & Young LLP
23.2 Consent of Jones, Day, Reavis & Pogue (included in
Exhibit 5.1)
24.1 Power of attorney
25.1 Statement of Eligibility under the Trust Indenture Act of
1939 on Form T-1.
99.1 Letter of Transmittal
99.2 Notice of Guaranteed Delivery
99.3 Letter regarding Exchange Offer
99.4 Letter to Depository Trust Company Participants