The Michaels Companies, Inc.
Annual Report 2017

Plain-text annual report

Table of Contents UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended January 28, 2017 Commission file number 001-36501 THE MICHAELS COMPANIES, INC. A Delaware Corporation IRS Employer Identification No. 37-1737959 8000 Bent Branch Drive Irving, Texas 75063 (972) 409-1300 The Michaels Companies, Inc.’s common stock, par value $0.06775 per share, is registered pursuant to Section 12(b) of the Securities Exchange Act of 1934 (the “Act) and is listed on the NASDAQ Global Select Market. The Michaels Companies, Inc. does not have any securities registered under Section 12(g) of the Act. The Michaels Companies, Inc. is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. The Michaels Companies, Inc. (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. The Michaels Companies, Inc. has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will be contained, to the best of the Registrant’s knowledge, in the definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. The Michaels Companies, Inc. is a large accelerated filer. The Michaels Companies, Inc. is not a shell company (as defined in Rule 12b-2 of the Exchange Act). The aggregate market value of The Michaels Companies, Inc.’s common stock held by non-affiliates as of July 30, 2016 was approximately $2,415,252,000 based upon the closing sales price of $26.36 quoted on The NASDAQ Global Select Market as of July 29, 2016. For this purpose, directors and officers have been assumed to be affiliates. As of March 1, 2017, 188,894,383 shares of The Michaels Companies, Inc.’s common stock were outstanding. The registrant will incorporate by reference information required in response to Part III, items 10-14, from its definitive proxy statement for its annual meeting of shareholders, to be held on June 7, 2017. DOCUMENTS INCORPORATED BY REFERENCE Table of Contents THE MICHAELS COMPANIES, INC. TABLE OF CONTENTS Part I. Item 1. Business Item 1A. Risk Factors Item 1B. Unresolved Staff Comments Item 2. Properties Item 3. Legal Proceedings Item 4. Mine Safety Disclosures Part II. Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Item 6. Selected Financial Data Item 7. Management Discussion and Analysis of Financial Condition and Results of Operations Item 7A. Quantitative and Qualitative Disclosures about Market Risk Item 8. Consolidated Financial Statements and Supplementary Data Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Item 9A. Controls and Procedures Part III. Item 10. Directors, Executive Officers and Corporate Governance Item 11. Executive Compensation Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Item 13. Certain Relationships and Related Transactions, and Director Independence Item 14. Principal Accounting Fees and Services Part IV. Item 15. Exhibits and Financial Statement Schedules 2 Page 3 9 20 21 23 23 23 25 26 41 41 41 41 43 43 43 43 43 44 Table of Contents ITEM 1. BUSINESS. PART I The following discussion, as well as other portions of this Annual Report on Form 10-K, contains forward-looking statements that reflect our plans, estimates and beliefs. Any statements contained herein (including, but not limited to, statements to the effect that Michaels or its management “anticipates”, “plans”, “estimates”, “expects”, “believes”, “intends”, and other similar expressions) that are not statements of historical fact should be considered forward-looking statements and should be read in conjunction with our consolidated financial statements and related notes contained elsewhere in this report. Specific examples of forward-looking statements include, but are not limited to, statements regarding our forecasts of financial performance, share repurchases, store openings, capital expenditures and working capital requirements. Our actual results could materially differ from those discussed in these 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 Annual Report on Form 10-K and particularly in “Item 1A. Risk Factors” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations”. Unless the context otherwise indicates, references in this Annual Report on Form 10-K to “we”, “our”, “us”, “our Company”, “the Company”, and “Michaels” mean The Michaels Companies, Inc., together with its subsidiaries. General Michaels Stores, Inc. (“MSI”) is headquartered in Irving, Texas and was incorporated in the state of Delaware in 1983. In July 2013, MSI was reorganized into a holding company structure and The Michaels Companies, Inc. was incorporated in Delaware in connection with the reorganization. With $5,197.3 million in sales in fiscal 2016, the Company is the largest arts and crafts specialty retailer in North America (based on store count) providing materials, project ideas and education for creative activities. Our mission is to inspire and enable customer creativity, create a fun and rewarding place to work, foster meaningful connections with our communities and lead the industry in growth and innovation. With crafting classes, store events, project sheets, store displays, mobile applications and online videos, we offer a shopping experience that can inspire creativity and build confidence in our customers’ artistic abilities. On February 2, 2016, we completed the acquisition of Lamrite West, Inc. and certain of its affiliates and subsidiaries (“Lamrite”) for $150.0 million, prior to certain purchase price adjustments, utilizing our existing cash on hand. Lamrite operates an international wholesale business under the Darice brand name (“Darice”) and 35 arts and crafts retail stores, located primarily in Ohio and the surrounding states, under the Pat Catan’s brand name (“Pat Catan’s”). We acquired Lamrite to enhance our private brand development capabilities, accelerate our direct sourcing initiatives and strengthen our business-to-business capabilities. As of January 28, 2017, we operated 1,223 Michaels retail stores in 49 states and Canada, with approximately 18,000 average square feet of selling space per store. We operated 109 Aaron Brothers stores in nine states, with approximately 5,500 average square feet of selling space and 35 Pat Catan’s stores in five states, with approximately 32,000 average square feet of selling space. We also operate an international wholesale business under the Darice brand name. 3 Table of Contents Merchandising Michaels. Each Michaels store offers approximately 33,000 basic stock-keeping units (“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 net sales: General crafts Home décor and seasonal Framing Papercrafting Fiscal Year 2015 2016 2014 50 % 22 17 11 100 % 100 % 52 % 21 17 10 52 % 21 17 10 100 % We have a product development and design team focused on quality, innovation and cost mitigation. Our internal product development and global sourcing teams position us to continue delivering a differentiated level of innovation, quality and value to our customers. Our global sourcing network allows us to control new product introductions, maintain quality standards, monitor delivery times, and manage product costs and inventory levels to enhance profitability. In an industry with few well-known national brands, our private brands are recognized as a leader in many categories. We continue to expand our private brands and improve the selection of products we design, develop and deliver to our customers. In fiscal 2016, we acquired Lamrite as part of our strategy to enhance our private brand and direct sourcing capabilities. Our private brands totaled approximately 57% of net sales in fiscal 2016 and include, among others, Recollections®, Studio Decor®, Bead Landing®, Creatology®, Ashland®, Celebrate It®, ArtMinds®, Artist’s Loft®, Craft Smart®, Loops & Threads®, Make Market™, Foamies®, LockerLookz®, Imagin8® and Sticky Sticks®. We continue to search for ways to leverage our position as a market leader by establishing strategic partnerships and exclusive product relationships to provide our customers with exciting merchandise. We have partnerships with popular brands such as Wilton, Crayola and Elmer’s. We will continue to explore opportunities to form future partnerships and exclusive product associations. Aaron Brothers. Each Aaron Brothers store offers approximately 5,900 SKUs, including photo frames, a full line of ready-made frames, art prints, framed art, art supplies and custom framing services. The merchandising strategy for our Aaron Brothers stores is to provide a unique, upscale framing assortment in an appealing environment with attentive customer service. Pat Catan’s. Each Pat Catan’s store offers approximately 53,000 SKUs, including an assortment of kids craft items, fine art supplies, yarn, floral supplies, scrapbooking materials, home décor, bakeware and wedding related merchandise. The merchandising strategy for our Pat Catan’s stores is to provide a wide variety of affordably priced craft supplies. Darice. We operate an international wholesale business under the Darice brand name. Darice sources products from domestic and foreign suppliers for resale to a variety of retail outlets worldwide, including our Michaels and Pat Catan’s stores. Darice offers over 50,000 SKUs consisting of a wide range of craft and hobby items. We also develop Darice branded products carried by both Company owned and third-party stores reflecting the breadth of our product line and our ability to distribute and source quality products at competitive prices. E-commerce. While we expect e-commerce to remain a relatively small portion of our business, we believe it provides an important avenue to communicate with our customers in an interactive way that reinforces the Michaels brand and drives traffic to our stores and website. Since the launch of our e-commerce platform in fiscal 2014, we continue to develop new features, functionality, marketing programs and product assortments. 4 Table of Contents Seasonality Our business is highly seasonal, with higher sales in the third and fourth fiscal quarters. Our fourth quarter, which includes the Holiday selling season, has on average accounted for approximately 34% of our net sales and approximately 45% of our operating income. Purchasing and Inventory Management We purchase merchandise from a variety of different vendors through our wholly-owned subsidiary, Michaels Stores Procurement Company, Inc. We believe our buying power and ability to make centralized purchases enable us to acquire products on favorable terms. Centralized merchandising management teams negotiate with vendors in an attempt to obtain the lowest net merchandise costs and to improve product mix and inventory levels. In fiscal 2016, there were no vendors or sourcing agents accounting for more than 10% of total purchases. In fiscal 2016, we formed Darice International Sourcing Group as part of our strategy to develop our direct sourcing capabilities. We believe our direct sourcing operation allows us to maintain greater control over the manufacturing process resulting in improved product quality and lower costs. In addition, our stores purchase custom frames, framing supplies and mats from our framing operation and wholly-owned subsidiary, Artistree, Inc. (“Artistree”), which consists of a manufacturing facility and four regional processing centers. The majority of the products sold in our stores are manufactured in Asia. Goods manufactured in Asia 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 U.S. Our automated replenishment system uses perpetual inventory records to analyze on-hand SKU quantities by store, as well as other pertinent information such as sales forecasts, seasonal selling patterns, promotional events and vendor lead times, to generate recommended merchandise reorder information. These recommended orders are reviewed daily and purchase orders are delivered electronically to our vendors and our distribution centers. In addition to improving our store in-stock position, these systems enable us to better forecast merchandise ordering quantities for our vendors and give us the ability to identify, order and replenish the stores’ merchandise using less store labor. These systems also allow us to react more quickly to sales trends and allow our store team members to devote more time to customer service, thereby improving inventory productivity and sales opportunities. Artistree We own and operate Artistree, a vertically-integrated framing operation which supplies precut mats and high quality custom framing merchandise across our store networks. We believe Artistree provides a competitive advantage to our stores and gives us quality control over the entire framing process. Custom framing orders are processed and shipped to our stores where the custom frame order is completed for customer pick-up. Our moulding manufacturing plant, located in Kernersville, North Carolina, converts lumber into finished frame moulding that is used at our regional processing centers to fulfill custom framing orders for our stores. We manufacture approximately 33% of the moulding that we process and import approximately 45% from quality manufacturers in Brazil, Indonesia, Malaysia, China and Italy. During fiscal 2016, we operated four regional processing centers located in City of Industry, California; DFW Airport, Texas; Kernersville, North Carolina; and Mississauga, Ontario. Combined, these facilities occupy approximately 579,000 square feet and, in fiscal 2016, processed 29.4 million linear feet of frame moulding and 4.3 million individual custom cut mats and foam boards for our stores. Our precut mats and custom frame supplies are packaged and distributed out of our DFW Airport regional processing center. 5 Table of Contents Distribution We currently operate eight distribution centers to supply our stores with merchandise. Approximately 90% of our stores’ merchandise receipts are shipped through the distribution network with the remainder shipped directly from vendors to stores. Our distribution centers are located in California, Florida, Illinois, Ohio, Pennsylvania, Texas and Washington. We also utilize a third-party warehouse to support the distribution of our seasonal merchandise, as well as a third-party fulfillment center for our e-commerce merchandise. Our distribution facilities use warehouse management and control software systems to maintain and support product purchase decisions. Store replenishment order selection is performed using pick-to-light and radio frequency processing technologies. Product is delivered to stores using a dedicated fleet of trucks and contract carriers. Our Industry According to recent internal market research, approximately 55% of U.S. households participated in at least one crafting project during 2016, which represented approximately 68 million households. This research indicated that crafting activities continue to grow in popularity and market size has expanded to approximately $35.8 billion relative to prior studies. We believe the broad, multi-generational appeal, high personal attachment and the low-cost, project-based nature of crafting creates a loyal, resilient following consistent with the research insights. 6 Table of Contents Store Expansion and Relocation The following table shows our total store growth for the last five years: Michaels stores: Open at beginning of period New stores Relocated stores opened Closed stores Relocated stores closed Open at end of period Aaron Brothers stores: Open at beginning of period New stores Relocated stores opened Closed stores Relocated stores closed Open at end of period Pat Catan's stores: Open at beginning of period Acquired stores New stores Relocated stores opened Closed stores Relocated stores closed Open at end of period Total store count at end of period 2016 2015 Fiscal Year 2014 2013 2012 1,196 32 14 (5) (14) 1,223 117 1 — (9) — 109 — 32 3 1 — (1) 35 1,367 1,168 30 17 (2) (17) 1,196 120 — — (3) — 117 — — — — — — — 1,313 1,136 32 13 — (13) 1,168 121 5 — (6) — 120 — — — — — — — 1,288 1,099 40 14 (3) (14) 1,136 125 — 2 (5) (1) 121 — — — — — — — 1,257 1,064 38 13 (3) (13) 1,099 134 — — (8) (1) 125 — — — — — — — 1,224 We believe, based on an internal real estate and market penetration study of Michaels stores, that the combined U.S. and Canadian markets can support between 1,400 and 1,500 Michaels stores. We plan to open approximately 30 Michaels stores, including approximately 13 relocations in fiscal 2017. We continue to pursue a store relocation program to improve the real estate location quality and performance of our store base. During fiscal 2017, we plan to close up to five Michaels stores and 15 Aaron Brothers stores. Many of our store closings are stores that have reached the end of their lease term. We believe our ongoing store evaluation process results in strong performance across our store base. We have developed a standardized procedure to allow for the efficient opening of new stores and their integration into our information and distribution systems. We develop the merchandise layout floor plan and organize the advertising and promotions in connection with the opening of each new store. In addition, we maintain qualified store opening teams to provide new store team members with training. Our Michaels store operating model, which is based on historical store performance, assumes an average store size of approximately 18,000 selling square feet. Our fiscal 2016 average initial net investment, which varies by site and specific store characteristics, was $1.2 million per Michaels store, including store build-out costs, pre-opening expenses and average first year inventory. 7 Table of Contents Employees As of January 28, 2017, we employed approximately 50,000 team members, approximately 38,000 of whom were employed on a part-time basis. The number of part-time team members substantially increases during the Holiday selling season. Of our full-time team members, approximately 4,400 are engaged in various executive, operating, training, distribution and administrative functions in our support center, division offices, administrative offices and distribution centers and the remainder are engaged in store operations. None of our team members are subject to a collective bargaining agreement. Competition We are the largest arts and crafts specialty retailer in North America based on store count. The market in which we compete is highly fragmented and includes stores across the U.S. and Canada operated primarily by small, independent retailers along with a few regional and national chains. We believe customers choose where to shop based upon store location, breadth of 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 consists of several multi-store chains, each operating more than 100 stores, including: Hobby Lobby Stores, Inc., which operates more than 700 stores in 47 states; Jo- Ann Stores, Inc., which operates approximately 850 stores in 49 states; and A.C. Moore Arts & Crafts, Inc., which operates approximately 140 stores primarily in the Eastern U.S. We believe all of these chains are significantly smaller than Michaels with respect to net sales. · Mass merchandisers. This category of retailers typically dedicate only a small portion of their selling space to a limited selection of home décor, arts and crafts supplies and seasonal merchandise, but they do seek to capitalize on the latest trends by stocking products that are complementary to those trends and their current merchandise offerings. These mass merchandisers generally have limited customer service staffs with minimal experience in crafting projects. · · Small, local specialty retailers. This category includes local independent arts and crafts retailers and custom framing shops. Typically, these stores are single-store operations managed by the owner. These stores generally have limited resources for advertising, purchasing and distribution. Many of these stores have established a loyal customer base within a given community and compete based on relationships and customer service. Internet. This category includes all internet-based retailers that sell arts and crafts merchandise, completed projects and online custom framing. Our internet competition is inclusive of those companies discussed in the categories above, as well as others that may only sell products online. These retailers provide consumers with the ability to search and compare products and prices without having to visit a physical store. These sellers generally offer a wide variety of products but do not offer product expertise or project advice. Foreign Sales Substantially all of our international business is in Canada, which accounted for approximately 9% of total sales in fiscal 2016 and fiscal 2015 and 10% of total sales in fiscal 2014. Approximately 8% of our assets were located outside of the U.S. in fiscal 2016 and approximately 7% of our assets were located outside of the U.S. in fiscal 2015 and fiscal 2014. See Note 12 to the consolidated financial statements for net sales and total assets by country. Trademarks and Service Marks As of January 28, 2017, we own or have rights to trademarks, service marks or trade names we use in connection with the operation of our business, including “Aaron Brothers”, “Artistree”, “Darice”, “Lamrite”, “Michaels”, “Michaels the Arts and Crafts Store”, “Pat Catan’s”, “Recollections”, “Make Creativity Happen”, “Where Creativity Happens”, and the stylized Michaels logo. We have registered our primary private brands including Recollections®, Studio Decor®, Bead Landing®, Creatology®, Ashland®, Celebrate It®, ArtMinds®, Artist’s Loft®, Craft Smart®, Loops & Threads®, Make 8 Table of Contents Market™, Foamies®, LockerLookz®, Imagin8® and Sticky Sticks® and various sub-brands associated with these primary marks. Solely for convenience, some of the trademarks, service marks and trade names referred to in this Annual Report on Form 10-K are listed without the copyright, trademark and registered trademark symbols, but we will assert, to the fullest extent under applicable law, our rights to our copyrights, trademarks, service marks, trade names and domain names. Available Information We provide links to our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports, and other documents filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), on our Internet website, free of charge, at www.michaels.com under the heading “Investor Relations”. These reports are available as soon as reasonably practicable after we electronically file them with the Securities and Exchange Commission (“SEC”). The reports may also be accessed at the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. These filings are also available through the SEC’s EDGAR system at www.sec.gov. We use our website (www.michaels.com) as a means of disclosing material non-public information and for complying with our disclosure obligations under Regulation Fair Disclosure promulgated by the SEC. These disclosures are included on our website in the “Investor Relations” section. Accordingly, investors should monitor this portion of our website, in addition to following our press releases, SEC filings, public conference calls and webcasts. We webcast our earnings calls and certain events we participate in or host with members of the investment community on the investor relations section of our website. Additionally, we provide notifications of news or announcements regarding press and earnings releases as part of the investor relations section of our website. The contents of our website are not part of this Annual Report on Form 10-K, or any other report we file with, or furnish to, the SEC. ITEM 1A. RISK FACTORS. Our financial performance is subject to various risks and uncertainties. The risks described below are those we believe are the material risks we face. Any of the risk factors described below, as well as risks not currently known to us, could significantly and adversely affect our business, prospects, sales, revenues, gross profit, cash flows, financial condition and results of operations. We face risks related to the effect of economic uncertainty. In the event of an economic downturn or slow recovery, our growth, prospects, results of operations, cash flows and financial condition could be adversely impacted. Our stores offer arts and crafts supplies and products for the crafter and custom framing for the do-it-yourself home decorator, which some customers may perceive as discretionary. Pressure on discretionary income brought on by economic downturns and slow recoveries, including housing market declines, rising energy prices and weak labor markets, may cause consumers to reduce the amount they spend on discretionary items. The inherent uncertainty related to predicting economic conditions makes it difficult for us to accurately forecast future demand trends, which could cause us to purchase excess inventories, resulting in increases in our inventory carrying cost, or limit our ability to satisfy customer demand and potentially lose market share. 9 Table of Contents We face risks related to our substantial indebtedness. Our substantial leverage could adversely affect our ability to raise additional capital to fund our operations, limit our ability to react to changes in the economy or our industry, expose us to interest rate risk associated with our variable rate debt and prevent us from meeting our obligations under our notes and credit facilities. As of January 28, 2017, we had total outstanding debt of $2,773.5 million, of which $2,263.5 million was subject to variable interest rates and $510.0 million was subject to fixed interest rates. As of January 28, 2017, we had $735.5 million of additional borrowing capacity (after giving effect to $57.6 million of letters of credit then outstanding) under our Amended Revolving Credit Facility. Our substantial indebtedness could have important consequences to us, including: · making it more difficult for us to satisfy our obligations with respect to our debt, and any failure to comply with the obligations under our debt instruments, including restrictive covenants, could result in an event of default under the agreements governing our indebtedness; · · · · · · increasing our vulnerability to general economic and industry conditions; requiring a substantial portion of our cash flow from operations to be dedicated to the payment of principal and interest on our debt, thereby reducing our ability to use our cash flow to fund our operations, capital expenditures, selling and marketing efforts, product development, future business opportunities and other purposes; exposing us to the risk of increased interest rates as certain of our borrowings, including under our Senior Secured Credit Facilities, which consist of the Amended Revolving Credit Facility and the Amended Term Loan Credit Facility (each, as defined below), are at variable rates; restricting us from making strategic acquisitions or causing us to make non‑strategic divestitures; limiting our ability to obtain additional financing for working capital, capital expenditures, product development, debt service requirements, acquisitions, and general corporate or other purposes; or limiting our ability to plan for, or adjust to, changing market conditions and placing us at a competitive disadvantage compared to our competitors who may be less highly leveraged. The occurrence of any one of these events could have an adverse effect on our business, financial condition, results of operations, and ability to satisfy our obligations under our indebtedness. We and our subsidiaries may be able to incur substantial additional indebtedness in the future, subject, in the case of MSI and Michaels Funding, Inc. (“Holdings”) and their subsidiaries, to the restrictions contained in our Senior Secured Credit Facilities and the indenture governing our notes. In addition, our Senior Secured Credit Facilities and indenture governing our notes do not restrict us from creating new holding companies that may be able to incur indebtedness without regard to the restrictions set forth in our Senior Secured Credit Facilities and indenture governing our notes. If new indebtedness is added to our current debt levels, the related risks that we now face could intensify. Our debt agreements contain restrictions that limit our flexibility in operating our business. Our Senior Secured Credit Facilities and the indenture governing our notes contain various covenants that limit our ability to engage in specified types of transactions. These covenants limit the ability of the relevant borrowers, issuers, guarantors and their restricted subsidiaries to, among other things: · · incur or guarantee additional debt; pay dividends or distributions on their capital stock or redeem, repurchase or retire their capital stock or indebtedness; 10 Table of Contents · issue stock of subsidiaries; · make certain investments, loans, advances and acquisitions; · · create liens on our assets to secure debt; enter into transactions with affiliates; · merge or consolidate with another company; or · sell or otherwise transfer assets. In addition, under the Amended Term Loan Credit Facility, MSI is required to meet specified financial ratios in order to undertake certain actions, and under our Amended Revolving Credit Facility, MSI is required to meet specified financial ratios in order to undertake certain actions, and under certain circumstances, MSI may be required to maintain a specified fixed charge coverage ratio. Our ability to meet those tests can be affected by events beyond our control, and we cannot assure you we will meet them. A breach of any of these covenants could result in a default under our Senior Secured Credit Facilities, which could also lead to an event of default under our notes if any of the Senior Secured Credit Facilities were accelerated. Upon the occurrence of an event of default under our Senior Secured Credit Facilities, the lenders could elect to declare all amounts outstanding under our Senior Secured Credit Facilities to be immediately due and payable and terminate all commitments to extend further credit. If we were unable to repay those amounts, the lenders under our Senior Secured Credit Facilities could proceed against the collateral granted to them to secure such indebtedness. Holdings, MSI and certain of MSI’s subsidiaries have pledged substantially all of their assets, including the capital stock of MSI and certain of its subsidiaries, as collateral under our Senior Secured Credit Facilities. If the indebtedness under our Senior Secured Credit Facilities or our notes were to be accelerated, our assets may not be sufficient to repay such indebtedness in full. Changes in customer demands could materially adversely affect our sales, results of operations and cash flow. Our success depends on our ability to anticipate and respond in a timely manner to changing customer demands 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, or experience shortages of key items, either of which could have a material adverse impact on our operating results and cash flow. In addition, adverse weather conditions, economic instability and consumer confidence volatility could have material adverse impacts on our sales and operating results. We have experienced a data breach in the past and any future failure to adequately maintain security and prevent unauthorized access to electronic and other confidential information could result in an additional data breach which could materially adversely affect our reputation, financial condition and operating results. The protection of our customer, team members and Company data is critically important to us. Our customers and team members have a high expectation that we will adequately safeguard and protect their sensitive personal information. We have become increasingly centralized and dependent upon automated information technology processes. In addition, a portion of our business operations is conducted electronically, increasing the risk of attack or interception that could cause loss or misuse of data, system failures or disruption of operations. This risk has increased with the launch of our e‑commerce platform in fiscal 2014. Improper activities by third parties, exploitation of encryption technology, new data‑hacking tools and discoveries and other events or developments may result in a future compromise or breach of our networks, payment card terminals or other payment systems. In particular, the techniques used by criminals to obtain unauthorized access to sensitive data change frequently and often are not recognized until launched against a target; accordingly, we may be unable to anticipate these techniques or implement adequate preventative measures. Any failure to maintain the security of our customers’ sensitive information, or data belonging to ourselves or our suppliers, could put us at a competitive disadvantage, result in deterioration of our customers’ confidence in us, and subject us to potential litigation, liability, fines and penalties, resulting in a possible material adverse impact on our financial condition and results of operations. While we maintain insurance coverage that may, subject to policy terms and conditions, cover certain aspects 11 Table of Contents of cyber risks, such insurance coverage may be insufficient to cover all losses and would not remedy damage to our reputation. There can be no assurance that we will not suffer a criminal attack in the future, that unauthorized parties will not gain access to personal information, or that any such incident will be discovered in a timely manner. Competition, including Internet-based competition, could negatively impact our business. The retail arts and crafts industry, including custom framing, is competitive, which could result in pressure to reduce prices and losses in our market share. We must remain competitive in the areas of quality, price, breadth of selection, customer service and convenience to retain and grow our market share. We compete with mass merchants, which dedicate a portion of their selling space to a limited selection of craft supplies and seasonal and holiday merchandise, along with national and regional chains and local merchants. We also compete with specialty retailers, which include Hobby Lobby Stores, Inc., A.C. Moore Arts & Crafts, Inc. and Jo‑Ann Stores, Inc. Some of our competitors, particularly the mass merchants, are larger and have greater financial resources than we do. We also face competition from Internet‑based retailers, such as Amazon.com, Inc., in addition to traditional store‑based retailers, who may be larger, more experienced and able to offer products we cannot. This could result in increased price competition since our customers could more readily search and compare non‑private brand products. Furthermore, we ultimately compete with alternative sources of entertainment and leisure for our customers. Our reliance on foreign suppliers increases our risk of obtaining adequate, timely and cost-effective product supplies. To a significant extent, we rely on foreign manufacturers for our merchandise, particularly manufacturers located in China. 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, economic, social or environmental conditions (including acts of terrorism, the outbreak of war or the occurrence of a natural disaster), transportation delays (including dock strikes and other work stoppages), restrictive actions by foreign governments, or changes in U.S. laws and regulations affecting imports or domestic distribution. Reliance on foreign manufacturers also increases our exposure to trade infringement claims and reduces our ability to return product for various reasons. We are at a risk for higher costs associated with goods manufactured in China. Significant increases in wages or wage taxes paid by contract facilities may increase the cost of goods manufactured, which could have a material adverse effect on our profit margins and profitability. All of our products manufactured overseas and imported into the U.S. are subject to duties collected by the U.S. Customs Service. We may be subjected to additional duties or tariffs, significant monetary penalties, the seizure and 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 growth depends on our ability to open new stores and increase comparable store sales. One of our key business strategies is to expand our base of retail stores. If we are unable to continue this strategy, our ability to increase our sales, profitability and cash flow could be impaired. To the extent we are unable to open new stores as we anticipate, our sales growth would primarily come from increases in comparable store sales. Growth in profitability would then depend significantly on our ability to improve gross margin. We may be unable to continue our store growth 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 team members. Damage to the reputation of the Michaels brand or our private and exclusive brands could adversely affect our sales. We believe the Michaels brand name and many of our private and exclusive brand names are powerful sales and marketing tools and we devote significant resources to promoting and protecting them. To be successful in the future, we must continue to preserve, grow and utilize the value of Michaels’ reputation. Reputational value is based in large part on perceptions of subjective qualities, and even isolated incidents may erode trust and confidence. In addition, we develop and promote private and exclusive brands, which we believe have generated national recognition. Our Michaels private 12 Table of Contents brands totaled approximately 57% of net sales in fiscal 2016 and 54% of net sales in fiscal 2015. Damage to the reputations (whether or not justified) of our brand names could arise from product failures, data privacy or security incidents, litigation or various forms of adverse publicity (including adverse publicity generated as a result of a vendor’s or a supplier’s failure to comply with general social accountability practices), especially in social media outlets, and may generate negative customer sentiment, potentially resulting in a reduction in our sales and earnings. A weak fourth quarter would materially adversely affect our result of operations. Our business is highly seasonal. Our inventories and short-term borrowings may grow in the third fiscal quarter 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. Suppliers from whom our products are sourced may fail us and transitioning to other qualified vendors could materially adversely affect our revenue and profit growth. The products we sell are sourced from a wide variety of domestic and international vendors. Global sourcing has become an increasingly important part of our business, as we have undertaken efforts to increase the amount of product we source directly from overseas manufacturers. Our ability to find qualified vendors who meet our standards and supply products in a timely and efficient manner is a significant challenge, especially with respect to goods sourced from outside the U.S. Any issues related to transitioning vendors could adversely affect our revenue and gross profit. 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, access to capital, production difficulties, quality control issues and problems in delivering agreed‑upon quantities on schedule. We may not be able, if necessary, to return products to these suppliers and obtain refunds of our purchase price or obtain reimbursement or indemnification from them if their products prove defective. These suppliers may also be unable to withstand a downturn in economic conditions. Significant failures on the part of our key suppliers could have a material adverse effect on our results of operations. In addition, many of these suppliers require extensive advance notice of our requirements to supply products in the quantities we desire. This long lead time may limit our ability to respond timely to shifts in demand. Unexpected or unfavorable consumer responses to our promotional or merchandising programs could materially adversely affect our sales, results of operations, cash flow and financial condition. Brand recognition, quality and price have a significant influence on consumers’ choices among competing products and brands. Advertising, promotion, merchandising and the cadence of new product introductions also have a significant impact on consumers’ buying decisions. If we misjudge consumer responses to our existing or future promotional activities, this could have a material adverse impact on our sales, results of operations, cash flow and financial condition. We believe improvements in our merchandise offering help drive sales at our stores. We could be materially adversely affected by poor execution of changes to our merchandise offering or by unexpected consumer responses to changes in our merchandise offering. Our marketing programs, e-commerce initiatives and use of consumer information are governed by an evolving set of laws and enforcement trends and unfavorable changes in those laws or trends, or our failure to comply with existing or future laws, could substantially harm our business and results of operations. We collect, maintain and use data provided to us through our online activities and other customer interactions in our business. Our current and future marketing programs depend on our ability to collect, maintain and use this information, and our ability to do so is subject to certain contractual restrictions in third‑party contracts as well as evolving international, federal and state laws and enforcement trends. We strive to comply with all applicable laws and other legal obligations 13 Table of Contents relating to privacy, data protection and consumer protection, including those relating to the use of data for marketing purposes. It is possible, however, that these requirements may be interpreted and applied in a manner that is inconsistent from one jurisdiction to another, or may conflict with other rules or may conflict with our practices. If so, we may suffer damage to our reputation and be subject to proceedings or actions against us by governmental entities or others. Any such proceeding or action could hurt our reputation, force us to spend significant amounts to defend our practices, distract our management, increase our costs of doing business and result in monetary liability. In addition, as data privacy and marketing laws change, we may incur additional costs to ensure we remain in compliance with such laws. If applicable data privacy and marketing laws become more restrictive at the federal or state level, our compliance costs may increase, our ability to effectively engage customers via personalized marketing may decrease, our investment in our e‑commerce platform may not be fully realized, our opportunities for growth may be curtailed by our compliance capabilities or reputational harm and our potential liability for security breaches may increase. Product recalls and/or product liability, as well as changes in product safety and other consumer protection laws, may adversely impact our operations, merchandise offerings, reputation, results of operations, cash flow and financial condition. We are subject to regulations by a variety of federal, state and international regulatory authorities, including the Consumer Product Safety Commission. In fiscal 2016, we purchased merchandise from approximately 620 vendors. Since a majority of our merchandise is manufactured in foreign countries, one or more of our vendors may not adhere to product safety requirements or our quality control standards, and we may not identify the deficiency before merchandise ships to our stores. Any issues of product safety, including but not limited to those manufactured in foreign countries, could cause us to recall some of those products. If our vendors fail to manufacture or import merchandise that adheres to our quality control standards, our reputation and brands could be damaged, potentially leading to increases in customer litigation against us. Furthermore, to the extent we are unable to replace any recalled products, we may have to reduce our merchandise offerings, resulting in a decrease in sales, especially if a recall occurs near or during a seasonal period. If our vendors are unable or unwilling to recall products failing to meet our quality standards, we may be required to recall those products at a substantial cost to us. Moreover, changes in product safety or other consumer protection laws could lead to increased costs to us for certain merchandise, or additional labor costs associated with readying merchandise for sale. Long lead times on merchandise ordering cycles increase the difficulty for us to plan and prepare for potential changes to applicable laws. The Consumer Product Safety Improvement Act of 2008 imposes significant requirements on manufacturing, importing, testing and labeling requirements for our products. In the event that we are unable to timely comply with regulatory changes or regulators do not believe we are complying with current regulations applicable to us, significant fines or penalties could result, and could adversely affect our reputation, results of operations, cash flow and financial condition. Changes in regulations or enforcement, or our failure to comply with existing or future regulations, may adversely impact our business. We are subject to federal, state and local regulations with respect to our operations in the U.S. We are further subject to federal, provincial and local regulations internationally, including in Canada and China, each of which are distinct from those in the U.S., and may be subject to greater international regulation as our business expands. There are a number of legislative and regulatory initiatives that could adversely impact our business if they are enacted or enforced. Those initiatives include wage or workforce issues (such as minimum‑wage requirements, overtime and other working conditions and citizenship requirements), collective bargaining matters, environmental regulation, price and promotion regulation, trade regulations and others. Proposed changes in tax regulations may also change our effective tax rate as our business is subject to a combination of applicable tax rates in the various countries, states and other jurisdictions in which we operate. New accounting pronouncements and interpretations of existing accounting rules and practices have occurred and may occur in the future. A change in accounting standards or practices can have a significant effect on our reported results of operations. Failure to comply with legal requirements could result in, among other things, increased litigation risk that could affect us adversely by subjecting us to significant monetary damages and other remedies or by increasing our litigation expenses, administrative enforcement actions, fines and civil and criminal liability. We are currently subject to various class action 14 Table of Contents lawsuits alleging violations of wage and workforce laws and similar matters (see Note 13 to the consolidated financial statements). If such issues become more expensive to address, or if new issues arise, they could increase our expenses, generate negative publicity, or otherwise adversely affect us. Significant increases in inflation or commodity prices, such as petroleum, natural gas, electricity, steel, wood and paper, may adversely affect our costs, including cost of merchandise. Significant future increases in commodity prices or inflation could adversely affect our costs, including cost of merchandise and distribution costs. Furthermore, the transportation industry may experience a shortage or reduction of capacity, which could be exacerbated by higher fuel prices. Our results of operations may be adversely affected if we are unable to secure, or are able to secure only at significantly higher costs, adequate transportation resources to fulfill our receipt of goods or delivery schedules to the stores. We may be subject to information technology system failures or network disruptions, or our information systems may prove inadequate, resulting in damage to our reputation, business operations and financial condition. We depend on our management information systems for many aspects of our business, including our perpetual inventory, automated replenishment and weighted-average cost stock ledger systems which are necessary to properly forecast, manage, analyze and record our inventory. The Company may be subject to information technology system failures and network disruptions. These may be caused by natural disasters, accidents, power disruptions, telecommunications failures, acts of terrorism or war, denial‑of‑service attacks, computer viruses, physical or electronic break‑ins, or similar events or disruptions. System redundancy may be ineffective or inadequate, and the Company’s disaster recovery planning may not be sufficient for all eventualities. Such failures or disruptions could prevent access to the Company’s online services and preclude store transactions. System failures and disruptions could also impede the manufacturing and shipping of products, transactions processing and financial reporting. Additionally, we may be materially adversely affected if we are unable to improve, upgrade, maintain, and expand our systems. 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, direct sourcing initiatives and receipt processing. We continue to implement enhancements to our distribution systems and processes, which are designed to improve efficiency throughout the supply chain and at our stores. If we are unable to successfully implement significant changes, this could disrupt our supply chain, which could have a material adverse impact on our results of operations. Our total assets include intangible assets, goodwill and substantial amounts of property and equipment. Changes in estimates or projections used to assess the fair value of these assets, or operating results that are lower than our current estimates at certain store locations, may cause us to incur impairment charges that could adversely affect our results of operation. Our total assets include intangible assets, goodwill and substantial amounts of property and equipment. We make certain estimates and projections in connection with impairment analyses for these long lived assets, in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification ("ASC") 360, "Property, Plant and Equipment " ("ASC 360"), and ASC 350, "Intangibles— Goodwill and Other" ("ASC 350"). We also review the carrying value of these assets for impairment on an annual basis and whenever events or changes in circumstances indicate that the carrying value of the asset may not be recoverable in accordance with ASC 360 or ASC 350. We will record an impairment loss when the carrying value of the underlying asset, asset group or reporting unit exceeds its fair value. These calculations require us to make a number of estimates and projections of future results. If these estimates or projections change, we may be required to record additional impairment charges on certain of these assets. If these impairment charges are significant, our results of operations would be adversely affected. 15 Table of Contents Changes in newspaper subscription rates may result in reduced exposure to our circular advertisements. A substantial portion of our promotional activities utilize circular advertisements in local newspapers. A continued decline in consumer subscriptions of these newspapers could reduce the frequency with which consumers receive our circular advertisements, thereby negatively affecting sales, results of operations and cash flow. Disruptions in the capital markets could increase our costs of doing business. Any disruption in the capital markets could make it difficult for us to raise additional capital when needed, or to eventually refinance our existing indebtedness on acceptable terms or at all. Similarly, if our suppliers face challenges in obtaining credit when needed, or otherwise face difficult business conditions, they may become unable to offer us the merchandise we use in our business thereby causing reductions in our revenues, or they may demand more favorable payment terms, all of which could adversely affect our results of operations, cash flows and financial condition. Our real estate leases generally obligate us for long periods, which subject us to various financial risks. We lease virtually all of our store, distribution center and administrative locations, generally for long terms. While we have the right to terminate some of our leases under specified conditions by making specified payments, we may not be able to terminate a particular lease if or when we would like to do so. If we decide to close stores, we are generally required to continue paying rent and operating expenses for the balance of the lease term, or pay to exercise rights to terminate, and the performance of any of these obligations may be expensive. When we assign or sublease vacated locations, we may remain liable on the lease obligations if the assignee or sublessee does not perform. In addition, when leases for the stores in our ongoing operations expire, we may be unable to negotiate renewals, either on commercially acceptable terms, or at all, which could cause us to close stores. Accordingly, we are subject to the risks associated with leasing real estate, which can have a material adverse effect on our results. We have co-sourced certain of our information technology, accounts payable, payroll, accounting and human resources functions and may co-source other administrative functions, which makes us more dependent upon third parties. We place significant reliance on third‑party providers for the co‑sourcing of certain of our information technology (“IT”), accounts payable, payroll, accounting and human resources functions. This co‑sourcing initiative is a component of our ongoing strategy to increase efficiencies, increase our IT capabilities, manage our costs and seek additional cost savings. These functions are generally performed in offshore locations. As a result, we rely on third parties to ensure that certain functional needs are sufficiently met. This reliance subjects us to risks arising from the loss of control over these processes, changes in pricing that may affect our operating results, and potentially, termination of provision of these services by our suppliers. If our service providers fail to perform, we may have difficulty arranging for an alternate supplier or rebuilding our own internal resources, and we could incur significant costs, all of which may have a significant adverse effect on our business. We may co‑source other administrative functions in the future, which would further increase our reliance on third parties. Further, the use of offshore service providers may expose us to risks related to local political, economic, social or environmental conditions (including acts of terrorism, the outbreak of war, or the occurrence of natural disaster), restrictive actions by foreign governments or changes in U.S. laws and regulations. We are exposed to fluctuations in exchange rates between the U.S. and Canadian dollar, which is the functional currency of our Canadian subsidiaries. Our Canadian operating subsidiaries purchase inventory in U.S. dollars, which is sold in Canadian dollars and exposes us to foreign exchange rate fluctuations. In addition, our customers at border locations can be sensitive to cross‑border price differences. Substantial foreign currency fluctuations could adversely affect our business. In fiscal 2016, exchange rates had a positive impact on our consolidated operating results due to a 7% increase in the Canadian exchange rate. 16 Table of Contents We are dependent upon the services of our senior management team. We are dependent on the services, abilities and experience of our executive officers, including Carl S. Rubin, our Chief Executive Officer, and Denise A. Paulonis, our Chief Financial Officer. The permanent loss of the services of either of these senior executives and any change in the composition of our senior management team could have a negative impact on our ability to execute on our business and operating strategies. Failure to attract and retain quality sales, distribution center and other team members in appropriate numbers as well as experienced buying and management personnel could adversely affect our performance. Our performance depends on recruiting, developing, training and retaining quality sales, distribution center and other team members in large numbers as well as experienced buying and management personnel. Many of our store level team members are in entry level or part‑time positions with historically high rates of turnover. Our ability to meet our labor needs while controlling labor costs is subject to external factors such as unemployment levels, prevailing wage rates, minimum wage legislation, changing demographics, health and other insurance costs and governmental labor and employment requirements. In the event of increasing wage rates, if we fail to increase our wages competitively, the quality of our workforce could decline, causing our customer service to suffer, while increasing our wages could cause our earnings to decrease. The market for retail management is highly competitive and, similar to other retailers, we face challenges in securing sufficient management talent. If we do not continue to attract, train and retain quality team members, our performance could be adversely affected. Our results may be adversely affected by serious disruptions or catastrophic events, including geo-political events and weather. Unforeseen public health issues, such as pandemics and epidemics, and geo‑political events, such as civil unrest in a country in which our suppliers are located or terrorist or military activities disrupting transportation, communication or utility systems, as well as natural disasters such as hurricanes, tornadoes, floods, earthquakes and other adverse weather and climate conditions, whether occurring in the U.S. or abroad, particularly during peak seasonal periods, could disrupt our operations or the operations of one or more of our vendors or could severely damage or destroy one or more of our stores or distribution facilities located in the affected areas. For example, day‑to‑day operations, particularly our ability to receive products from our vendors or transport products to our stores, could be adversely affected, or we could be required to close stores or distribution centers in the affected areas or in areas served by the affected distribution center. These factors could also cause consumer confidence and spending to decrease or result in increased volatility in the U.S. and global financial markets and economy. Such occurrences could significantly impact our operating results and financial performance. For example, during fiscal 2015, one of our stores was damaged by weather related to Hurricane Joaquin, resulting in closure and lost sales. Had the hurricane impacted a larger geographic area, it is possible that we would have suffered a substantial negative impact to our sales for a prolonged period. Any difficulty executing or integrating an acquisition, a business combination or a major business initiative could adversely affect our business or results of operations. Any difficulty in executing or integrating an acquisition, a business combination or a major business initiative, including the recent acquisition of Lamrite, may result in our inability to achieve anticipated benefits from these transactions in the time frame that we anticipate, or at all, which could adversely affect our business or results of operations. Such transactions may also disrupt the operation of our current activities and divert management's attention from other business matters. In addition, the Company’s current credit agreements place certain limited constraints on our ability to make an acquisition or enter into a business combination, and future borrowing agreements could place tighter constraints on such actions. Substantial changes to fiscal and tax policies may adversely affect our business. Legislative actions, including changes in fiscal and tax policies, may adversely affect our business. For example, any restrictions or limitations on trade with China and other countries or the imposition of a tariff or border tax on all foreign imports could negatively impact our business. A majority of the products currently sold in Michaels stores are 17 Table of Contents manufactured in Asia. Therefore, any such restrictions or tariffs imposed on products that we or our suppliers import for sale in the U.S. would adversely and directly impact our tax liability and cost of goods sold. Further, such a policy change may require us to raise our prices, which could result in the loss of customers and harm our business. Our holding company structure makes us, and certain of our direct and indirect subsidiaries, dependent on the operations of our, and their, subsidiaries to meet our financial obligations. We, and certain of our direct and indirect subsidiaries, have no significant assets other than the interest in direct and indirect subsidiaries, including MSI. As a result, we, and certain of our direct and indirect subsidiaries, rely exclusively upon payments, dividends and distributions from direct and indirect subsidiaries’ cash flows. Our ability to pay dividends, if any are declared, to our shareholders is dependent on the ability of our subsidiaries to generate sufficient net income and cash flows to pay upstream dividends and make loans or loan repayments. We are subject to certain phase-in provisions of The NASDAQ Stock Market and, as a result, we are not currently subject to certain corporate governance requirements. Until the expiration of the phase-in period on December 16, 2017, you will not have the same protections as those afforded to stockholders of companies that are subject to such governance requirements. Following the December 2016 secondary offering, our significant stockholders, affiliates of or funds advised by Bain Capital Partners, LLC and The Blackstone Group L.P. (the “Sponsors”) ceased to indirectly beneficially own a majority controlling interest in us. As a result, we are no longer a “controlled company” within the meaning of the corporate governance standards of The NASDAQ Stock Market. However, we continue to rely on a phase-in provision for the requirement that we have a Compensation Committee that is composed entirely of independent directors. Accordingly, for up to one year from the expiration of the phase- in period, which will occur on December 16, 2017, you will not have the same protections afforded to stockholders of companies that are subject to all of the corporate governance requirements of The NASDAQ Stock Market. The Sponsors continue to have significant influence over us and their interest may conflict with yours and those of our Company. Although we are no longer a “controlled company”, the Sponsors continue to beneficially own approximately 38% of our outstanding common stock as of January 28, 2017. For so long as the Sponsors continue to hold a significant portion of our outstanding common stock, the Sponsors may continue to be able to strongly influence or effectively control our decisions. Our stock price could be extremely volatile and may decline and, as a result, you may not be able to resell your shares at or above the price you paid for them. Since listing our common stock on The NASDAQ Global Select Market in June 2014 in connection with our IPO, the price of our common stock has ranged from a low of $14.51 on August 1, 2014 to a high of $31.37 on June 6, 2016. In addition, the stock market in general has been highly volatile. As a result, the market price of our common stock is likely to be similarly volatile, and investors in our common stock may experience a decrease, which could be substantial, in the value of their stock, including decreases unrelated to our operating performance or prospects, and could lose part or all of their investment. The price of our common stock could be subject to wide fluctuations in response to a number of factors, including those described elsewhere in this filing and others such as: · · · · variations in our operating performance and the performance of our competitors; actual or anticipated fluctuations in our quarterly or annual operating results; publication of research reports by securities analysts about us or our competitors or our industry; our failure or the failure of our competitors to meet analysts’ projections or guidance that we or our competitors may give to the market; 18 Table of Contents · · · · · · · · · additions and departures of key personnel; strategic decisions by us or our competitors, such as acquisitions, divestitures, spin‑offs, joint ventures, strategic investments or changes in business strategy; the passage of legislation or other regulatory developments affecting us or our industry; speculation in the press or investment community; adverse publicity; changes in accounting principles; terrorist acts, acts of war or periods of widespread civil unrest; natural disasters and other calamities; and changes in general market and economic conditions. In the past, securities class action litigation has often been initiated against companies following periods of volatility in their stock price. This type of litigation could result in substantial costs and divert our management’s attention and resources, and could also require us to make substantial payments to satisfy judgments or to settle litigation. Provisions in our charter documents and Delaware law may deter takeover efforts that may be beneficial to stockholder value. Delaware law and provisions in our certificate of incorporation and bylaws could make it harder for a third party to acquire us, even if doing so might be beneficial to our stockholders. These provisions include limitations on our stockholders’ ability to act by written consent. In addition, our Board has the right to issue preferred stock without stockholder approval that could be used to dilute a potential hostile acquirer. Our certificate of incorporation imposes some restrictions on mergers and other business combinations between us and any holder of 15% or more of our outstanding common stock other than the Sponsors, who own approximately 38% of our outstanding common stock as of January 28, 2017. As a result, you may lose your ability to sell your stock for a price in excess of the prevailing market price due to these protective measures and efforts by stockholders to change the direction or management of the Company may be unsuccessful. Our certificate of incorporation designates the Court of Chancery of the State of Delaware as the sole and exclusive forum for certain types of actions and proceedings that may be initiated by our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers or employees. Our certificate of incorporation provides that, subject to limited exceptions, the Court of Chancery of the State of Delaware will be the sole and exclusive forum for (i) any derivative action or proceeding brought on our behalf, (ii) any action asserting a claim of breach of a fiduciary duty owed by any director, officer or other employee to us or our stockholders, (iii) any action asserting a claim against us arising pursuant to any provision of the Delaware General Corporation Law or our certificate of incorporation or the bylaws or (iv) any action asserting a claim against us governed by the internal affairs doctrine. Any person or entity purchasing or otherwise acquiring any interest in shares of our capital stock shall be deemed to have notice of and to have consented to the provisions of our certificate of incorporation described above. This choice of forum provision may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our directors, officers or other employees, which may discourage such lawsuits against us and our directors, officers and employees. Alternatively, if a court were to find these provisions of our certificate of incorporation inapplicable to, or unenforceable in respect of, one or more of the specified types of actions or proceedings, we may incur additional costs associated with resolving such matters in other jurisdictions, which could adversely affect our business and financial condition. 19 Table of Contents Because our executive officers hold or may hold restricted shares or option awards that will vest upon a change of control, these officers may have interests in us that conflict with yours. Our executive officers hold or may hold restricted shares and options to purchase shares that would automatically vest upon a change of control. As a result, these officers may view certain change of control transactions more favorably than an investor due to the vesting opportunities available to them and, as a result, may have an economic incentive to support a transaction that you may not believe to be favorable to stockholders. Because we have no current plans to pay cash dividends on our common stock for the foreseeable future, you may not receive any return on investment unless you sell your common stock for a price greater than you paid. We plan to retain future earnings, if any, for future operation, expansion and debt repayment and have no current plans to pay any cash dividends for the foreseeable future. Any decision to declare and pay dividends in the future will be made at the discretion of our Board and will depend on, among other things, our results of operations, financial condition, cash requirements, contractual restrictions and other factors that our Board may deem relevant. In addition, our ability to pay dividends may be limited by covenants of any existing and future outstanding indebtedness we or our subsidiaries incur, including our Senior Secured Credit Facilities. As a result, you may not receive any return on an investment in our common stock unless you sell our common stock for a price greater than you paid. ITEM 1B. UNRESOLVED STAFF COMMENTS. Not applicable. 20 Table of Contents ITEM 2. PROPERTIES We lease substantially all of the sites for our Michaels, Aaron Brothers and Pat Catan’s stores, with the majority of our stores having initial lease terms of approximately 10 years. 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. As of January 28, 2017, in connection with stores that we plan to open or relocate in future fiscal years, we had signed approximately 37 leases for Michaels stores. Management believes our facilities are suitable and adequate for our business as presently conducted. As of January 28, 2017, we leased the following non-store facilities: Locations Distribution centers: Hazleton, Pennsylvania Jacksonville, Florida Lancaster, California Centralia, Washington New Lenox, Illinois Haslet, Texas City of Commerce, California (Aaron Brothers) Strongsville, Ohio (Darice warehouse) Artistree: DFW Airport, Texas (regional processing and fulfillment operations center) Kernersville, North Carolina (manufacturing plant and regional processing center) City of Industry, California (regional processing center) Mississauga, Ontario (regional processing center) Office space: Irving, Texas (corporate office support center) Strongsville, Ohio (Lamrite office support center) Atlanta, Georgia (Darice showroom) Mississauga, Ontario (Canadian regional office) Kowloon Bay, Hong Kong Ningbo, China Coppell, Texas (new store staging warehouse) 21 Square Footage 692,000 506,000 763,000 718,000 693,000 433,000 174,000 217,000 4,196,000 271,000 156,000 90,000 62,000 579,000 296,000 505,000 6,000 3,000 4,000 17,000 831,000 82,000 5,688,000 Table of Contents The following table indicates the number of our retail stores located in each state or province as of January 28, 2017: State/Province Alabama Alaska Alberta Arizona Arkansas British Columbia California Colorado Connecticut Delaware District of Columbia Florida Georgia Idaho Illinois Indiana Iowa Kansas Kentucky Louisiana Maine Manitoba Maryland Massachusetts Michigan Minnesota Mississippi Missouri Montana Nebraska Nevada New Brunswick New Hampshire New Jersey New Mexico New York Newfoundland and Labrador North Carolina North Dakota Nova Scotia Ohio Oklahoma Ontario Oregon Pennsylvania Prince Edward Island Quebec Rhode Island Saskatchewan South Carolina South Dakota Tennessee Texas Utah Vermont Virginia Washington West Virginia Wisconsin Wyoming Total 22 Michaels 12 3 23 27 5 17 136 22 20 5 1 82 35 7 41 18 8 8 12 15 3 4 25 32 35 23 7 21 5 6 10 3 9 31 4 62 1 36 3 7 32 7 58 15 48 1 16 4 3 15 2 17 83 13 2 37 23 5 17 1 1,223 Number of Stores Aaron Brothers Pat Catan's Total 12 3 23 31 5 17 206 24 20 5 1 82 36 8 41 19 8 8 12 15 3 4 25 32 36 23 7 21 5 6 13 3 9 31 4 62 1 36 3 7 58 7 58 17 54 1 16 4 3 15 2 17 102 13 2 37 30 6 17 1 1,367 4 70 2 1 1 3 2 19 7 1 1 26 6 1 109 35 Table of Contents ITEM 3. LEGAL PROCEEDINGS. Information regarding legal proceedings is incorporated by reference from Note 13 to the consolidated financial statements. ITEM 4. MINE SAFETY DISCLOSURES. Not applicable. PART II ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES. Market Information Our common stock is listed on The NASDAQ Global Select Market under the symbol “MIK”. As of January 28, 2017, there were approximately 375 holders of record of our common stock. The following table sets forth the high and low sales price per share for the periods indicated of our common stock on The NASDAQ Global Select Market: Fiscal Year 2016 2015 First Quarter Second Quarter Third Quarter Fourth Quarter Dividends Low High High Low $ 29.56 $ 20.25 $ 30.00 $ 25.77 $ 31.37 $ 25.52 $ 28.49 $ 24.60 $ 26.57 $ 22.11 $ 26.84 $ 21.78 $ 25.57 $ 19.25 $ 24.05 $ 19.46 The Company does not anticipate paying any cash dividends in the near future. We anticipate that all of our earnings for the foreseeable future will be used to repay debt, to repurchase outstanding shares, for working capital, to support our operations and to finance the growth and development of our business. Any future determination to pay dividends will be at the discretion of our Board, subject to compliance with applicable law and any contractual provisions, including under agreements for indebtedness, that restrict or limit our ability to pay dividends, and will depend upon, among other factors, our results of operations, financial condition, earnings, capital requirements and other factors that our Board may deem relevant. For additional information concerning restrictions relating to agreements for indebtedness, see Note 7 to the consolidated financial statements. 23 Table of Contents Performance Graph The following graph shows a comparison of cumulative total return to holders of The Michaels Companies, Inc.’s common shares against the cumulative total return of the S&P 500 Index and S&P 500 Retail Index from June 27, 2014 (the date the Company’s stock commenced trading on the NASDAQ Global Select Market) through January 28, 2017. The comparison of the cumulative total returns for each investment assumes that $100 was invested in The Michaels Companies, Inc. common shares and the respective indices on June 27, 2014 through January 28, 2017 including reinvestment of any dividends. Historical share price performance should not be relied upon as an indication of future share price performance. The Michaels Companies, Inc. S&P 500 Index S&P 500 Retail Index 6/27/2014 1/31/2015 1/30/2016 1/28/2017 $ 100.00 $ 151.76 $128.24 $115.06 100.00 103.10 102.41 123.78 100.00 108.50 97.18 102.61 24 Table of Contents ITEM 6. SELECTED FINANCIAL DATA. The following financial information for the five most recent fiscal years has been derived from our consolidated financial statements. This information should be read in conjunction with the consolidated financial statements and related notes thereto included elsewhere herein. Fiscal Year 2014 (in thousands, except earnings per share, other operating and store count data) 2015 2016 2013 2012 (2) (1) (3) Results of Operations Data: Net sales Operating income Interest expense Losses on early extinguishments of debt and refinancing costs Net income Earnings per common share: $ 5,197,292 715,280 126,270 $ 4,912,782 720,604 139,405 $ 4,738,144 626,529 198,409 $ 4,569,792 610,402 214,497 $ 4,407,545 592,050 245,466 7,292 378,159 8,485 362,912 74,312 217,395 14,420 243,430 32,551 199,734 Basic Diluted $ $ 1.84 1.82 $ $ 1.75 1.72 $ $ 1.07 1.05 $ $ 1.39 1.36 $ $ 1.14 1.12 Weighted-average common shares outstanding: Basic Diluted Balance Sheet Data: Cash and equivalents Merchandise inventories Total current assets Total assets Total current liabilities Current portion of long-term debt Long-term debt Total liabilities Stockholders’ deficit Other Operating Data: Average net sales per selling square foot Comparable store sales Comparable store sales, at constant currency Total selling square footage (in thousands) Stores Open at End of Year: Michaels Aaron Brothers Pat Catan's Total stores open at end of year (4) 204,735 206,354 206,845 209,346 203,229 207,101 174,797 178,628 174,715 178,068 $ 298,813 1,127,777 1,542,805 2,147,640 1,024,224 31,125 2,723,187 3,846,066 (1,698,426) $ 409,391 1,002,607 1,507,723 2,031,287 912,860 24,900 2,744,942 3,755,382 (1,724,095) $ 378,295 958,171 1,423,778 1,961,108 889,632 24,900 3,089,781 4,072,633 (2,111,525) $ 238,864 901,308 1,237,336 1,767,132 825,556 16,400 3,633,279 4,549,414 (2,782,282) $ 55,961 862,478 1,007,479 1,519,510 851,618 150,514 2,855,834 3,823,471 (2,303,961) $ $ 223 (0.5)% $ 223 1.8 % $ 220 1.7 % $ 218 2.9 % (0.4)% 3.2 % 2.4 % 3.4 % 215 1.5 % 1.5 % 23,539 22,068 21,605 21,108 20,588 1,223 109 35 1,367 1,196 117 — 1,313 1,168 120 — 1,288 1,136 121 — 1,257 1,099 125 — 1,224 (1) Fiscal 2012 consisted of 53 weeks while all other periods presented consisted of 52 weeks. (2) Fiscal 2016 results of operations and balance sheet data includes the impact of the acquisition of Lamrite on February 2, 2016, including non-recurring purchase accounting adjustment and integrations costs of $11.4 million. Lamrite’s net sales totaled $232.3 million in fiscal 2016. (3) Fiscal 2014 operating income includes a $32.3 million charge associated with the IPO primarily related to a $30.2 million fee paid to certain related parties to terminate our management agreement. (4) The calculation of average net sales per selling square foot includes only Michaels comparable stores. Aaron Brothers, which is a smaller store model, and Pat Catan’s, which is a larger store model, are excluded from the calculation. 25 Table of Contents ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. We report on the basis of a 52- or 53-week fiscal year, which ends on the Saturday closest to January 31. All references to fiscal year mean the year in which that fiscal year began. References to “fiscal 2016” relate to the 52 weeks ended January 28, 2017, references to “fiscal 2015” relate to the 52 weeks ended January 30, 2016 and references to “fiscal 2014” relate to the 52 weeks ended January 31, 2015. Michaels Stores, Inc. (“MSI”) is headquartered in Irving, Texas and was incorporated in the state of Delaware in 1983. In July 2013, MSI was reorganized into a holding company structure and The Michaels Companies, Inc. (the “Company”) was incorporated in Delaware in connection with the reorganization. In July 2014, we completed an initial public offering (“IPO”) of 27.8 million shares of common stock at a public offering price of $17.00 per share, resulting in net proceeds of $445.7 million. Fiscal 2016 Overview With $5,197.3 million in net sales in fiscal 2016, we are the largest arts and crafts specialty retailer in North America (based on store count) providing materials, project ideas and education for creative activities, under the retail brands of Michaels, Aaron Brothers and Pat Catan’s. We also operate an international wholesale business under the Darice brand name (“Darice”) and a market-leading vertically-integrated custom framing business under the Artistree brand name. At January 28, 2017, we operated 1,223 Michaels stores, 109 Aaron Brothers stores and 35 Pat Catan’s stores. Financial highlights for fiscal 2016 include the following: · Net sales increased to $5,197.3 million, a 5.8% improvement over last year, primarily driven by the acquisition of Lamrite West, Inc. (“Lamrite”) and the opening of 19 additional stores (net of closures). · Comparable store sales decreased 0.5%, or 0.4%, at constant exchange rates. · Our Michaels retail stores’ private brand merchandise drove approximately 57% of net sales in fiscal 2016 compared to 54% of net sales in fiscal 2015. · We reported operating income of $715.3 million, a decrease of 0.7% from the prior year, including $11.4 million of purchase accounting adjustments and integration costs. · We reported net income of $378.2 million, an increase of 4.2% from the prior year. · Adjusted EBITDA, a non-GAAP measure that is a required calculation in our debt agreements, improved by 0.8%, from $866.2 million in fiscal 2015 to $872.7 million in fiscal 2016 (see “Management Discussion and Analysis of Financial Condition and Results of Operations - Non- GAAP Measures”). · We refinanced our term loan credit facility and our revolving credit facility during fiscal 2016. 26 Table of Contents In fiscal 2016, we made significant progress implementing our strategic initiatives, including: · · · · · · · · the acquisition of Lamrite, which enhanced our private brand development capabilities, accelerated our direct sourcing initiatives and strengthened our business-to-business capabilities through an international wholesale business under the Darice brand name; the introduction of our fully-integrated “Make” brand campaign through television, radio, social media and in-store events intended to leverage the growing customer trends of “do-it-yourself” and “personalization” while also positioning Michaels in a more contemporary light; creating flexible merchandising space in our stores to highlight newness and present stronger, more cohesive seasonal product statements to customers; the launch of our Michaels Rewards program, which allows us to differentiate our business from others in our channel while providing us with valuable data to help tailor customer communications more effectively; the improvement of our in-store and online education programs, including the addition of more free classes for children and adults; improving our in-store presentation and raising operational standards to deliver a better shopping experience; delivering trend-right merchandise to our customers; and the authorization from our Board of Directors to purchase up to $500.0 million of the Company’s common stock on the open market. Fiscal 2017 Outlook In fiscal 2017, we intend to continue to expand our industry leadership through innovation and strategic initiatives such as: · making our stores more inviting to a broader set of customers, including those new to do-it- yourself projects and more experienced crafters; · · · · · continuing to enhance our in-store shopping experience by creating a more visually appealing environment and making it easier for our customers to shop; broadening our merchandising and sourcing capabilities to better identify and source new trends, merchandise and categories that enhance our portfolio of exclusive brands and products; strengthening our connections with customers and reaching new customers through an expanded marketing program, including print, digital, direct mail, broadcast and community events; expanding our omni-channel offering of merchandise, promotional and marketing events; and strengthening our business-to-business operations. Comparable Store Sales Comparable store sales represents the change in net sales for stores open the same number of months in the comparable period of the previous year, including stores that were relocated or expanded during either period, as well as e-commerce sales. A store is deemed to become comparable in its 14 month of operation in order to eliminate grand opening sales distortions. A store temporarily closed more than two weeks is not considered comparable during the month th 27 Table of Contents it is closed. If a store is closed longer than two weeks but less than two months, it becomes comparable in the month in which it reopens, subject to a mid-month convention. A store closed longer than two months becomes comparable in its 14 month of operation after its reopening. Pat Catan’s stores will not be included in comparable store sales until the beginning of fiscal 2017, the 13 month after the acquisition. th th Results of Operations The following table sets forth the percentage relationship to net sales of line items of our consolidated statements of comprehensive income. This table should be read in conjunction with the following discussion and with our consolidated financial statements, including the related notes. Net sales Cost of sales and occupancy expense Gross profit Selling, general and administrative Related party expenses Store pre-opening costs Operating income Interest expense Losses on early extinguishments of debt and refinancing costs Other (income) expense, net Income before income taxes Income taxes Net income Fiscal 2016 Compared to Fiscal 2015 2016 100.0 % 61.0 39.0 25.2 — 0.1 13.8 2.4 0.1 — 11.2 3.9 7.3 % Fiscal Year 2015 100.0 % 59.9 40.1 25.3 — 0.1 14.7 2.8 0.2 — 11.6 4.3 7.4 % 2014 100.0 % 59.9 40.1 26.0 0.8 0.1 13.2 4.2 1.6 0.1 7.4 2.8 4.6 % Net Sales. Net sales increased $284.5 million in fiscal 2016, or 5.8%, compared to fiscal 2015. The increase in net sales was due to a $232.3 million increase related to the acquisition of Lamrite in fiscal 2016 and a $75.1 million increase related to 19 additional stores opened (net of closures) since January 30, 2016. The increase was partially offset by a $22.9 million decrease in comparable store sales. Comparable store sales decreased 0.5% compared to fiscal 2015 due to a decrease in customer transactions, partially offset by an increase in average ticket. Gross Profit. Gross profit was 39.0% of net sales in fiscal 2016 compared to 40.1% in fiscal 2015. The 110 basis point decline was primarily due to an increase in promotional activity and lower margins associated with Lamrite’s wholesale business, including $4.0 million of non-recurring purchase accounting adjustments related to inventory. The decline was partially offset by an increase in retail prices and sourcing efficiencies. Selling, General and Administrative . Selling, general and administrative (“SG&A”) was 25.2% of net sales in fiscal 2016 compared to 25.3% in fiscal 2015. SG&A increased $65.1 million to $1,308.1 million in fiscal 2016 due primarily to $72.4 million of expenses related to Lamrite, including $7.4 million of integration costs, a $14.9 million increase in payroll-related costs, $10.7 million of costs associated with operating 19 additional stores (net of closures) and $9.0 million of costs to create flexible space in our stores to present new and seasonally relevant merchandise. The increase was partially offset by a $45.6 million decrease in performance-based compensation. Interest Expense. Interest expense decreased $13.1 million to $126.3 million in fiscal 2016 compared to fiscal 2015. The decrease was primarily attributable to $8.0 million of interest savings from the partial redemption of our term loan credit facility in the fourth quarter of fiscal 2015, $3.8 million of interest savings from the redemption of our remaining 28 Table of Contents outstanding 7.5%/8.25% PIK Toggle Notes due 2018 (“PIK Notes”) during the second quarter of fiscal 2015 and $1.1 million of interest savings from the refinancing of our revolving credit facility in the second quarter of fiscal 2016. Losses on Early Extinguishments of Debt and Refinancing Costs. We recorded a loss on the early extinguishment of debt of $7.3 million during fiscal 2016, consisting of $6.9 million related to the amendment of our term loan credit facility and $0.4 million related to the refinancing of our revolving credit facility. During fiscal 2015, we recorded a loss on the early extinguishment of debt of $8.5 million related to the redemption of our remaining outstanding PIK Notes and the partial prepayment of our Amended Term Loan Credit Facility maturing in 2020 (“Additional Term Loan”), consisting of $4.4 million to write off related debt issuance costs, $3.6 million of redemption premiums and a $0.5 million write-off of the unamortized net discount of the Additional Term Loan. Income Taxes. The effective tax rate for fiscal 2016 was 35.0% compared to 36.6% in the prior year. The effective tax rate for fiscal 2016 was lower than the prior year primarily due to benefits realized associated with our direct sourcing initiatives implemented in the current year and a decrease in state taxes. Fiscal 2015 Compared to Fiscal 2014 Net Sales. Net sales increased $174.6 million in fiscal 2015, or 3.7%, compared to fiscal 2014. The increase in net sales was due to a $91.5 million increase primarily related to 25 additional stores opened (net of closures) since January 31, 2015 and an $83.1 million increase in comparable store sales. Comparable store sales increased 1.8%, or 3.2% at constant exchange rates, due primarily to an increase in our average ticket. Gross Profit. Gross profit was 40.1% as a percent of net sales for both fiscal 2015 and fiscal 2014. An improvement related to an increase in retail prices and sourcing efficiencies was offset by an increase in promotional activity as a result of the continued competitive retail environment and the negative impact of foreign exchange rates. Selling, General, and Administrative . SG&A was 25.3% of net sales in fiscal 2015 compared to 26.0% in fiscal 2014. SG&A increased $9.1 million to $1,243.0 million in fiscal 2015 due primarily to $10.9 million of costs associated with operating 25 additional stores (net of closures) and an increase in marketing costs of $4.0 million, partially offset by a decrease in Canadian operating costs due primarily to the impact of foreign exchange rates. Related Party Expenses. Related party expenses decreased $35.7 million in fiscal 2015 compared to the prior year due to the termination of the management services agreement in connection with our IPO completed in July 2014. Interest Expense. Interest expense decreased $59.0 million to $139.4 million in fiscal 2015. The decrease is primarily attributable to $39.7 million of interest savings from the redemption of the remaining outstanding PIK Notes in fiscal 2014 and fiscal 2015 and $19.5 million of interest savings from the refinancing of the 7.75% Senior Notes due 2018 (“2018 Senior Notes”) during fiscal 2014. Losses on Early Extinguishments of Debt and Refinancing Costs. We recorded a loss on the early extinguishment of debt of $8.5 million during fiscal 2015 related to the redemption of our remaining outstanding PIK Notes and the partial prepayment of our Additional Term Loan, consisting of $4.4 million to write off related debt issuance costs, $3.6 million of redemption premiums and a $0.5 million write-off of the unamortized net discount of the Additional Term Loan. During fiscal 2014, we recorded a loss on the early extinguishment of debt of $74.3 million related to the redemption of our 2018 Senior Notes and the partial redemption of our PIK Notes, consisting of $58.8 million of redemption premiums and $20.6 million to write off related debt issuance costs. The loss in fiscal 2014 was partially offset by a $5.1 million write-off of the unamortized premium on the 2018 Senior Notes. Income Taxes. The effective tax rate for fiscal 2015 was 36.6% compared to 38.1% in the prior year. The effective tax rate in fiscal 2015 was lower than the prior year primarily due to our assertion in fiscal 2015 to indefinitely reinvest the fiscal 2014 and fiscal 2015 earnings of our Canadian subsidiary into our operations outside of the U.S., which is taxed at a lower rate than the U.S. 29 Table of Contents Liquidity and Capital Resources We require cash principally for day-to-day operations, to finance capital investments, purchase inventory, service our outstanding debt and for seasonal working capital needs. We expect that our available cash, cash flow generated from operating activities and funds available under our Amended Revolving Credit Facility (as defined below) will be sufficient to fund planned capital expenditures, working capital requirements, debt repayments, debt service requirements and anticipated growth for the foreseeable future. Our ability to satisfy our liquidity needs and continue to refinance or reduce debt could be adversely affected by the occurrence of any of the events described under “Item 1A. Risk Factors” or our failure to meet our debt covenants as described below. Our Amended Revolving Credit Facility provides senior secured financing of up to $850.0 million, subject to a borrowing base. As of January 28, 2017, the borrowing base was $793.1 million, of which we had no outstanding borrowings, $57.6 million of outstanding standby letters of credit and $735.5 million of unused borrowing capacity. Our cash and cash equivalents totaled $298.8 million at January 28, 2017, of which $86.9 million was held by our foreign subsidiaries. If it were necessary to repatriate these funds for use in the U.S., we would be required to pay U.S. taxes on the amount of undistributed earnings in our foreign subsidiaries. However, it is our intent to indefinitely reinvest these funds outside the U.S. On February 2, 2016, we completed the acquisition of Lamrite for $150.0 million, prior to certain purchase price adjustments, utilizing our existing cash on hand. Lamrite operates an international wholesale business under the Darice brand name and 35 arts and crafts retail stores, located primarily in Ohio and the surrounding states, under the Pat Catan’s brand name. The retail stores have approximately 32,000 average square feet of selling space per store. The acquisition is helping to enhance our private brand development capabilities, accelerate our direct sourcing initiatives and strengthen our business-to-business capabilities. In fiscal 2016, the Board of Directors authorized the Company to purchase $500.0 million of the Company’s common stock on the open market. The share repurchase program does not have an expiration date, and the timing and number of repurchase transactions under the program will depend on market conditions, corporate considerations, debt agreements and regulatory requirements. Shares repurchased under the program are held as treasury shares until retired. During fiscal 2016, we repurchased 17.2 million shares for an aggregate amount of $400.7 million. During the first quarter of fiscal 2017, we repurchased an additional 4.8 million shares of our common stock for an aggregate amount of $99.3 million, utilizing the remaining availability under our share repurchase program. We had total outstanding debt of $2,773.5 million at January 28, 2017, of which $2,263.5 million was subject to variable interest rates and $510.0 million was subject to fixed interest rates. Our substantial indebtedness could adversely affect our ability to raise additional capital, limit our ability to react to changes in the economy or our industry, expose us to interest rate risk and prevent us from meeting our obligations. Management reacts strategically to changes in economic conditions and monitors compliance with debt covenants to seek to mitigate any potential material impacts to our financial condition and flexibility. We intend to use excess operating cash flows to invest in growth opportunities, repurchase outstanding shares and repay portions of our indebtedness, depending on prevailing market conditions, liquidity requirements, contractual restrictions and other factors. As such, we and our subsidiaries, affiliates and significant shareholders may, from time to time, seek to retire or purchase our outstanding debt (including publicly issued debt) through cash purchases and/or exchanges, in open market purchases, privately negotiated transactions, by tender offer or otherwise. If we use our excess cash flows to repay our debt, it will reduce the amount of excess cash available for additional capital expenditures. Cash Flow from Operating Activities Cash flows provided by operating activities was $564.4 million in fiscal 2016, an increase of $60.4 million from fiscal 2015. The improvement was primarily due to the timing of vendor payments and lower interest payments as a result of debt redemptions, partially offset by an increase in estimated federal tax payments and integration costs incurred as a result of the acquisition of Lamrite. 30 Table of Contents Inventory increased 12.5% to $1,127.8 million at January 28, 2017, from $1,002.6 million at January 30, 2016. The increase in inventory was primarily due to $91.5 million in additional inventory from the acquisition of Lamrite. Average inventory per Michaels store (inclusive of distribution centers, in-transit and inventory for the Company’s e-commerce site) increased 1.6% to $826,000 at January 28, 2017, from $813,000 at January 30, 2016. The increase was primarily due to additional inventory to support our core business, including improving our in-stock presentation and supporting key paper crafting initiatives. Cash Flow from Investing Activities The following table includes capital expenditures paid during the periods presented (in thousands): New and relocated stores and stores not yet opened Existing stores Information systems Corporate and other (1) 2016 2014 Fiscal Year 2015 $ 22,489 $ 30,315 $ 29,846 48,289 49,898 47,290 32,228 40,191 27,584 17,099 13,088 17,845 $114,462 $123,920 $137,780 (1) In fiscal 2016, we incurred capital expenditures related to the opening of 46 Michaels stores, including the relocation of 14 stores, and the opening of one Aaron Brothers store and four Pat Catan’s stores, including the relocation of one Pat Catan’s store. In fiscal 2015, we incurred capital expenditures related to the opening of 47 Michaels stores, including the relocation of 17 stores. In fiscal 2014, we incurred capital expenditures related to the opening of 45 Michaels stores, including the relocation of 13 stores, and five Aaron Brothers stores. We currently estimate that our capital expenditures will be $125.0 million to $135.0 million in fiscal 2017. We plan to invest in the infrastructure necessary to support the further development of our business. In fiscal 2017, we plan to open approximately 30 new Michaels stores, including approximately 13 relocations. Term Loan Credit Facility On January 28, 2013, MSI entered into an amended and restated credit agreement maturing on January 28, 2020 (the “Credit Agreement”) to amend various terms of MSI’s then existing term loan credit agreement with Deutsche Bank AG New York Branch (“Deutsche Bank”) and other lenders. The Credit Agreement, together with the related security, guarantee and other agreements, is referred to as the “Term Loan Credit Facility”. On July 2, 2014, MSI issued an additional $850.0 million of debt under the Term Loan Credit Facility maturing in 2020 (“Additional Term Loan”). The Additional Term Loan was issued at 99.5% of face value, resulting in an effective interest rate of 4.02%. The net proceeds from this borrowing and the issuance of an additional $250.0 million of the 5.875% senior subordinated notes were used to fully redeem the then outstanding 2018 Senior Notes and to pay the applicable make-whole premium and accrued interest. On December 28, 2015, MSI voluntarily prepaid $150.0 million in principal of the Additional Term Loan for an aggregate redemption price (including any unpaid interest) of $151.0 million. On September 28, 2016, MSI entered into an amendment with Deutsche Bank and other lenders to amend and restate our Term Loan Credit Facility. The amended and restated credit agreement, together with the related security, guarantee and other agreements, is referred to as the “Amended Term Loan Credit Facility”. The Amended Term Loan Credit Facility matures on January 28, 2023. As of January 28, 2017, the Amended Term Loan Credit Facility provides for senior secured financing of $2,263.5 million. MSI has the right under the Amended Term Loan Credit Facility to request additional term loans (a) in the aggregate amount of up to $750.0 million or (b) at MSI’s election, an amount of additional term loans if the consolidated secured debt ratio (as defined in the Amended Term Loan Credit Facility) is no more than 3.25 to 1.00 on a pro forma basis as of the last day of the most recently ended four quarter period, subject to certain adjustments. The lenders under 31 Table of Contents the Amended Term Loan Credit Facility will not be under any obligation to provide any such additional term loans, and the incurrence of any such additional term loans is subject to customary conditions. Borrowings under the Amended Term Loan Credit Facility bear interest at a rate per annum, at MSI’s option, of either (a) a margin of 1.75% plus a base rate defined as the highest of (1) the prime rate of Deutsche Bank, (2) the federal funds effective rate plus 0.5%, and (3) the one-month London Interbank Offered Rate (“LIBOR”) plus 1% or (b) a margin of 2.75% plus the applicable LIBOR. Subsequent to the first fiscal quarter following the amendment, the applicable margin will be 1.50% for base rate loans and 2.50% for LIBOR loans if our consolidated secured debt ratio is below 1.50:1.00 for the applicable quarter. There are no limitations on dividends and certain other restricted payments so long as (a) no event of default shall have occurred and be continuing and (b) immediately after giving pro forma effect to such restricted payment(s) and the application of proceeds therefrom, the consolidated total leverage ratio is less than or equal to 3.75 to 1.00. MSI must offer to prepay outstanding term loans at 100% of the principal amount, plus any unpaid interest, with the proceeds of certain asset sales or casualty events under certain circumstances. MSI may voluntarily prepay outstanding loans under the Amended Term Loan Credit Facility at any time without premium or penalty other than customary breakage costs with respect to LIBOR loans; provided, that if MSI enters into certain repricing transactions on or before March 28, 2017, the amount of the repricing payment will be subject to a premium equal to 1.0%. MSI is required to make scheduled quarterly payments equal to 0.25% of the original principal amount of the term loans (subject to adjustments relating to the incurrence of additional term loans) for the first six years and three quarters of the Amended Term Loan Credit Facility, with the balance paid on January 28, 2023. All obligations under the Amended Term Loan Credit Facility are unconditionally guaranteed, jointly and severally, by Michaels Funding, Inc. (“Holdings”) and all of MSI’s existing domestic material subsidiaries and are required to be guaranteed by certain of MSI’s future domestic wholly-owned material subsidiaries (“the Subsidiary Guarantors”). All obligations under the Amended Term Loan Credit Facility, and the guarantees of those obligations, are secured, subject to certain exceptions, by substantially all of the assets of Holdings, MSI and the Subsidiary Guarantors, including: · · · a first-priority pledge of MSI’s capital stock and all of the capital stock held directly by MSI and the Subsidiary Guarantors (which pledge, in the case of any foreign subsidiary, is limited to 65% of the voting stock of such foreign subsidiary and 100% of the non-voting stock of such subsidiary); a first-priority security interest in, and mortgages on, substantially all other tangible and intangible assets of Holdings, MSI and each Subsidiary Guarantor, including substantially all of MSI’s and its subsidiaries’ owned real property and equipment, but excluding, among other things, the collateral described below; and a second-priority security interest in personal property consisting of inventory and related accounts, cash, deposit accounts, all payments received by Holdings, MSI or the Subsidiary Guarantors from credit card clearinghouses and processors or otherwise in respect of all credit card charges and debit card charges for sales of inventory by Holdings, MSI and the Subsidiary Guarantors, and certain related assets and proceeds of the foregoing. The Amended Term Loan Credit Facility contains a number of negative covenants that are substantially similar to, but more restrictive in certain respects than, those governing the 2020 Senior Subordinated Notes (as defined below), as well as certain other customary representations and warranties, affirmative and negative covenants and events of default. As of January 28, 2017, MSI was in compliance with all covenants. 32 Table of Contents 5.875% Senior Subordinated Notes due 2020 On December 19, 2013, MSI issued $260.0 million in principal amount of 5.875% senior subordinated notes maturing in 2020 (“2020 Senior Subordinated Notes”). On June 16, 2014, MSI issued an additional $250.0 million of the 2020 Senior Subordinated Notes at 102% of face value, resulting in an effective interest rate of 5.76%. Interest is payable semi-annually on June 15 and December 15 of each year. The net proceeds from this borrowing, and the $850.0 million Additional Term Loan, were used to fully redeem the outstanding 2018 Senior Notes and to pay the applicable make-whole premium and accrued interest. The 2020 Senior Subordinated Notes are guaranteed, jointly and severally, fully and unconditionally, on an unsecured senior subordinated basis, by each of MSI’s subsidiaries that guarantee indebtedness under the Amended Revolving Credit Facility and the Amended Term Loan Credit Facility (collectively defined as the “Senior Secured Credit Facilities”). The 2020 Senior Subordinated Notes and the guarantees are MSI’s and the guarantors’ unsecured senior subordinated obligations and are (i) subordinated in right of payment to all of MSI’s and the guarantors’ existing and future senior debt, including the Senior Secured Credit Facilities; (ii) rank equally in right of payment to all of MSI’s and the guarantors’ future senior subordinated debt; (iii) effectively subordinated to all of MSI’s and the guarantors’ existing and future secured debt (including the Senior Secured Credit Facilities) to the extent of the value of the assets securing such debt; (iv) rank senior in right of payment to all of the MSI’s and the guarantors’ existing and future debt and other obligations that are, by their terms, expressly subordinated in right of payment to the 2020 Senior Subordinated Notes; and (v) are structurally subordinated to all obligations of MSI’s subsidiaries that are not guarantors of the 2020 Senior Subordinated Notes. MSI may redeem all or part of the 2020 Senior Subordinated Notes, upon notice, at the redemption prices set forth below (expressed as percentages of the principal amount of the 2020 Senior Subordinated Notes to be redeemed), plus any unpaid interest through the applicable date of redemption, if redeemed during the twelve-month period beginning on December 15 of each of the years indicated below: Year 2016 2017 2018 and thereafter Percentage 102.938 % 101.469 % 100.000 % Upon a change in control, MSI is required to offer to purchase all of the 2020 Senior Subordinated Notes at a price in cash equal to 101% of the aggregate principal amount, plus any unpaid interest. The 2020 Senior Subordinated Indenture contains covenants limiting MSI’s ability, and the ability of MSI’s restricted subsidiaries, to incur or guarantee additional debt, prepay debt that is subordinated to the 2020 Senior Subordinated Notes, issue stock of subsidiaries, make certain investments, loans, advances and acquisitions, create liens on MSI’s and such subsidiaries’ assets to secure debt, enter into transactions with affiliates, merge or consolidate with another company; and sell or otherwise transfer assets. The covenants also limit MSI’s ability, and the ability of MSI’s restricted subsidiaries, to pay dividends or distributions on MSI’s capital stock or repurchase MSI’s capital stock, subject to certain exceptions, including dividends, distributions and repurchases up to an amount in excess of (i) $100.0 million plus (ii) a basket that builds based on 50% of MSI’s consolidated net income (as defined in the 2020 Senior Subordinated Indenture) and certain other amounts, in each case, to the extent such payment capacity is not applied as otherwise permitted under the 2020 Senior Subordinated Indenture and subject to certain conditions. However, there are no limitations on dividends and certain other restricted payments so long as (a) no default shall have occurred and be continuing and (b) immediately after giving pro forma effect to such restricted payment(s) and the application of proceeds therefrom, the consolidated total leverage ratio is less than or equal to 3.25 to 1.00. As of January 28, 2017, the permitted restricted payment amount was $658.5 million. As of January 28, 2017, MSI was in compliance with all covenants. 33 Table of Contents Revolving Credit Facility On September 17, 2012, MSI entered into a second amended and restated credit agreement (the “Credit Agreement”) with Wells Fargo Bank, National Association (“Wells Fargo”) and other lenders to amend various terms of MSI’s then existing senior secured asset-based revolving credit facility. The Credit Agreement, together with related security, guarantee and other agreements, is referred to as the “Revolving Credit Facility”. On May 27, 2016, MSI entered into an amended and restated credit agreement with Wells Fargo and other lenders to, among other things, increase the availability and extend the maturity date of our Revolving Credit Facility. The amended credit agreement, together with the related security, guarantee and other agreements, is referred to as the “Amended Revolving Credit Facility”. The Amended Revolving Credit Facility provides for senior secured financing of up to $850.0 million, subject to a borrowing base. The borrowing base under the Amended Revolving Credit Facility equals the sum of: (i) 90% of eligible credit card receivables, (ii) 85% of eligible trade receivables, (iii) 90% to 92.5% of the appraised value of eligible inventory, plus (iv) 90% to 92.5% of the lesser of (a) the appraised value of eligible inventory supported by letters of credit, and (b) the face amount of the letters of credit, less (v) certain reserves. The Amended Revolving Credit Facility matures in May 2021, subject to a springing maturity date if certain of our outstanding indebtedness has not been repaid, redeemed, refinanced, cash collateralized or if the necessary availability reserves have not been established prior to such time (the “ABL Maturity Date”). As of January 28, 2017 and January 30, 2016, the borrowing base was $793.1 million and $650.0 million, respectively, of which MSI had availability of $735.5 million and $586.8 million, respectively. Borrowing capacity is available for letters of credit and borrowings on same-day notice. Outstanding standby letters of credit as of January 28, 2017 totaled $57.6 million. The Amended Revolving Credit Facility also provides MSI with the right to request up to $200.0 million of additional commitments. The lenders will not be under any obligation to provide any such additional commitments, and any increase in commitments is subject to customary conditions. If we were to request additional commitments, and the lenders were to agree to provide such commitments, the facility size could be increased up to $1,050.0 million, however, MSI’s ability to borrow would still be limited by the borrowing base. Borrowings under the Amended Revolving Credit Facility bear interest at a rate per annum equal to, at our option, either (a) a base rate determined by reference to the highest of (1) the prime rate of Wells Fargo, (2) the federal funds effective rate plus 0.50% and (3) LIBOR subject to certain adjustments plus 1.00% or (b) LIBOR subject to certain adjustments, in each case plus an applicable margin. The initial applicable margin is (a) 0.25% for prime rate borrowings and 1.25% for LIBOR borrowings. The applicable margin is subject to adjustment each fiscal quarter based on the excess availability under the Amended Revolving Credit Facility. Excess availability is defined as the Loan Cap (as defined below) plus certain unrestricted cash of Holdings, MSI and the Subsidiary Guarantors, less the outstanding credit extensions. Same-day borrowings bear interest at the base rate plus the applicable margin. MSI is required to pay a commitment fee on the unutilized commitments under the Amended Revolving Credit Facility, which initially is 0.25% per annum. In addition, MSI must pay customary letter of credit fees and agency fees. All obligations under the Amended Revolving Credit Facility are unconditionally guaranteed, jointly and severally, by Holdings and all of MSI’s existing domestic material subsidiaries and are required to be guaranteed by the Subsidiary Guarantors. All obligations under the Amended Revolving Credit Facility, and the guarantees of those obligations, are secured, subject to certain exceptions, by substantially all of the assets of Holdings, MSI and the Subsidiary Guarantors, including: · a first-priority security interest in personal property consisting of inventory and related accounts, cash, deposit accounts, all payments received by Holdings, MSI or the Subsidiary Guarantors from credit card clearinghouses and processors or otherwise in respect of all credit card charges and debit card charges for sales of inventory by Holdings, MSI and the Subsidiary Guarantors, and certain related assets and proceeds of the foregoing; 34 Table of Contents · · a second-priority pledge of all of MSI’s capital stock and the capital stock held directly by MSI and the Subsidiary Guarantors (which pledge, in the case of the capital stock of any foreign subsidiary, is limited to 65% of the voting stock of such foreign subsidiary and 100% of the non- voting stock of such subsidiary); and a second-priority security interest in, and mortgages on, substantially all other tangible and intangible assets of Holdings, MSI and each Subsidiary Guarantor, including substantially all of MSI’s and its subsidiaries’ owned real property and equipment. If, at any time, the aggregate amount of outstanding loans, unreimbursed letter of credit drawings and undrawn letters of credit under the Amended Revolving Credit Facility exceeds the lesser of (i) the commitment amount and (ii) the borrowing base (the “Loan Cap”), MSI will be required to repay outstanding loans and cash collateralize letters of credit in an aggregate amount equal to such excess, with no reduction of the commitment amount. If availability under the Amended Revolving Credit Facility is less than the greater of (i) 10.0% of the Loan Cap and (ii) $50.0 million for five consecutive business days, or, if certain events of default have occurred, MSI will be required to repay outstanding loans and cash collateralize letters of credit with the cash MSI is required to deposit daily in a collection account maintained with the agent under the Amended Revolving Credit Facility. Availability under the Amended Revolving Credit Facility means the Loan Cap minus the outstanding credit extensions. MSI may voluntarily reduce the unutilized portion of the commitment amount and repay outstanding loans at any time without premium or penalty, other than customary breakage costs with respect to LIBOR loans. There is no scheduled amortization under the Amended Revolving Credit Facility. The principal amount of the loans outstanding is due and payable in full on the ABL Maturity Date. The covenants limiting dividends and other restricted payments, investments, loans, advances and acquisitions, and prepayments or redemptions of indebtedness, each permit the restricted actions in an unlimited amount, subject to the satisfaction of certain payment conditions, principally that MSI must meet specified excess availability requirements and minimum consolidated fixed charge coverage ratios, to be tested on a pro forma basis as of the date of the restricted action and for the 90-day period preceding such restricted action. Adjusted EBITDA, as defined in the Amended Revolving Credit Facility, is used in the calculation of the consolidated fixed charge coverage ratios. From the time when MSI has excess availability less than the greater of (a) 10.0% of the Loan Cap and (b) $50.0 million, until the time when MSI has excess availability greater than the greater of (a) 10.0% of the Loan Cap and (b) $50.0 million for 30 consecutive days, the Amended Revolving Credit Facility will require MSI to maintain a consolidated fixed charge coverage ratio of at least 1.0 to 1.0. The Amended Revolving Credit Facility also contains certain customary representations and warranties, affirmative covenants and provisions relating to events of default (including change of control and cross-default to material indebtedness). The Amended Revolving Credit Facility contains a number of covenants that, among other things and subject to certain exceptions, restrict MSI’s ability, and the ability of its restricted subsidiaries, to: · · incur or guarantee additional indebtedness; pay dividends on MSI’s capital stock or redeem, repurchase or retire MSI’s capital stock; · make investments, loans, advances and acquisitions; · · · · · create restrictions on the payment of dividends or other amounts to MSI from its restricted subsidiaries; engage in transactions with MSI’s affiliates; sell assets, including capital stock of MSI’s subsidiaries; prepay or redeem indebtedness; consolidate or merge; and 35 Table of Contents · create liens. PIK Toggle Notes On July 29, 2013, Michaels FinCo Holdings, LLC (“FinCo Holdings”) and Michaels FinCo, Inc. (“FinCo Inc.”) issued $800.0 million aggregate principal amount of PIK Notes in a private transaction. On July 2, 2014, the Company completed an IPO and received net proceeds totaling $445.7 million. The net proceeds were used to redeem $439.1 million of the outstanding PIK Notes and to pay other expenses of the offering. The aggregate redemption price (including redemption premium and any unpaid interest) was $473.5 million. On December 10, 2014, the Company redeemed $180.0 million of the PIK Notes for an aggregate redemption price (including redemption premium and any unpaid interest) of $188.4 million. On May 6, 2015, the Company redeemed the remaining $180.9 million of the PIK Notes for an aggregate redemption price (including redemption premium and any unpaid interest) of $188.0 million. This final payment retired the PIK Notes and discharged the obligations under the indenture governing the PIK Notes. Off-Balance Sheet Arrangements We have no off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of Regulation S-K. We do not typically enter into off-balance sheet arrangements, except for arrangements related to operating lease commitments, service contract commitments and trade letters of credit, as disclosed in the contractual obligations table below. Neither we nor our subsidiaries typically guarantee the obligations of unrelated parties. Contractual Obligations As of January 28, 2017, our contractual obligations were as follows (in thousands): Payments Due By Fiscal Year Total Less Than 1 Year 1-3 Years 3-5 Years More Than 5 Years (1) Total debt Operating lease commitments Interest payments Other commitments (3) (4) (2) $ 2,773,475 $ 31,125 $ 2,049,987 422,885 703,051 117,058 148,340 115,481 553,575 $ 2,138,975 462,982 465,795 158,804 — $ 5,674,853 $ 686,549 $ 1,011,758 $ 1,215,785 $ 2,760,761 49,800 $ 698,325 195,873 231,316 32,317 542 (1) Total debt only includes principal payments owed on the 2020 Senior Subordinated Notes and the Amended Term Loan Credit Facility. The amounts shown above do not include unamortized premiums/discounts and deferred debt issuance costs reflected in the Company’s consolidated balance sheets since they do not represent contractual obligations. (2) Our operating lease commitments generally include non-cancelable leases for property and equipment used in our operations. Excluded from our operating lease commitments are amounts related to insurance, taxes and common area maintenance associated with property and equipment. Such amounts historically represented approximately 34% of the total lease obligation over the previous three fiscal years. (3) Debt associated with our Amended Term Loan Credit Facility was $2,263.5 million at January 28, 2017 and is subject to variable interest rates. The amounts included in interest payments in the table for the Amended Term Loan Credit Facility were based on the indexed interest rate in effect at January 28, 2017. Debt associated with the 2020 Senior Subordinated Notes was $510.0 million at January 28, 2017 and was subject to fixed interest rates. We had no outstanding borrowings under our Amended Revolving Credit Facility at January 28, 2017. Under our Amended Revolving Credit Facility, we are required to pay a commitment fee of 0.25% per year on the unutilized commitments. The amounts included in interest payments for the Amended Revolving Credit Facility were based on this annual commitment fee. (4) Other commitments include trade letters of credit and service contract obligations. Our service contract obligations were calculated based on the time period remaining in the contract or to the earliest possible date of termination, if permitted to be terminated by Michaels upon notice, whichever is shorter. 36 Table of Contents Non-GAAP Measures The following table sets forth certain non-GAAP measures the Company uses to manage our performance and measure compliance with certain debt covenants. The Company defines “EBITDA (excluding losses on early extinguishments of debt and refinancing costs)” as net income before interest, income taxes, depreciation, amortization and losses on early extinguishments of debt and refinancing costs. The Company defines “Adjusted EBITDA” as EBITDA (excluding losses on early extinguishments of debt and refinancing costs) adjusted for certain defined amounts in accordance with the Company’s Amended Term Loan Credit Facility and Amended Revolving Credit Facility (collectively, the “Adjustments”). The Company has presented EBITDA (excluding losses on early extinguishments of debt and refinancing costs) and Adjusted EBITDA to provide investors with additional information to evaluate our operating performance and our ability to service our debt. Adjusted EBITDA is a required calculation under the Company’s Senior Secured Credit Facilities. As it relates to the Senior Secured Credit Facilities, Adjusted EBITDA is used in the calculations of fixed charge coverage and leverage ratios, which under certain circumstances determine mandatory repayments or maintenance covenants and may restrict the Company’s ability to make certain payments (characterized as restricted payments), investments (including acquisitions) and debt repayments. As EBITDA (excluding losses on early extinguishments of debt and refinancing costs) and Adjusted EBITDA are not measures of operating performance or liquidity calculated in accordance with U.S. generally accepted accounting principles (“GAAP”), these measures should not be considered in isolation of, or as a substitute for, net income, as an indicator of operating performance, or net cash provided by operating activities as an indicator of liquidity. Our computation of EBITDA (excluding losses on early extinguishments of debt and refinancing costs) and Adjusted EBITDA may differ from similarly titled measures used by other companies. 37 Table of Contents The following table shows a reconciliation of EBITDA (excluding losses on early extinguishments of debt and refinancing costs) and Adjusted EBITDA to net income and net cash provided by operating activities (in thousands): Fiscal Year Net cash provided by operating activities Depreciation and amortization Share-based compensation Debt issuance costs amortization Accretion of long-term debt, net Deferred income taxes Losses on early extinguishments of debt and refinancing costs (Losses) gains on disposition of property and equipment Excess tax benefits from share-based compensation Changes in assets and liabilities Net income Interest expense Losses on early extinguishments of debt and refinancing costs Income taxes Depreciation and amortization Interest income EBITDA (excluding losses on early extinguishments of debt and refinancing costs) Adjustments: Share-based compensation Management fees to Sponsors and others Severance costs Store pre-opening costs Store remodel costs Foreign currency transaction losses Store closing costs Lamrite integration costs IPO costs Other (1) Adjusted EBITDA 2016 2014 2015 $ 564,417 $ 504,047 $ 441,997 (110,858) (114,756) (19,387) (15,064) (10,333) (8,467) 516 150 (15,282) (8,611) (74,312) (8,485) (3,995) 25 5,081 14,507 3,968 (434) 217,395 362,912 198,409 139,405 74,312 8,485 133,639 209,208 110,858 114,756 (363) (615) (115,801) (16,506) (6,583) 334 (4,570) (7,292) (120) 10,027 (45,747) 378,159 126,270 7,292 203,614 115,801 (820) 830,316 834,151 734,250 16,506 — 6,113 4,554 895 667 2,877 7,390 — 3,382 19,387 35,682 4,123 5,172 3,886 2,757 1,931 — 2,134 3,497 $ 872,700 $ 866,171 $ 812,819 15,064 — 2,733 4,858 4,554 579 (104) — — 4,336 (1) Other adjustments primarily relate to items such as moving and relocation expenses, franchise taxes, sign on bonuses and certain legal expenses. Critical Accounting Policies and Estimates We have prepared our consolidated financial statements in conformity with U.S. GAAP. These consolidated financial statements include some amounts that are based on our informed judgments and estimates. Our significant accounting policies are discussed in Note 1 to the consolidated financial statements. Our critical accounting policies represent those policies that are subject to judgments and uncertainties. The following discussion addresses our most critical accounting policies, which are those that are both important to the portrayal of our financial condition and results of operations and that require significant judgment or use of complex estimates. Merchandise Inventories. Merchandise inventories are valued at the lower of cost or market, with cost determined using a weighted-average method. Cost is calculated based upon the purchase price of an item at the time it is received by us, and also includes the cost of warehousing, handling, purchasing, and importing, as well as inbound and 38 Table of Contents outbound transportation, partially offset by vendor allowances. This net inventory cost is recognized through cost of sales when the inventory is sold. It is impractical for us to assign specific allocated overhead costs and vendor allowances to individual units of inventory. As such, to match net inventory costs against the related revenues, we estimate the net inventory costs to be deferred and recognized each period as the inventory is sold. We utilize perpetual inventory records to value inventory in our stores. Physical inventory counts are performed in a significant number of stores during each fiscal quarter by a third-party inventory counting service, with substantially all stores open longer than one year subject to at least one count each fiscal year. We adjust our perpetual records based on the results of the physical counts. We maintain a provision for estimated shrinkage based on the actual historical results of our physical inventories. We compare our estimates to the actual results of the physical inventory counts as they are taken and adjust the shrink estimates accordingly. A 10% change in our estimated shrinkage reserve would have affected net income by $1.0 million for fiscal 2016. We also evaluate our merchandise to ensure that the expected net realizable value of the merchandise held at the end of a fiscal period exceeds cost. In the event that the expected net realizable value is less than cost, we reduce the value of that inventory accordingly. A 10% change in our inventory valuation reserve would have affected net income by $0.9 million in fiscal 2016. Vendor allowances, which primarily represent volume rebates and cooperative advertising funds, are recorded as a reduction of the cost of the merchandise inventories and a subsequent reduction in cost of sales when the inventory is sold. We generally earn vendor allowances as a percentage of certain merchandise purchases with no minimum purchase requirements. Goodwill and Other Indefinite-Lived Intangible Assets. We review goodwill and other indefinite- lived intangible assets for impairment each year in the fourth quarter, or more frequently if events occur which indicate the carrying value may not be recoverable. We elected to perform a qualitative assessment for our Michaels-U.S. reporting unit to determine whether it is more likely than not (that is, a likelihood of more than 50 percent) that the fair value of the goodwill is less than its carrying value. Factors used in our qualitative assessment include, but are not limited to, macroeconomic conditions, industry and market conditions, cost factors, overall financial performance and Company and reporting unit specific events. If, based on our qualitative assessment, we determine that it is more likely than not that the fair value is less than the carrying amount, we will compare the carrying value of the Michaels-U.S. goodwill to its estimated fair value. If the carrying value of the goodwill exceeds the estimated fair value, we determine the fair value of all assets and liabilities of the reporting unit, including the implied fair value of goodwill. If the carrying value of goodwill exceeds the implied fair value, we recognize an impairment charge equal to the difference. For all other reporting units, we estimated the fair value of goodwill and indefinite-lived intangible assets using the present value of future cash flows expected to be generated by the reporting units. If the carrying value of the goodwill or indefinite-lived intangible assets exceeds the estimated fair value, an impairment charge is recorded to write the assets down to their estimated fair value. We estimate fair value using the present value of future cash flows expected to be generated by the reporting unit using a weighted-average cost of capital, terminal values and updated financial projections. If our actual results are not consistent with the estimates and assumptions used to calculate fair value, we could be required to recognize an impairment. Based on the results of our assessments, no impairments were required for the fiscal periods presented in the consolidated financial statements. Long-Lived Assets. Long-lived assets other than goodwill and assets with indefinite lives, such as property and equipment and intangible assets subject to amortization, are evaluated for indicators of impairment whenever events or changes in circumstances indicate their carrying amounts may not be recoverable. For store assets, we evaluate the performance of individual stores for indicators of impairment and underperforming stores are selected for further evaluation to determine whether their carrying amounts are recoverable. Our initial indicator that store assets are considered to be recoverable is that the estimated undiscounted cash flows for the remaining lease term exceed the carrying value of the assets. If the evaluation indicates that the carrying value of the asset may not be recoverable, the potential impairment is measured based on a projected discounted cash flow method using assumptions about key store variables, including sales, growth rate, gross margin, payroll and other 39 Table of Contents controllable expenses. Furthermore, management considers other factors when evaluating stores for impairment, including the individual store’s execution of its operating plan and other local market conditions. If the carrying value exceeds the fair value, an impairment is recorded. Our evaluation requires consideration of a number of factors including changes in consumer demographics, key store level assumptions and other uncertain future events. Accordingly, our accounting estimates may change from period to period. These factors could cause management to conclude impairment indicators exist and require that tests be performed, which could result in a determination that the value of long-lived assets is impaired, resulting in a write down to fair value. Self-Insurance. We have insurance coverage for losses in excess of self-insurance limits for medical claims, general liability and workers’ compensation claims. Our liability represents an estimate of the ultimate cost of claims incurred as of the balance sheet dates. The estimated liability is not discounted and is established based upon analysis of historical data and actuarial estimates. While we believe these estimates are reasonable based on the information currently available, if actual trends, including the severity or frequency of claims, medical cost inflation, or fluctuations in premiums differ from our estimates, our results of operations could be impacted. A 10% change in our self-insurance reserves would have affected net income by $4.2 million in fiscal 2016. Share-Based Compensation. ASC 718, Stock Compensation (“ASC 718”) requires all share-based payments to employees, including grants of employee stock options and restricted shares, to be recognized using the fair value method of accounting. Share-based awards are recognized ratably over the requisite service period. All grants of our stock options have an exercise price equal to the fair market value of our common stock on the date of grant. Because we were privately held prior to June 27, 2014 and there was no public market for the common stock, the fair value of our equity was estimated by our management, relying in part on an independent appraisal of the fair market value by a third-party valuation firm and approved by our Board at the time option grants were awarded. For the first and second quarters of fiscal 2014, valuations completed relied on projections of our future performance, estimates of our weighted-average cost of capital, and metrics based on the performance of a peer group of similar companies, including valuation multiples and stock price volatility. Following our IPO, the exercise price of stock options are based on the closing market price of our common stock on the grant date. The following table details information on stock options granted by quarter for fiscal 2016: Quarter end date April 30, 2016 July 30, 2016 October 29, 2016 January 28, 2017 Number of options granted Weighted- average exercise price Weighted- average fair value of options at grant 226,730 $ 27.49 $ 30,150 $ 28.74 $ 1,424,995 $ 23.94 $ 63,575 $ 24.38 $ 6.94 7.41 6.13 6.49 Other assumptions used in the option value models for estimating the fair value of stock option awards include expected volatility of our common stock share price, expected terms of the options, expected dividends and risk-free interest rates. The expected volatility rate is based on our historical volatility as well as historical and implied volatilities from the exchange-traded options on the common stock of a peer group of companies. We utilize historical exercise and post-vesting employment behavior to estimate the expected terms of the options and assume a zero dividend rate. The risk-free interest rate is based on the yields of U.S. Treasury instruments with approximately the same term as the expected life of the stock option award. Our forfeiture assumptions are estimated based on historical experience and anticipated events. We update our assumptions quarterly based on historical trends and current market observations. Income Taxes. Deferred tax assets, including the benefit of net operating loss and tax credit carryforwards, are evaluated based on the guidelines for realization and are reduced by a valuation allowance if it is deemed more likely than not that such assets will not be realized. We consider several factors in evaluating the realizability of our deferred tax assets, including the nature, frequency and severity of recent losses, the remaining years available for carryforward, the tax laws of the applicable jurisdiction, the future profitability of the operations in the jurisdiction, and tax planning 40 Table of Contents strategies. Our judgments and estimates concerning realizability of deferred tax assets could change if any of the evaluation factors change, resulting in an increase or decrease to income tax expense in any period. We record a liability for uncertain tax positions to the extent a tax position taken or expected to be taken in a tax return does not meet certain recognition or measurement criteria. Considerable management judgment is necessary to assess the inherent uncertainties related to the interpretations of complex tax laws, regulations and taxing authority rulings, as well as to the expiration of statutes of limitations in the numerous and varied jurisdictions in which we operate. Our judgments and estimates may change as a result of evaluation of new information, such as the outcome of tax audits or changes to or further interpretations of tax laws and regulations, resulting in an increase or decrease to income tax expense in any period. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Foreign Currency Risk We are exposed to fluctuations in exchange rates between the U.S. and Canadian dollar, which is the functional currency of our Canadian subsidiaries. Our sales, costs and expenses of our Canadian subsidiaries, when translated into U.S. dollars, can fluctuate due to exchange rate movement. A 10% increase or decrease in the exchange rate of the Canadian dollar would have increased or decreased net income by approximately $11 million for fiscal 2016. Interest Rate Risk We have market risk exposure arising from changes in interest rates on our Amended Term Loan Credit Facility and our Amended Revolving Credit Facility. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Debt” for further detail. The interest rates on our Amended Term Loan Credit Facility and our Amended Revolving Credit Facility will reprice periodically, which will impact our earnings and cash flow. The interest rate on our 2020 Senior Subordinated Notes is fixed. Based on our overall interest rate exposure to variable rate debt outstanding as of January 28, 2017, a 1% change in interest rates would impact income before income taxes by approximately $23 million for fiscal 2016. A 1% change in interest rates would impact the fair value of our long-term fixed rate debt by approximately $14 million. A change in interest rates would not materially affect the fair value of our variable rate debt as the debt reprices periodically. Inflation Risk We do not believe inflation and changing commodity prices have had a material impact on our net sales, income from continuing operations, plans for expansion or other capital expenditures for any year during the three-year period ended January 28, 2017. However, we cannot be sure inflation and changing commodity prices will not have an adverse impact on our operating results, financial condition, plans for expansion or other capital expenditures in future periods. ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. See the Index to Consolidated Financial Statements and Supplementary Data on page F-1. The Consolidated Financial Statements and Supplementary Data are included on pages F-2 through F-36 and are incorporated herein by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. Not applicable. ITEM 9A. CONTROLS AND PROCEDURES. Included in this Annual Report on Form 10-K are certifications by our Chief Executive Officer and our Chief Financial Officer, which are required in accordance with Rule 13a-14 of the Securities Exchange Act of 1934, as amended. 41 Table of Contents This section includes information concerning the controls and controls evaluation referred to in the certifications. Page F-2 of this Report includes the attestation report of Ernst & Young LLP, our independent registered public accounting firm, regarding its audit of the effectiveness of our internal control over financial reporting. This section should be read in conjunction with the Ernst & Young LLP attestation for a complete understanding of this section. Evaluation of Disclosure Controls and Procedures We maintain a set of disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d- 15(e) promulgated by the SEC under the Securities Exchange Act of 1934) designed to provide reasonable assurance information, which is required to be timely disclosed, is accumulated and communicated to management in a timely fashion. We note the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. An evaluation was carried out under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls are effective to provide reasonable assurance that information required to be disclosed in the reports that we file or submit under the Securities and Exchange Act of 1934, as amended, is accumulated and communicated to management, including our Chief Executive Officer and our Chief Financial Officer, to allow timely decisions regarding required disclosure and are effective to provide reasonable assurance that such information is recorded, processed, summarized and reported within the time periods specified by the SEC’s rules and forms. Changes in Internal Control Over Financial Reporting There have been no changes in our internal controls over financial reporting during the quarter ended January 28, 2017 that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. Management Report on Internal Control over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended. Internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company, (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that receipts and expenditures are being made only in accordance with authorizations of management and directors of the company, and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Due to its inherent limitations, internal control over financial reporting may not prevent or detect misstatements and, even when determined to be effective, can only provide reasonable, not absolute, assurance with respect to financial statement preparation and presentation. Projections of any evaluation of effectiveness to future periods are subject to risk that controls may become inadequate as a result of changes in conditions or deterioration in the degree of compliance. Management assessed the effectiveness of our internal control over financial reporting as of January 28, 2017. Management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in its Internal Control—Integrated Framework (2013). Management’s assessment included the evaluation of such elements as the design and operating effectiveness of financial reporting controls, process documentation, accounting policies and the overall control environment. This assessment is supported by testing and monitoring performed or supervised by our Internal Audit organization. Based on management’s assessment, management has concluded that the Company’s internal control over financial reporting was effective as of January 28, 2017. The independent registered public accounting firm, Ernst & Young 42 Table of Contents LLP, issued an attestation report on the effectiveness of our internal control over financial reporting. The Ernst & Young LLP report is included on Page F-2 of this Annual Report on Form 10-K. PART III ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE. The information required by this item will be contained in our Definitive Proxy Statement and is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION. The information required by this item will be contained in our Definitive Proxy Statement and is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS. The information required by this item will be contained in our Definitive Proxy Statement and is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE. The information required by this item will be contained in our Definitive Proxy Statement and is incorporated herein by reference. ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES. The information required by this item will be contained in our Definitive Proxy Statement and is incorporated herein by reference. 43 Table of Contents PART IV ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES. The following documents are filed as a part of this report: (1) Consolidated Financial Statements: See Index to Consolidated Financial Statements and Supplementary Data on page F-1. (2) Financial Statement Schedules: All financial statement schedules are omitted because they are not required or are not applicable, or the required information is provided in the consolidated financial statements or notes described in 15(1) above. (3) Exhibits: The exhibits listed in the accompanying Index to Exhibits attached hereto are filed or incorporated by reference into this Annual Report on Form 10-K. 44 Table of Contents THE MICHAELS COMPANIES, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Reports of Independent Registered Public Accounting Firm Consolidated Statements of Comprehensive Income for the fiscal years ended January 28, 2017, January 30, 2016 and January 31, 2015 Consolidated Balance Sheets at January 28, 2017 and January 30, 2016 Consolidated Statements of Cash Flows for the fiscal years ended January 28, 2017, January 30, 2016 and January 31, 2015 Consolidated Statements of Stockholders’ Deficit for the fiscal years ended January 28, 2017, January 30, 2016 and January 31, 2015 Notes to Consolidated Financial Statements F-1 Page F-2 F-4 F-5 F-6 F-7 F-8 Table of Contents REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors and Stockholders The Michaels Companies, Inc. We have audited The Michaels Companies, Inc.’s (the Company) internal control over financial reporting as of January 28, 2017, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). The Michaels Companies, Inc.’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management Report on Internal Control over Financial Reporting (see Item 9A). Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (U.S.). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, The Michaels Companies, Inc. maintained, in all material respects, effective internal control over financial reporting as of January 28, 2017, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (U.S.), the consolidated balance sheets as of January 28, 2017 and January 30, 2016 and the related consolidated statements of comprehensive income, stockholders’ deficit and cash flows for the three years in the period ended January 28, 2017 and our report dated March 7, 2017 expressed an unqualified opinion thereon. /s/ Ernst & Young LLP Dallas, TX March 7, 2017 F-2 Table of Contents REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors and Stockholders The Michaels Companies, Inc. We have audited the accompanying consolidated balance sheets of The Michaels Companies, Inc. (the Company) as of January 28, 2017 and January 30, 2016 and the related consolidated statements of comprehensive income, stockholders’ deficit and cash flows for each of the three years in the period ended January 28, 2017. 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 the standards of the Public Company Accounting Oversight Board (U.S.). 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of The Michaels Companies, Inc. at January 28, 2017 and January 30, 2016 and the consolidated results of its operations and its cash flows for each of the three years in the period ended January 28, 2017, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (U.S.), The Michaels Companies, Inc.’s internal control over financial reporting as of January 28, 2017, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated March 7, 2017 expressed an unqualified opinion thereon. /s/ Ernst & Young LLP Dallas, TX March 7, 2017 F-3 Table of Contents THE MICHAELS COMPANIES, INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (in thousands, except per share data) 2016 Fiscal Year 2015 2014 Net sales Cost of sales and occupancy expense Gross profit Selling, general and administrative Related party expenses Store pre-opening costs Operating income Interest expense Losses on early extinguishments of debt and refinancing costs Other (income) expense, net Income before income taxes Income taxes Net income Other comprehensive income, net of tax: Foreign currency translation adjustment and other Comprehensive income Earnings per common share: Basic Diluted Weighted-average common shares outstanding: Basic Diluted $ 5,197,292 $ 4,912,782 $ 4,738,144 2,836,965 1,901,179 1,233,901 35,682 5,067 626,529 198,409 3,169,476 2,027,816 1,308,052 — 4,484 715,280 126,270 2,944,431 1,968,351 1,242,961 — 4,786 720,604 139,405 7,292 (55) 581,773 203,614 378,159 7,832 385,991 1.84 1.82 $ $ $ $ 8,485 594 572,120 209,208 362,912 (10,251) 352,661 1.75 1.72 $ $ $ $ 74,312 2,774 351,034 133,639 217,395 (12,003) 205,392 1.07 1.05 $ $ $ $ 204,735 206,354 206,845 209,346 203,229 207,101 See accompanying notes to consolidated financial statements. F-4 Table of Contents Current Assets: Cash and equivalents Merchandise inventories Prepaid expenses and other Accounts receivable, net Income taxes receivable Total current assets Property and equipment, net Goodwill Other intangible assets, net Deferred income taxes Other assets Total assets THE MICHAELS COMPANIES, INC. CONSOLIDATED BALANCE SHEETS (in thousands, except per share data) ASSETS January 28, January 30, 2017 2016 5,825 298,813 $ 87,175 23,215 $ 409,391 1,127,777 1,002,607 85,010 9,484 1,231 1,542,805 1,507,723 378,507 94,290 471 40,399 9,897 $ 2,147,640 $ 2,031,287 413,164 119,074 23,702 36,834 12,061 LIABILITIES AND STOCKHOLDERS’ DEFICIT Current Liabilities: Accounts payable Accrued liabilities and other Current portion of long-term debt Income taxes payable Total current liabilities Long-term debt Other liabilities Total liabilities Commitments and contingencies Stockholders’ Deficit: Common stock, $0.06775 par value, 350,000 shares authorized; 193,311 shares issued and outstanding at January 28, 2017 and 208,996 shares issued and outstanding at January 30, 2016 Additional paid-in-capital Accumulated deficit Accumulated other comprehensive loss Total stockholders’ deficit Total liabilities and stockholders’ deficit $ 457,704 517,268 $ 385,616 397,497 24,900 31,125 44,640 78,334 1,024,224 912,860 2,723,187 2,744,942 97,580 3,846,066 3,755,382 98,655 12,948 233,129 13,979 592,420 (1,930,279) (2,308,438) (22,056) (14,224) (1,698,426) (1,724,095) $ 2,147,640 $ 2,031,287 See accompanying notes to consolidated financial statements. F-5 Table of Contents THE MICHAELS COMPANIES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization Share-based compensation Debt issuance costs amortization Accretion of long-term debt, net Deferred income taxes Losses on early extinguishments of debt and refinancing costs Losses (gains) on disposition of property and equipment Excess tax benefits from share-based compensation Changes in assets and liabilities, excluding acquired net assets: Merchandise inventories Prepaid expenses and other Accounts receivable Other assets Accounts payable Accrued interest Accrued liabilities and other Income taxes Other liabilities Net cash provided by operating activities Cash flows from investing activities: Additions to property and equipment Acquisition of Lamrite West, net of cash acquired Purchases of long-term investments Net cash used in investing activities Cash flows from financing activities: Common stock repurchased Payment of PIK notes Borrowings on term loan credit facility Payments on term loan credit facility Borrowings on asset-based revolving credit facility Payments on asset-based revolving credit facility Payment of 2018 senior notes Issuance of 2020 senior subordinated notes Issuance of common stock Payment of debt issuance costs Payment of dividends Proceeds from stock options exercised Excess tax benefits from share-based compensation Other financing activities Net cash used in financing activities Net change in cash and equivalents Cash and equivalents at beginning of period Cash and equivalents at end of period 2016 Fiscal Year 2015 2014 $ 378,159 $ 362,912 $ 217,395 115,801 16,506 6,583 (334) 4,570 7,292 120 (10,027) (40,800) (1,004) 8,948 (711) 38,248 7,015 (4,806) 37,276 1,581 564,417 114,756 15,064 8,467 (150) 8,611 8,485 (25) (14,507) (44,213) (4,875) 3,725 (34) 24,217 1,852 (23,530) 44,941 (1,649) 504,047 110,858 19,387 10,333 (516) 15,282 74,312 3,995 (5,081) (60,343) 8,379 2,234 (324) 76,710 (45,647) 14,294 1,006 (277) 441,997 (114,462) (151,100) (1,325) (266,887) (123,920) — (5,000) (128,920) (137,780) — — (137,780) (404,971) — — (18,675) 42,000 (42,000) — — — (11,326) (415) 17,252 10,027 — (408,108) (21,977) (184,467) — (174,900) 45,047 (45,047) — — — — (492) 22,655 14,507 643 (344,031) (21,557) (627,142) 845,750 (20,650) 23,000 (23,000) (1,057,239) 255,000 445,660 (12,363) (530) 27,211 5,081 (4,007) (164,786) (110,578) 409,391 31,096 378,295 $ 298,813 $ 409,391 $ 139,431 238,864 378,295 See accompanying notes to consolidated financial statements. F-6 Table of Contents THE MICHAELS COMPANIES, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ DEFICIT For the Three Years Ended January 28, 2017 (in thousands) Number of Common Common Shares Stock 175,024 $ 11,889 $ — — Accumulated Other Accumulated Comprehensive Income (Loss) Deficit Total Additional Paid-in Capital 94,376 $ (2,888,745) $ — 217,395 198 $ (2,782,282) 217,395 — — — — — — 15,983 3,221 218 26,993 (1,278) (190) (21,367) — — — — (12,003) — (12,003) 15,983 — 27,211 — (21,557) 1,058 27,778 1,882 441,846 — — — 205,803 13,799 557,831 (2,671,350) 362,912 — — — — — — 443,728 — (11,805) (2,111,525) 362,912 — — — — — — 15,502 3,447 233 41,011 — — — (10,251) — (10,251) 15,502 — 41,244 (1,055) 801 208,996 (53) — 13,979 (21,924) — 592,420 — — — — — (2,308,438) 378,159 — — (22,056) — (21,977) — (1,724,095) 378,159 — — — — — 17,379 2,160 147 (17,845) (1,178) (403,802) 27,132 — — — — 7,832 — 7,832 17,379 — — 27,279 (404,980) 193,311 $ 12,948 $ 233,129 $ (1,930,279) $ (14,224) $ (1,698,426) Balance at February 1, 2014 Net income Foreign currency translation and other Share-based compensation Exercise of stock options and other awards Repurchase of stock and retirements Issuance of common stock in IPO Issuance of restricted shares, net Balance at January 31, 2015 Net income Foreign currency translation and other Share-based compensation Exercise of stock options and other awards Repurchase of stock and retirements Issuance of restricted shares, net Balance at January 30, 2016 Net income Foreign currency translation and other Share-based compensation Exercise of stock options and other awards Repurchase of stock and retirements Balance at January 28, 2017 See accompanying notes to consolidated financial statements. F-7 Table of Contents THE MICHAELS COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Description of Business The Michaels Companies, Inc. owns and operates specialty retail stores in 49 states and Canada featuring arts, crafts, framing, floral, home décor and seasonal merchandise for the hobbyist and do-it-yourself home decorator. All expressions of the “Company”, “us”, “we”, “our”, and all similar expressions are references to The Michaels Companies, Inc. and our consolidated, wholly-owned subsidiaries, unless otherwise expressly stated or the context otherwise requires. Our consolidated financial statements include the accounts of The Michaels Companies, Inc. and our wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated. Michaels Stores, Inc. (“MSI”) is headquartered in Irving, Texas and was incorporated in the state of Delaware in 1983. In July 2013, MSI was reorganized into a holding company structure and The Michaels Companies, Inc. incorporated in Delaware in connection with the reorganization. In July 2014, we completed an initial public offering (“IPO”) of 27.8 million shares of common stock at a public offering price of $17.00 per share, resulting in net proceeds of $445.7 million. Fiscal Year We report on the basis of a 52-week or 53-week fiscal year, which ends on the Saturday closest to January 31. All references to fiscal year mean the year in which that fiscal year began. References to “fiscal 2016” relate to the 52 weeks ended January 28, 2017, references to “fiscal 2015” relate to the 52 weeks ended January 30, 2016 and references to “fiscal 2014” relate to the 52 weeks ended January 31, 2015. Preferred Shares The Company’s Board of Directors has authorized the issuance of 50.0 million shares of preferred stock under The Michaels Companies, Inc. Certificate of Incorporation. No preferred shares have been issued as of January 28, 2017. Share Repurchase Program In fiscal 2016, the Board of Directors authorized the Company to purchase $500.0 million of the Company’s common stock on the open market. The share repurchase program does not have an expiration date, and the timing and number of repurchase transactions under the program will depend on market conditions, corporate considerations, debt agreements and regulatory requirements. Shares repurchased under the program are held as treasury shares until retired. During fiscal 2016, we repurchased 17.2 million shares for an aggregate amount of $400.7 million. During the first quarter of fiscal 2017, we repurchased an additional 4.8 million shares of our common stock for an aggregate amount of $99.3 million, utilizing the remaining availability under our share repurchase program. Foreign Currency The functional currency of our Canadian operations is the Canadian dollar. Translation adjustments result from translating our Canadian subsidiaries’ financial statements into U.S. dollars. Balance sheet accounts are translated at exchange rates in effect at the balance sheet date. Income statement accounts are translated at average exchange rates during the year. Translation adjustments are recorded as a component of accumulated other comprehensive income in our consolidated statements of stockholders’ deficit. The translation adjustments recorded in accumulated other comprehensive loss, net of taxes, was a gain of $7.8 million in fiscal 2016 and a loss of $10.3 million and $12.0 million in fiscal 2015 and fiscal 2014, respectively. Transaction gains and losses are recorded as a part of other (income) expense, net in our consolidated statements of comprehensive income and were immaterial in fiscal 2016, fiscal 2015 and fiscal 2014. F-8 Table of Contents Cash and Equivalents Cash and equivalents are comprised of cash, money market mutual funds, and short-term interest bearing securities with original maturities of three months or less. Cash and equivalents also include proceeds due from credit card transactions with settlement terms of less than five days. The carrying amount of cash equivalents approximates fair value due to the short-term maturity of those instruments. Merchandise Inventories Merchandise inventories are valued at the lower of cost or market, with cost determined using a weighted-average method. Cost is calculated based upon the purchase price of an item at the time it is received by us and also includes the cost of warehousing, handling, purchasing, and importing, as well as inbound and outbound transportation, partially offset by vendor allowances. This net inventory cost is recognized through cost of sales when the inventory is sold. It is impractical for us to assign specific allocated overhead costs and vendor allowances to individual units of inventory. As such, to match net inventory costs against the related revenues, we estimate the net inventory costs to be deferred and recognized each period as the inventory is sold. We utilize perpetual inventory records to value inventory in our stores. Physical inventory counts are performed in a significant number of stores during each fiscal quarter by a third-party inventory counting service, with substantially all stores open longer than one year subject to at least one count each fiscal year. We adjust our perpetual records based on the results of the physical counts. We maintain a provision for estimated shrinkage based on the actual historical results of our physical inventories. We compare our estimates to the actual results of the physical inventory counts as they are taken and adjust the shrink estimates accordingly. Vendor allowances, which primarily represent volume rebates and cooperative advertising funds, are recorded as a reduction to the cost of the merchandise inventories and a subsequent reduction in cost of sales when the inventory is sold. We generally earn vendor allowances as a percentage of certain merchandise purchases with no minimum purchase requirements. We recognized vendor allowances of $83.1 million, or 1.6% of net sales, in fiscal 2016, $82.3 million, or 1.7% of net sales, in fiscal 2015, and $91.8 million, or 1.9% of net sales, in fiscal 2014. We routinely identify merchandise that requires some price reduction to accelerate sales of the product. The need for this reduction is generally attributable to clearance of seasonal merchandise or product that is being displaced from its assigned location in the store to make room for new merchandise. Additional stock keeping units (“SKUs”) that are candidates for repricing are identified using our perpetual inventory data. In each case, the appropriate repricing is determined centrally at our store support center. Price changes are transmitted electronically to the store and instructions are provided to our stores regarding product placement, signage and display to ensure the product is effectively cleared. We also evaluate our merchandise to ensure that the expected net realizable value of the merchandise held at the end of a fiscal period exceeds cost. In the event that the expected net realizable value is less than cost, we reduce the value of that inventory accordingly. Accounts Receivable, net Accounts receivable consist primarily of trade receivables related to Darice's wholesale business and amounts due from taxing authorities. The Company assesses the collectability of all receivables on an ongoing basis and establishes an allowance for doubtful accounts, if necessary. Factors such as payment terms, historical loss experience and economic conditions are generally considered in determining the allowance for doubtful accounts. The allowance for doubtful accounts was immaterial in fiscal 2016 and fiscal 2015. Property and Equipment Property and equipment is recorded at cost. Depreciation is recorded on a straight-line basis over the estimated useful lives of the assets. Amortization of property under capital leases is on a straight-line basis over the lease term and is included in depreciation expense. We expense repairs and maintenance costs as incurred. We capitalize and depreciate F-9 Table of Contents significant renewals or betterments that substantially extend the life of the asset. Useful lives are generally estimated as follows: Buildings Leasehold improvements Fixtures and equipment Computer equipment Capitalized software (a) Years 30 10 8 5 5 (a) We amortize leasehold improvements over the lesser of the useful life of the asset or the remaining lease term of the underlying facility. Capitalized Software Costs We capitalize certain costs related to the acquisition and development of internal use software that is expected to benefit future periods. These costs are being amortized on a straight-line basis over the estimated useful life, which is generally five years. As of January 28, 2017 and January 30, 2016, we had unamortized capitalized software costs of $81.8 million and $83.2 million, respectively. These amounts are included in property and equipment, net in the consolidated balance sheets. Amortization expense related to capitalized software costs totaled $29.9 million, $31.2 million and $40.5 million in fiscal 2016, fiscal 2015 and fiscal 2014, respectively. Goodwill and Other Indefinite-Lived Intangible Assets Under the provisions of Accounting Standards Codification (“ASC”) 350, Intangibles—Goodwill and Other, we review goodwill and other indefinite-lived intangible assets for impairment each year in the fourth quarter, or more frequently if events occur which indicate the carrying value may not be recoverable. We elected to perform a qualitative assessment for our Michaels-U.S. reporting unit to determine whether it is more likely than not (that is, a likelihood of more than 50 percent) that the fair value of the goodwill is less than its carrying value. Factors used in our qualitative assessment include, but are not limited to, macroeconomic conditions, industry and market conditions, cost factors, overall financial performance and Company and reporting unit specific events. For all other reporting units, we estimated the fair value of each reporting unit using the present value of future cash flows expected to be generated using a weighted-average cost of capital, terminal values and updated financial projections for the next five years, all of which are Level 3 fair value inputs. Based on the results of our assessments, no impairments were required for the fiscal periods presented in the consolidated financial statements. If our actual results are not consistent with the estimates and assumptions used to calculate fair value, we could be required to recognize an impairment. Long-Lived Assets Long-lived assets other than goodwill and assets with indefinite lives, such as property and equipment and intangible assets subject to amortization, are evaluated for indicators of impairment whenever events or changes in circumstances indicate their carrying amounts may not be recoverable. Our evaluation compares 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 based on the estimated fair value of the assets. Our impairment analysis contains management assumptions about key variables including sales, growth rate, gross margin, payroll and other controllable expenses. If actual results differ from these estimates, we may be exposed to additional impairment losses that may be material. As a result of our impairment review, there were no material impairment charges recorded in the fiscal periods presented in the consolidated financial statements. Reserve for Closed Facilities We maintain a reserve for future rental obligations, carrying costs and other closing costs related to closed facilities, which consists primarily of closed and relocated stores. In accordance with ASC 420, Exit or Disposal Cost Obligations, we recognize exit costs for any store closures at the time the store is closed. Such costs are recorded within the cost of sales and occupancy expense line item in our consolidated statements of comprehensive income. F-10 Table of Contents The cost of closing a store or facility is recorded at the estimated fair value of expected cash flows which we calculate as the lesser of the present value of future rental obligations remaining under the lease (less estimated sublease rental income) or the lease termination fee (if an executed termination agreement exists). The determination of the reserves is dependent on our ability to make reasonable estimates of costs to be incurred post-closure and of rental income to be received from subleases. The following is activity related to closed facilities (in thousands): Fiscal Year 2015 2016 2014 Balance at beginning of fiscal year Additions charged to costs and expenses Payment of rental obligations and other Balance at end of fiscal year Self-Insurance $ 915 $ 3,386 $ 4,598 1,931 (3,143) 915 $ 3,386 1,946 (4,417) 2,877 (1,538) $ 2,254 $ We have insurance coverage for losses in excess of self-insurance limits for medical claims, general liability and workers’ compensation claims. Our liability represents an estimate of the ultimate cost of claims incurred as of the balance sheet dates. The estimated liability is not discounted and is established based upon analysis of historical data and actuarial estimates. While we believe these estimates are reasonable based on the information currently available, if actual trends, including the severity or frequency of claims, medical cost inflation, or fluctuations in premiums differ from our estimates, our results of operations could be impacted. In the event our insurance carriers are unable to pay claims submitted to them, we would record a liability for such estimated payments we expect to incur. Revenue Recognition Revenue from sales of our merchandise is recognized when the customer takes possession of the merchandise. Revenue is presented net of point-of-sale coupons, discounts and sales taxes collected. Sales related to custom framing are recognized when the order is picked up by the customer. We allow for merchandise to be returned under most circumstances up to 180 days after purchase and provide a reserve for estimated returns. We use historical customer return behavior to estimate our reserve requirements. We record a gift card liability on the date we issue the gift card to the customer. We record revenue and reduce the gift card liability as the customer redeems the gift card or when the likelihood of redemption by the customer is remote (“gift card breakage”). We estimate gift card breakage based on customers’ historical redemption rates and patterns. If actual redemption patterns vary from the Company’s estimates or if regulations change, actual gift card breakage may differ from the amounts recorded. Gift card breakage income is recorded in net sales in the consolidated statements of comprehensive income over the estimated redemption period. Costs of Sales and Occupancy Expense The costs of merchandise sales are expensed as the merchandise is sold. Included in our costs of sales are the following: · · · purchase price of merchandise, net of vendor allowances and rebates; costs associated with our international direct sourcing business; inbound freight, inspection costs, duties and import agent commissions; · warehousing, handling, transportation (including internal transfer costs such as distribution center-to-store freight costs), purchasing and receiving costs; and · share-based compensation costs for those employees involved in preparing inventory for sale. F-11 Table of Contents Included in our occupancy expenses are the following costs which are recognized as period costs as described below: · · · · store expenses such as rent, insurance, taxes, common area maintenance, utilities, repairs and maintenance; amortization of store buildings and leasehold improvements; store closure costs; and store remodel costs. Rent is recognized on a straight-line basis, including consideration of rent holiday, tenant improvement allowances received from the landlords and applicable rent escalations over the term of the lease. The commencement date of the lease term is the earlier of the date when we become legally obligated for the rent payments or the date when we take possession of the building for construction purposes. Selling, General and Administrative Included in selling, general and administrative (“SG&A”) are store personnel costs, store operating expenses, advertising, store depreciation and corporate overhead costs. Advertising costs are expensed in the period in which the advertising first occurs. Advertising costs totaled $194.6 million, $188.9 million and $185.0 million in fiscal 2016, fiscal 2015 and fiscal 2014, respectively. Store Pre-Opening Costs We expense all start-up activity costs as incurred. Store pre-opening costs consist primarily of payroll-related costs incurred prior to the store opening. Income Taxes We record income tax expense using the liability method and are subject to income tax in many jurisdictions, including the U.S., numerous states and localities, Canada, and other foreign countries. Income taxes payable or receivable are recorded for tax liabilities or refunds reflected on filed, or expected to be filed, tax returns. Deferred income taxes arise from temporary differences between amounts recorded in the consolidated statements of comprehensive income and tax bases of assets and liabilities measured using enacted tax rates in effect for the years in which the differences are expected to reverse. The effect of a change in tax rates is recognized as income tax expense or benefit in the period of the enactment date. Deferred tax assets, including the benefit of net operating loss and tax credit carryforwards, are evaluated based on the guidelines for realization and are reduced by a valuation allowance if it is deemed more likely than not that such assets will not be realized. We recognize the income tax benefit from an uncertain tax position when it is more likely than not that, based on technical merits, the position will be sustained upon examination, including resolutions of any related appeals or litigation processes. We recognize accrued interest and penalties related to uncertain tax positions as a component of income tax expense. Share-Based Compensation ASC 718, Stock Compensation (“ASC 718”), requires all share-based compensation to employees, including grants of employee stock options and restricted shares, to be recognized using the fair value method of accounting. Share-based awards are recognized ratably over the requisite service period. F-12 Table of Contents Estimates The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires us 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. Reclassification Certain prior year amounts have been reclassified in the accompanying consolidated financial statements to conform to our fiscal 2016 presentation. Accounting Pronouncements Recently Adopted In April 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2015-05, “Intangibles — Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement” (“ASU 2015-05”). ASU 2015-05 provides guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The new guidance does not change the accounting for a customer’s accounting for service contracts. We adopted ASU 2015-05 in the first quarter of fiscal 2016 and its adoption did not have a material impact to the consolidated financial statements. Recent Accounting Pronouncements Not Yet Adopted In January 2017, the FASB issued ASU 2017-04, “Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment” (“ASU 2017-04”). ASU 2017-04 simplifies the measurement of goodwill impairment by removing the second step of the goodwill impairment test, which requires the determination of the fair value of individual assets and liabilities of a reporting unit. Under ASU 2017-04, goodwill impairment is to be measured as the amount by which a reporting unit’s carrying value exceeds its fair value with the loss recognized not to exceed the total amount of goodwill allocated to the reporting unit. ASU 2017-04 is effective for fiscal years beginning after December 15, 2019, with early adoption permitted for interim or annual goodwill impairment tests performed after January 1, 2017. The standard is to be applied on a prospective basis. We do not anticipate a material impact to the consolidated financial statements once implemented. In October 2016, the FASB issued ASU No. 2016-16, “Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other than Inventory” (“ASU 2016-16”). ASU 2016-16 requires entities to recognize income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. ASU 2016-16 is effective for annual periods beginning after December 15, 2017, including interim reporting periods within that reporting period, with early adoption permitted. We are currently evaluating the new standard but do not anticipate a material impact to the consolidated financial statements once implemented. In August 2016, the FASB issued ASU No. 2016-15, “ Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments” (“ASU 2016-15”). ASU 2016-15 clarifies how companies should present and classify certain cash receipts and cash payments in the statement of cash flows. ASU 2016-15 is effective for annual periods beginning after December 15, 2017, including interim reporting periods within that reporting period, with early adoption permitted. We are currently evaluating the new standard but do not anticipate a material impact to the consolidated financial statements once implemented. In March 2016, the FASB issued ASU No. 2016-09, “Compensation – Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting” (“ASU 2016-09”). ASU 2016-09 identifies areas for simplification involving several aspects of accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, an option to recognize gross stock compensation expense with actual forfeitures recognized as they occur, as well as certain classifications on the statement of cash flows. ASU 2016-09 is effective for annual periods beginning after December 15, 2016, including interim periods within that F-13 Table of Contents reporting period, with early adoption permitted. We are currently evaluating the impact that ASU 2016-09 will have on the consolidated financial statements. In March 2016, the FASB issued ASU No. 2016-04, “Liabilities – Extinguishment of Liabilities (Subtopic 405-20): Recognition of Breakage for Certain Prepaid Stored-Value Products” (“ASU 2016-04”). ASU 2016-04 requires that breakage on prepaid stored-value product liabilities (for example, prepaid gift cards) be accounted for consistent with the breakage guidance in Topic 606: Revenue from Contracts with Customers. ASU 2016-04 is effective for annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period, with early adoption permitted. This standard is to be applied either using a modified retrospective approach or retrospectively to each period presented. We have evaluated the new standard and it will not have a material impact to the consolidated financial statements once implemented. In February 2016, the FASB issued ASU No. 2016-02, "Leases (Topic 842)" ("ASU 2016-02"). Under ASU 2016-02, an entity will be required to recognize right-of-use assets and lease liabilities on its balance sheet and disclose key information about leasing arrangements. ASU 2016-02 offers specific accounting guidance for a lessee, a lessor and sale and leaseback transactions. Lessees and lessors are required to disclose qualitative and quantitative information about leasing arrangements to enable a user of the financial statements to assess the amount, timing and uncertainty of cash flows arising from leases. ASU 2016-02 is effective for annual reporting periods beginning after December 15, 2018, including interim periods within that reporting period, with early adoption permitted. At adoption, this update will be applied using a modified retrospective approach. We are currently evaluating the impact that ASU 2016-02 will have on the consolidated financial statements. In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers” (“ASU 2014-09”). ASU 2014-09 supersedes the revenue recognition requirements in “Revenue Recognition (Topic 605)”, and requires entities to recognize revenue in a way that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. In March 2016, the FASB issued ASU No. 2016-08 , “Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net)” (“ASU 2016-08”) which is intended to improve the operability and understandability of the implementation guidance on principal versus agent considerations. In April 2016, the FASB issued ASU No. 2016-10, “Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing” (“ASU 2016-10”) which provides further guidance on identifying performance obligations and improves the operability and understandability of the licensing implementation guidance. In May 2016, the FASB issued ASU No. 2016-12, “Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients” (“ASU 2016-12”) which narrowly amended the revenue recognition guidance regarding collectability, noncash consideration, presentation of sales tax and transition. The guidance under these standards is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. These standards are to be applied using a modified retrospective approach or retrospectively, with early application permitted for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. We are currently evaluating the impact that the new standards will have on the consolidated financial statements. 2. FAIR VALUE MEASUREMENTS As defined in ASC 820, Fair Value Measurements (“ASC 820”), fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC 820 establishes a three-level valuation hierarchy for fair value measurements. These valuation techniques are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect less transparent active market data, as well as internal assumptions. These two types of inputs create the following fair value hierarchy: · · Level 1—Quoted prices for identical instruments in active markets; Level 2—Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose significant inputs are observable; and F-14 Table of Contents · Level 3—Instruments with significant unobservable inputs. Impairment losses related to store-level property and equipment are calculated using significant unobservable inputs including the present value of future cash flows expected to be generated using a risk- adjusted weighted-average cost of capital and comparable store sales growth assumptions, and therefore are classified as a Level 3 measurement in the fair value hierarchy. The carrying value of cash and cash equivalents, accounts receivable and accounts payable approximates their estimated fair values due to the short maturities of these instruments. The table below provides the fair values of our Amended Term Loan Credit Facility and our 2020 Senior Subordinated Notes (as defined in Note 7) as of January 28, 2017 and January 30, 2016. The fair values of our Amended Term Loan Credit Facility and our 2020 Senior Subordinated Notes were determined based on quoted market prices which are considered Level 2 inputs within the fair value hierarchy. Term loan credit facility Senior subordinated notes 3. PROPERTY AND EQUIPMENT, NET Property and equipment consists of the following (in thousands): Buildings and leasehold improvements Fixtures and equipment Capitalized software Construction in progress Less accumulated depreciation and amortization January 28, 2017 January 30, 2016 (in thousands) $2,266,304 $2,251,354 525,300 526,575 January 28, January 30, $ 2017 514,937 $ 764,498 154,422 54,279 1,488,136 (1,074,972) 2016 480,468 907,457 241,915 31,394 1,661,234 (1,282,727) 378,507 $ 413,164 $ During fiscal 2016, we retired approximately $320.0 million of fully depreciated assets that were no longer in service. 4. ACQUISITION On February 2, 2016, we acquired Lamrite for $150.0 million, prior to certain purchase price adjustments, utilizing our cash on hand. Lamrite operates an international wholesale business under the Darice brand name and 35 arts and crafts retail stores (32 as of the acquisition date), located primarily in Ohio and the surrounding states, under the Pat Catan’s brand name. We incurred integration related costs of $7.4 million during fiscal 2016. These expenses have been included in SG&A in the consolidated statements of comprehensive income. The acquisition was accounted for using the purchase method of accounting in accordance with ASC 805, Business Combinations. The acquisition resulted in goodwill primarily related to the expected benefits resulting from enhancements to our private brand development capability, direct sourcing initiatives and business-to-business capabilities, as well as the value of the existing Lamrite workforce. The goodwill recognized is expected to be deductible for tax purposes. The fair values of the intangible assets acquired were primarily determined by using the income approach. The income approach indicates value for a subject based on the present value of cash flows expected to be generated by the asset. Projected cash flows are discounted at a market rate of return that reflects the relative risk of achieving the cash F-15 Table of Contents flows and the time value of money. The fair value of inventory was determined based on the estimated selling price of the inventory less the expected costs of selling efforts and a reasonable profit margin. The following table summarizes the cash consideration for the acquisition of Lamrite (in thousands): Purchase contract amount Additional consideration to Lamrite shareholders for taxes Working capital and other adjustments Total purchase consideration $ 150,000 6,500 (3,090) $ 153,410 The following table summarizes the fair values of the assets acquired and liabilities assumed from the acquisition of Lamrite as of February 2, 2016 (in thousands): Cash and cash equivalents Trade accounts receivable Merchandise inventory Other current assets Property, plant and equipment Net favorable leases Intangible assets Other assets Current liabilities Other long-term liabilities (2) (1) Fair value of net assets acquired Goodwill Total purchase consideration $ 2,310 22,254 83,700 1,202 25,367 2,450 21,800 306 (30,490) (273) 128,626 24,784 $ 153,410 (1) (2) Includes customer relationships, trade and brand names and proprietary product designed. Intangible assets include $9.4 million of assets that are being amortized over a range of 6 to 18 years. Includes accounts payable, accrued expenses, accrued payroll and accrued taxes. Since the date of acquisition, the results of Lamrite's operations have been included in the Company’s results of operations. The Company has not presented pro forma financial information for prior periods because the impact on our previously reported consolidated financial statements would not have been material. F-16 Table of Contents 5. GOODWILL AND INTANGIBLE ASSETS The gross carrying amounts and accumulated amortization of our intangible assets, including amounts acquired in the Lamrite acquisition (see Note 4), for the year ended January 28, 2017 were as follows (in thousands): Definite-lived intangible assets: Customer relationships Proprietary product designs Other intangible assets Indefinite-lived intangible assets: Darice branded products Tradenames Amortization Period (in years) 16-18 7 2-23 Weighted Average Remaining Amortization Period (in years) Gross Carrying Amount Accumulated Amortization Net Carrying Value 16.93 6.00 9.77 $ 5,600 $ 3,400 4,229 13,229 (637) $ 4,963 2,424 (976) 2,590 (1,639) 9,977 (3,252) 6,200 7,525 13,725 6,200 7,525 13,725 Total intangible assets $26,954 $ (3,252) $23,702 In fiscal 2016, we recognized amortization expense of $2.4 million related to definite-lived intangible assets. Amortization expense was immaterial in fiscal 2015 and fiscal 2014. As of January 28, 2017, the amortization expense related to our definite-lived intangible assets for the next five years will be approximately $1.0 million to $2.0 million each year. As of January 28, 2017, goodwill totaled $119.1 million, including $94.3 million related to Michaels-U.S. and $24.8 million related to the acquisition of Lamrite on February 2, 2016. 6. ACCRUED LIABILITIES AND OTHER Accrued liabilities and other consists of the following (in thousands): Accrued payroll Self-insurance Accrued interest Property, sales and use taxes Gift card liability Accrued and straight-line rent Other January 28, 2017 $ $ 68,118 77,317 18,793 89,655 49,869 23,396 70,349 397,497 January 30, 2016 119,124 73,726 11,778 56,594 42,577 19,694 62,123 385,616 $ $ F-17 Table of Contents 7. DEBT Long-term debt consists of the following (in thousands): Term loan credit facility Senior subordinated notes Total debt Less unamortized discount/premium and debt costs Total debt, net Less current portion Long-term debt Interest Rate Variable $ 5.875 % $ January 28, January 30, 2017 2,263,475 510,000 2,773,475 (19,163) 2,754,312 (31,125) 2,723,187 $ $ 2016 2,282,150 510,000 2,792,150 (22,308) 2,769,842 (24,900) 2,744,942 The aggregate amount of scheduled maturities of debt for the next five years and thereafter is as follows (in thousands): Fiscal Year 2017 2018 2019 2020 2021 Thereafter Total debt payments $ 31,125 24,900 24,900 534,900 18,675 2,138,975 $ 2,773,475 As of January 28, 2017 and January 30, 2016, the weighted-average interest rate of the variable debt was 3.75% and 3.83%, respectively. Cash paid for interest totaled $113.3 million, $129.3 million and $234.3 million in fiscal 2016, fiscal 2015 and fiscal 2014, respectively. As of January 28, 2017, net debt issuance costs totaled $25.4 million. We amortize debt issuance costs using the straight-line method over the terms of the respective debt agreements (which range from five to seven years). Amortization expense related to debt issuance costs is recorded in interest expense in the accompanying consolidated statements of comprehensive income. The straight-line method produces results materially consistent with the effective interest method. Our expected amortization expense related to the debt issuance costs for each of the next five years and thereafter is as follows (in thousands): Fiscal Year 2017 2018 2019 2020 2021 Thereafter Total amortization expense Term Loan Credit Facility $ $ 5,098 5,098 5,098 4,965 2,752 2,380 25,391 On January 28, 2013, MSI entered into an amended and restated credit agreement maturing on January 28, 2020 (the “Credit Agreement”) to amend various terms of MSI’s then existing term loan credit agreement with Deutsche Bank AG New York Branch (“Deutsche Bank”) and other lenders. The Credit Agreement, together with the related security, guarantee and other agreements, is referred to as the “Term Loan Credit Facility”. F-18 Table of Contents On July 2, 2014, MSI issued an additional $850.0 million of debt under the Term Loan Credit Facility maturing in 2020 (“Additional Term Loan”). The Additional Term Loan was issued at 99.5% of face value, resulting in an effective interest rate of 4.02%. The net proceeds from this borrowing and the issuance of an additional $250.0 million of the 5.875% senior subordinated notes were used to fully redeem the then outstanding 7.75% Senior Notes due 2018 (“2018 Senior Notes”) and to pay the applicable make-whole premium and accrued interest. On December 28, 2015, MSI voluntarily prepaid $150.0 million in principal of the Additional Term Loan for an aggregate redemption price (including any unpaid interest) of $151.0 million. On September 28, 2016, MSI entered into an amendment with Deutsche Bank and other lenders to amend and restate our Term Loan Credit Facility. The amended and restated credit agreement, together with the related security, guarantee and other agreements, is referred to as the “Amended Term Loan Credit Facility”. The Amended Term Loan Credit Facility matures on January 28, 2023. As of January 28, 2017, the Amended Term Loan Credit Facility provides for senior secured financing of $2,263.5 million. MSI has the right under the Amended Term Loan Credit Facility to request additional term loans (a) in the aggregate amount of up to $750.0 million or (b) at MSI’s election, an amount of additional term loans if the consolidated secured debt ratio (as defined in the Amended Term Loan Credit Facility) is no more than 3.25 to 1.00 on a pro forma basis as of the last day of the most recently ended four quarter period, subject to certain adjustments. The lenders under the Amended Term Loan Credit Facility will not be under any obligation to provide any such additional term loans, and the incurrence of any such additional term loans is subject to customary conditions. Borrowings under the Amended Term Loan Credit Facility bear interest at a rate per annum, at MSI’s option, of either (a) a margin of 1.75% plus a base rate defined as the highest of (1) the prime rate of Deutsche Bank, (2) the federal funds effective rate plus 0.5%, and (3) the one-month London Interbank Offered Rate (“LIBOR”) plus 1% or (b) a margin of 2.75% plus the applicable LIBOR. Subsequent to the first fiscal quarter following the amendment, the applicable margin will be 1.50% for base rate loans and 2.50% for LIBOR loans if our consolidated secured debt ratio is below 1.50:1.00 for the applicable quarter. There are no limitations on dividends and certain other restricted payments so long as (a) no event of default shall have occurred and be continuing and (b) immediately after giving pro forma effect to such restricted payment(s) and the application of proceeds therefrom, the consolidated total leverage ratio is less than or equal to 3.75 to 1.00. MSI must offer to prepay outstanding term loans at 100% of the principal amount, plus any unpaid interest, with the proceeds of certain asset sales or casualty events under certain circumstances. MSI may voluntarily prepay outstanding loans under the Amended Term Loan Credit Facility at any time without premium or penalty other than customary breakage costs with respect to LIBOR loans; provided, that if MSI enters into certain repricing transactions on or before March 28, 2017, the amount of the repricing payment will be subject to a premium equal to 1.0%. MSI is required to make scheduled quarterly payments equal to 0.25% of the original principal amount of the term loans (subject to adjustments relating to the incurrence of additional term loans) for the first six years and three quarters of the Amended Term Loan Credit Facility, with the balance paid on January 28, 2023. All obligations under the Amended Term Loan Credit Facility are unconditionally guaranteed, jointly and severally, by Michaels Funding, Inc. (“Holdings”) and all of MSI’s existing domestic material subsidiaries and are required to be guaranteed by certain of MSI’s future domestic wholly-owned material subsidiaries (“the Subsidiary Guarantors”). All obligations under the Amended Term Loan Credit Facility, and the guarantees of those obligations, are secured, subject to certain exceptions, by substantially all of the assets of Holdings, MSI and the Subsidiary Guarantors, including: · a first-priority pledge of MSI’s capital stock and all of the capital stock held directly by MSI and the Subsidiary Guarantors (which pledge, in the case of any foreign subsidiary, is limited to 65% of the voting stock of such foreign subsidiary and 100% of the non-voting stock of such subsidiary); F-19 Table of Contents · · a first-priority security interest in, and mortgages on, substantially all other tangible and intangible assets of Holdings, MSI and each Subsidiary Guarantor, including substantially all of MSI’s and its subsidiaries’ owned real property and equipment, but excluding, among other things, the collateral described below; and a second-priority security interest in personal property consisting of inventory and related accounts, cash, deposit accounts, all payments received by Holdings, MSI or the Subsidiary Guarantors from credit card clearinghouses and processors or otherwise in respect of all credit card charges and debit card charges for sales of inventory by Holdings, MSI and the Subsidiary Guarantors, and certain related assets and proceeds of the foregoing. The Amended Term Loan Credit Facility contains a number of negative covenants that are substantially similar to, but more restrictive in certain respects than, those governing the 2020 Senior Subordinated Notes (as defined below), as well as certain other customary representations and warranties, affirmative and negative covenants and events of default. As of January 28, 2017, MSI was in compliance with all covenants. As of January 28, 2017, net debt issuance costs totaled $14.3 million and are being amortized as interest expense over the life of the Amended Term Loan Credit Facility. Debt issuance costs related to this facility are reflected as a reduction from the carrying value of debt in the consolidated balance sheets. As a result of the $150.0 million Additional Term Loan prepayment on December 28, 2015, MSI recorded a loss on the early extinguishment of debt of $2.4 million, consisting of $1.9 million of unamortized debt issuance costs and $0.5 million of unamortized net discount. As a result of the amendment of our Term Loan Credit Facility on September 28, 2016, MSI recorded a loss on the early extinguishment of debt of $6.9 million. 5.875% Senior Subordinated Notes due 2020 On December 19, 2013, MSI issued $260.0 million in principal amount of 5.875% senior subordinated notes maturing in 2020 (“2020 Senior Subordinated Notes”). On June 16, 2014, MSI issued an additional $250.0 million of the 2020 Senior Subordinated Notes at 102% of face value, resulting in an effective interest rate of 5.76%. Interest is payable semi-annually on June 15 and December 15 of each year. The net proceeds from this borrowing, and the $850.0 million Additional Term Loan, were used to fully redeem the outstanding 2018 Senior Notes and to pay the applicable make-whole premium and accrued interest. The 2020 Senior Subordinated Notes are guaranteed, jointly and severally, fully and unconditionally, on an unsecured senior subordinated basis, by each of MSI’s subsidiaries that guarantee indebtedness under the Amended Revolving Credit Facility and the Amended Term Loan Credit Facility (collectively defined as the “Senior Secured Credit Facilities”). The 2020 Senior Subordinated Notes and the guarantees are MSI’s and the guarantors’ unsecured senior subordinated obligations and are (i) subordinated in right of payment to all of MSI’s and the guarantors’ existing and future senior debt, including the Senior Secured Credit Facilities; (ii) rank equally in right of payment to all of MSI’s and the guarantors’ future senior subordinated debt; (iii) effectively subordinated to all of MSI’s and the guarantors’ existing and future secured debt (including the Senior Secured Credit Facilities) to the extent of the value of the assets securing such debt; (iv) rank senior in right of payment to all of the MSI’s and the guarantors’ existing and future debt and other obligations that are, by their terms, expressly subordinated in right of payment to the 2020 Senior Subordinated Notes; and (v) are structurally subordinated to all obligations of MSI’s subsidiaries that are not guarantors of the 2020 Senior Subordinated Notes. MSI may redeem all or part of the 2020 Senior Subordinated Notes, upon notice, at the redemption prices set forth below (expressed as percentages of the principal amount of the 2020 Senior Subordinated Notes to be redeemed), F-20 Table of Contents plus any unpaid interest thereon to the applicable date of redemption, if redeemed during the twelve-month period beginning on December 15 of each of the years indicated below: Year 2016 2017 2018 and thereafter Percentage 102.938 % 101.469 % 100.000 % Upon a change in control, MSI is required to offer to purchase all of the 2020 Senior Subordinated Notes at a price in cash equal to 101% of the aggregate principal amount, plus any unpaid interest. The 2020 Senior Subordinated Indenture contains covenants limiting MSI’s ability, and the ability of MSI’s restricted subsidiaries, to incur or guarantee additional debt, prepay debt that is subordinated to the 2020 Senior Subordinated Notes, issue stock of subsidiaries, make certain investments, loans, advances and acquisitions, create liens on MSI’s and such subsidiaries’ assets to secure debt, enter into transactions with affiliates, merge or consolidate with another company; and sell or otherwise transfer assets. The covenants also limit MSI’s ability, and the ability of MSI’s restricted subsidiaries, to pay dividends or distributions on MSI’s capital stock or repurchase MSI’s capital stock, subject to certain exceptions, including dividends, distributions and repurchases up to an amount in excess of (i) $100.0 million plus (ii) a basket that builds based on 50% of MSI’s consolidated net income (as defined in the 2020 Senior Subordinated Indenture) and certain other amounts, in each case, to the extent such payment capacity is not applied as otherwise permitted under the 2020 Senior Subordinated Indenture and subject to certain conditions. However, there are no limitations on dividends and certain other restricted payments so long as (a) no default shall have occurred and be continuing and (b) immediately after giving pro forma effect to such restricted payment(s) and the application of proceeds therefrom, the consolidated total leverage ratio is less than or equal to 3.25 to 1.00. As of January 28, 2017, the permitted restricted payment amount was $658.5 million. As of January 28, 2017, MSI was in compliance with all covenants. As of January 28, 2017, net debt issuance costs totaled $6.3 million and are being amortized as interest expense over the life of the 2020 Senior Subordinated Notes. Debt issuance costs related to these notes are reflected as a reduction from the carrying value of debt in the consolidated balance sheets. Revolving Credit Facility On September 17, 2012, MSI entered into a second amended and restated credit agreement (the “Credit Agreement”) with Wells Fargo Bank, National Association (“Wells Fargo”) and other lenders to amend various terms of MSI’s then existing senior secured asset-based revolving credit facility. The Credit Agreement, together with related security, guarantee and other agreements, is referred to as the “Revolving Credit Facility”. On May 27, 2016, MSI entered into an amended and restated credit agreement with Wells Fargo and other lenders to, among other things, increase the availability and extend the maturity date of our Revolving Credit Facility. The amended credit agreement, together with the related security, guarantee and other agreements, is referred to as the “Amended Revolving Credit Facility”. The Amended Revolving Credit Facility provides for senior secured financing of up to $850.0 million, subject to a borrowing base. The borrowing base under the Amended Revolving Credit Facility equals the sum of: (i) 90% of eligible credit card receivables, (ii) 85% of eligible trade receivables, (iii) 90% to 92.5% of the appraised value of eligible inventory, plus (iv) 90% to 92.5% of the lesser of (a) the appraised value of eligible inventory supported by letters of credit, and (b) the face amount of the letters of credit, less (v) certain reserves. The Amended Revolving Credit Facility matures in May 2021, subject to a springing maturity date if certain of our outstanding indebtedness has not been repaid, redeemed, refinanced, cash collateralized or if the necessary availability reserves have not been established prior to such time (the “ABL Maturity Date”). As of January 28, 2017 and January 30, 2016, the borrowing base was $793.1 million and $650.0 million, respectively, of which MSI had availability of $735.5 million and $586.8 million, respectively. Borrowing capacity is available for letters of credit and borrowings on same-day notice. Outstanding standby letters of credit as of January 28, 2017 totaled $57.6 million. The Amended Revolving Credit Facility also provides MSI with the right to request up to $200.0 million of additional commitments. The lenders will not be under any obligation to provide any such additional commitments, and F-21 Table of Contents any increase in commitments is subject to customary conditions. If we were to request additional commitments, and the lenders were to agree to provide such commitments, the facility size could be increased up to $1,050.0 million, however, MSI’s ability to borrow would still be limited by the borrowing base. Borrowings under the Amended Revolving Credit Facility bear interest at a rate per annum equal to, at our option, either (a) a base rate determined by reference to the highest of (1) the prime rate of Wells Fargo, (2) the federal funds effective rate plus 0.50% and (3) LIBOR subject to certain adjustments plus 1.00% or (b) LIBOR subject to certain adjustments, in each case plus an applicable margin. The initial applicable margin is (a) 0.25% for prime rate borrowings and 1.25% for LIBOR borrowings. The applicable margin is subject to adjustment each fiscal quarter based on the excess availability under the Amended Revolving Credit Facility. Excess availability is defined as the Loan Cap (as defined below) plus certain unrestricted cash of Holdings, MSI and the Subsidiary Guarantors, less the outstanding credit extensions. Same-day borrowings bear interest at the base rate plus the applicable margin. MSI is required to pay a commitment fee on the unutilized commitments under the Amended Revolving Credit Facility, which initially is 0.25% per annum. In addition, MSI must pay customary letter of credit fees and agency fees. All obligations under the Amended Revolving Credit Facility are unconditionally guaranteed, jointly and severally, by Holdings and all of MSI’s existing domestic material subsidiaries and are required to be guaranteed by the Subsidiary Guarantors. All obligations under the Amended Revolving Credit Facility, and the guarantees of those obligations, are secured, subject to certain exceptions, by substantially all of the assets of Holdings, MSI and the Subsidiary Guarantors, including: · · · a first-priority security interest in personal property consisting of inventory and related accounts, cash, deposit accounts, all payments received by Holdings, MSI or the Subsidiary Guarantors from credit card clearinghouses and processors or otherwise in respect of all credit card charges and debit card charges for sales of inventory by Holdings, MSI and the Subsidiary Guarantors, and certain related assets and proceeds of the foregoing; a second-priority pledge of all of MSI’s capital stock and the capital stock held directly by MSI and the Subsidiary Guarantors (which pledge, in the case of the capital stock of any foreign subsidiary, is limited to 65% of the voting stock of such foreign subsidiary and 100% of the non- voting stock of such subsidiary); and a second-priority security interest in, and mortgages on, substantially all other tangible and intangible assets of Holdings, MSI and each Subsidiary Guarantor, including substantially all of MSI’s and its subsidiaries’ owned real property and equipment. If, at any time, the aggregate amount of outstanding loans, unreimbursed letter of credit drawings and undrawn letters of credit under the Amended Revolving Credit Facility exceeds the lesser of (i) the commitment amount and (ii) the borrowing base (the “Loan Cap”), MSI will be required to repay outstanding loans and cash collateralize letters of credit in an aggregate amount equal to such excess, with no reduction of the commitment amount. If availability under the Amended Revolving Credit Facility is less than the greater of (i) 10.0% of the Loan Cap and (ii) $50.0 million for five consecutive business days, or, if certain events of default have occurred, MSI will be required to repay outstanding loans and cash collateralize letters of credit with the cash MSI is required to deposit daily in a collection account maintained with the agent under the Amended Revolving Credit Facility. Availability under the Amended Revolving Credit Facility means the Loan Cap minus the outstanding credit extensions. MSI may voluntarily reduce the unutilized portion of the commitment amount and repay outstanding loans at any time without premium or penalty, other than customary breakage costs with respect to LIBOR loans. There is no scheduled amortization under the Amended Revolving Credit Facility. The principal amount of the loans outstanding is due and payable in full on the ABL Maturity Date. The covenants limiting dividends and other restricted payments, investments, loans, advances and acquisitions, and prepayments or redemptions of indebtedness, each permit the restricted actions in an unlimited amount, subject to the satisfaction of certain payment conditions, principally that MSI must meet specified excess availability requirements and minimum consolidated fixed charge coverage ratios, to be tested on a pro forma basis as of the date of the restricted action F-22 Table of Contents and for the 90-day period preceding such restricted action. Adjusted EBITDA, as defined in the Amended Revolving Credit Facility, is used in the calculation of the consolidated fixed charge coverage ratios. From the time when MSI has excess availability less than the greater of (a) 10.0% of the Loan Cap and (b) $50.0 million, until the time when MSI has excess availability greater than the greater of (a) 10.0% of the Loan Cap and (b) $50.0 million for 30 consecutive days, the Amended Revolving Credit Facility will require MSI to maintain a consolidated fixed charge coverage ratio of at least 1.0 to 1.0. The Amended Revolving Credit Facility also contains certain customary representations and warranties, affirmative covenants and provisions relating to events of default (including change of control and cross-default to material indebtedness). The Amended Revolving Credit Facility contains a number of covenants that, among other things and subject to certain exceptions, restrict MSI’s ability, and the ability of its restricted subsidiaries, to: · · incur or guarantee additional indebtedness; pay dividends on MSI’s capital stock or redeem, repurchase or retire MSI’s capital stock; · make investments, loans, advances and acquisitions; · · · · · · create restrictions on the payment of dividends or other amounts to MSI from its restricted subsidiaries; engage in transactions with MSI’s affiliates; sell assets, including capital stock of MSI’s subsidiaries; prepay or redeem indebtedness; consolidate or merge; and create liens. As of January 28, 2017, net debt issuance costs totaled $4.8 million and are being amortized as interest expense over the life of the Amended Revolving Credit Facility. As a result of the refinancing of our Restated Revolving Credit Facility on May 27, 2016, MSI recorded a loss on the early extinguishment of debt of $0.4 million related to the write-off of net debt issuance costs. Debt issuance costs related to this facility are reflected as an asset within the consolidated balance sheets. PIK Toggle Notes On July 29, 2013, Michaels FinCo Holdings, LLC (“FinCo Holdings”) and Michaels FinCo, Inc. (“FinCo Inc.”) issued $800.0 million aggregate principal amount of 7.50%/8.25% PIK Toggle Notes due 2018 (“PIK Notes”) in a private transaction. On July 2, 2014, the Company completed an IPO and received net proceeds totaling $445.7 million. The net proceeds were used to redeem $439.1 million of the outstanding PIK Notes and to pay other expenses of the offering. The aggregate redemption price (including redemption premium and any unpaid interest) was $473.5 million. On December 10, 2014, the Company redeemed $180.0 million of the PIK Notes for an aggregate redemption price (including redemption premium and any unpaid interest) of $188.4 million. On May 6, 2015, the Company redeemed the remaining $180.9 million of the PIK Notes for an aggregate redemption price (including redemption premium and any unpaid interest) of $188.0 million. This final payment retired the PIK Notes and discharged the obligations under the indenture governing the PIK Notes. In fiscal 2014, we recorded a loss on the early extinguishment of debt of $18.4 million related to the redemption of the PIK Notes. The $18.4 million loss consisted of an $8.0 million redemption premium and a $10.4 million charge to write off debt issuance costs. In fiscal 2015, we recorded a loss on the early extinguishment of debt of $6.1 million related F-23 Table of Contents to the redemption of the PIK Notes. The $6.1 million loss consisted of a $3.6 million redemption premium and a $2.5 million charge to write off debt issuance costs. 7.75% Senior Notes due 2018 On October 21, 2010, MSI issued $800.0 million aggregate principal amount of 7.75% senior notes that matured on November 1, 2018 (“Senior Notes”) at a discounted price of 99.262% of face value, resulting in an effective interest rate of 7.875%. On September 27, 2012, MSI issued an additional $200.0 million aggregate principal amount of Senior Notes (the “Additional Senior Notes” and, together with the Senior Notes, the “2018 Senior Notes”) under the indenture (the “2018 Senior Indenture”). The Additional Senior Notes were issued at a premium of 106.25% of face value, resulting in an effective interest rate of 6.50%. On July 16, 2014 and August 1, 2014, we redeemed the 2018 Senior Notes in the aggregate principal amounts of $235.0 million and $765.0 million, respectively, plus the applicable make-whole premium and accrued interest, and the 2018 Senior Indenture was discharged. In fiscal 2014, we recorded a loss on the early extinguishment of debt of $55.9 million related to the redemption of the 2018 Senior Notes. The $55.9 million loss consisted of $50.8 million of redemption premiums and a $10.2 million charge to write off debt issuance costs. This loss was partially offset by a $5.1 million write-off of unamortized net premiums. 8. LEASES We operate stores and use 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 January 28, 2017 are as follows (in thousands): Fiscal Year 2017 2018 2019 2020 2021 Thereafter Total minimum rental commitments $ 422,885 378,368 319,957 259,801 205,994 462,982 $ 2,049,987 Rent expense applicable to non-cancelable operating leases was $416.2 million, $388.1 million and $376.8 million in fiscal 2016, fiscal 2015 and fiscal 2014, respectively. F-24 Table of Contents 9. INCOME TAXES The reconciliation of income tax expense computed at the U.S. federal statutory tax rate of 35% to income tax expense reported in our consolidated statements of comprehensive income is as follows (in thousands): Income taxes at statutory rate State income taxes, net of federal benefit Foreign tax rate differential Other Total Fiscal Year 2015 $ 203,621 35.0 % $ 200,242 35.0 % $ 122,862 35.0 % 2014 2016 10,665 1.8 (8,820) (1.5) (1,852) (0.3) 19,131 (2,583) (7,582) 3.3 (0.4) (1.3) 11,364 3.2 — — (587) (0.1) $ 203,614 35.0 % $ 209,208 36.6 % $ 133,639 38.1 % The components of our income tax expense are as follows (in thousands): Current: Federal State Foreign Total current income tax expense Deferred: Federal State Foreign Total deferred income tax expense 2016 Fiscal Year 2015 2014 $ 171,934 $ 164,384 $ 90,025 19,147 27,167 10,418 9,746 119,590 201,297 15,970 8,487 196,391 4,055 1,139 2,029 7,223 6,300 2,762 (1,151) 7,911 18,665 (1,786) (2,830) 14,049 Income taxes $ 203,614 $ 209,208 $ 133,639 The pretax income from foreign operations for fiscal 2016, fiscal 2015 and fiscal 2014 totaled $48.2 million, $33.2 million and $38.0 million, respectively. F-25 Table of Contents Significant components of deferred income tax assets and liabilities are as follows (in thousands): Deferred income tax assets: Accrued liabilities State income taxes Vacation accrual Share-based compensation Deferred rent Gift cards Self-insurance Original issue discount State and foreign net operating losses Other Total gross deferred income tax assets Valuation allowance Total deferred income tax assets, net of valuation allowance Deferred income tax liabilities: Merchandise inventories Property and equipment Cancellation of debt Total deferred income tax liabilities January 28, 2017 January 30, 2016 $ $ 16,403 4,077 2,408 9,765 18,714 8,985 24,602 8,845 4,615 2,294 100,708 (3,689) 97,019 (8,152) (37,895) (15,143) (61,190) 13,748 8,156 6,360 9,387 17,880 7,093 17,992 24,672 5,463 8,731 119,482 (3,050) 116,432 (9,350) (42,495) (24,188) (76,033) Net deferred income tax assets $ 35,829 $ 40,399 A valuation allowance is recorded to reduce the carrying amounts of deferred tax assets unless it is more likely than not that such assets will be realized. In evaluating our ability to realize our deferred tax assets we considered sources of future taxable income, including future reversals of existing taxable temporary differences, forecast of future profitability, taxable income in prior carryback years and tax-planning strategies. At January 28, 2017, we had state net operating loss carryforwards to reduce future taxable income of $4.6 million, net of federal tax benefits, expiring at various dates between fiscal 2017 and fiscal 2036. Cash paid for income taxes totaled $162.4 million, $154.9 million and $112.4 million in fiscal 2016, fiscal 2015 and fiscal 2014, respectively. A provision for income taxes has not been recognized for U.S. taxes on undistributed earnings of our foreign subsidiaries for fiscal 2016 and fiscal 2015 as these earnings were, and are expected to continue to be, permanently reinvested. The aggregate undistributed earnings of our foreign subsidiaries for which no deferred tax liability has been recognized was $99.7 million as of the end of fiscal 2016. If these earnings are remitted to the U.S. at a future date, additional tax liabilities will be incurred. The unrecognized deferred tax liabilities on the unremitted earnings was approximately $19.9 million at January 28, 2017. Unrecognized Tax Benefits We operate in a number of tax jurisdictions and are subject to examination of our income tax returns by tax authorities in those jurisdictions who may challenge any item on these tax returns. Because the tax matters challenged by tax authorities are typically complex, the ultimate outcome of these challenges is uncertain. In accordance with ASC 740, Income Taxes, we recognize these tax benefits in our consolidated financial statements only after determining that it is more likely than not that the tax benefits will be sustained. F-26 Table of Contents A reconciliation of gross unrecognized tax benefits from the end of fiscal 2015 through the end of fiscal 2016 is as follows (in thousands): Balance at beginning of year Additions based on tax positions related to the current year Additions for tax positions related to prior years Balance at end of year $ $ 19,136 4,561 11,192 34,889 Included in the balance of unrecognized tax benefits at January 28, 2017 is $12.3 million which, if recognized, would affect income tax expense. We do not expect any material changes to our liability for uncertain tax positions during the next 12 months. At January 28, 2017 and January 30, 2016, the total amount of interest and penalties accrued within the tax liability was $2.1 million and $4.6 million, respectively. There was no material interest and penalties recognized in the consolidated statements of comprehensive income in fiscal 2016, fiscal 2015 and fiscal 2014. Our income tax returns are subject to examination by taxing authorities in the jurisdictions in which we operate. The periods subject to examination for our federal return are fiscal 2013 to fiscal 2015 and fiscal 2009 to fiscal 2015 for our Canadian returns. State income tax returns are generally subject to examination for a period of three to five years after filing. We have various state income tax returns in the process of examination, appeals or settlements. Our income tax returns for fiscal 2011 and fiscal 2012 are currently under examination by the Canadian tax authorities. Our federal return for fiscal 2014 is currently under examination by the Internal Revenue Service. We are not aware of any issues which would result in a material assessment of tax obligations. 10. SHARE-BASED COMPENSATION The Michaels Companies, Inc. Amended and Restated 2014 Omnibus Long-Term Incentive Plan (“2014 Omnibus Plan”) provides for the grant of share-based awards for up to 21.3 million shares of common stock. As of January 28, 2017, there were 5.4 million shares of common stock remaining available for grant. Generally, awards vest ratably over four or five years and expire eight to ten years from the grant date. As of January 28, 2017, unrecognized compensation cost for all unvested share-based awards totaled $56.2 million and is expected to be recognized over a weighted-average period of 2.9 years. Share-based compensation expense totaled $16.5 million in fiscal 2016, $15.1 million in fiscal 2015 and $19.4 million in fiscal 2014 and is recorded in cost of sales and occupancy expense and SG&A in the consolidated statements of comprehensive income. Stock Options The fair value of each stock option is estimated using the Black-Scholes option pricing model. The following table presents the weighted-average assumptions used during fiscal years 2016, 2015 and 2014: (1) Risk-free interest rates Expected dividend yield Expected volatility Expected life of options in years (2) (3) 2016 Fiscal Year 2015 2014 1.1 % 0.0 % 29.8 % 4.1 1.2 % 0.0 % 29.7 % 4.0 1.3 % 0.0 % 27.6 % 4.0 (1) Based on interest rates for U.S. Treasury instruments with terms consistent with the expected lives of the awards. (2) We considered our historical volatility as well as the historical and implied volatilities for exchange-traded options of a peer group of companies. (3) Expected lives were based on an analysis of historical exercise and post-vesting employment termination. F-27 Table of Contents The stock option activity during the fiscal year ended January 28, 2017 was as follows: Number of Shares (in thousands) Weighted- Average Exercise Price Weighted- Average Remaining Contractual Term (in years) Aggregate Intrinsic Value (in thousands) Outstanding at beginning of year Granted Exercised Expired/Forfeited Outstanding at end of year 7,972 $ 1,746 (1,730) (326) 7,662 14.84 24.50 9.97 19.50 17.94 6.5 $ 27,431 Shares exercisable at end of year 3,306 $ 14.11 4.6 $ 19,772 The total grant date fair value of options that vested during fiscal 2016, fiscal 2015 and fiscal 2014 was $7.4 million, $7.3 million and $14.5 million, respectively. The intrinsic value for options that vested during fiscal 2016, fiscal 2015 and fiscal 2014 was $13.1 million, $18.1 million and $33.0 million, respectively. The intrinsic value for options exercised was $30.8 million in fiscal 2016, $65.6 million in fiscal 2015 and $42.1 million in fiscal 2014. As of the beginning of fiscal 2016, there were 4.3 million nonvested options with a weighted-average fair value of $4.97 per share. As of the end of fiscal 2016, there were 4.4 million nonvested options with a weighted-average fair value of $5.50 per share. The weighted-average fair value of options granted during fiscal 2016, fiscal 2015 and fiscal 2014 was $6.27, $6.01 and $3.77, respectively. During fiscal 2016, there were 1.5 million options that vested and 0.3 million options that were cancelled with a weighted-average fair value of $5.04 and $5.36 per share, respectively. Restricted Shares The Company issues restricted shares to certain key employees and its Board of Directors. Generally, restricted shares awarded to employees vest ratably over four or five years. Restricted shares awarded to Board of Director members vest ratably over one year. Compensation expense is recorded for all restricted stock awards and restricted stock units based on the amortization of the fair market value at the date of grant over the vesting period. Restricted stock award activity during the fiscal year ended January 28, 2017 was as follows: Outstanding at beginning of year Granted Vested Forfeited Outstanding at end of year F-28 Number of Shares (in thousands) Weighted- Average Fair Value 20.88 27.65 25.11 21.22 21.58 1,429 $ 133 (456) (142) 964 $ Table of Contents Restricted stock unit activity during the fiscal year ended January 28, 2017 was as follows: Outstanding at beginning of year Granted Vested Forfeited Outstanding at end of year 11. EARNINGS PER SHARE Number of Shares (in thousands) Weighted- Average Fair Value 23.12 23.93 24.86 23.80 23.91 38 $ 801 (9) (28) 802 $ The Company’s unvested restricted stock awards contain non-forfeitable rights to dividends and meet the criteria of a participating security as defined by ASC 260, “Earnings Per Share”. In applying the two-class method, net income is allocated to both common and participating securities based on their respective weighted-average shares outstanding for the period. Basic earnings per share is computed by dividing net income allocated to common shareholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share is computed by dividing income available to common shareholders by the weighted-average common shares outstanding plus the potential dilutive impact from the exercise of stock options and restricted stock units. Common equivalent shares are excluded from the computation if their effect is anti-dilutive. There were 2.3 million, 0.8 million and 0.3 million anti-dilutive shares in fiscal 2016, fiscal 2015 and fiscal 2014, respectively. The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share data): 2016 Fiscal Year 2015 2014 Basic earnings per common share: Net income Less income related to unvested restricted shares Income available to common shareholders - Basic $378,159 $362,912 $217,395 (835) $375,836 $361,012 $216,560 (2,323) (1,900) Weighted-average common shares outstanding - Basic 204,735 206,845 203,229 Basic earnings per common share $ 1.84 $ 1.75 $ 1.07 Diluted earnings per common share: Net income Less income related to unvested restricted shares Income available to common shareholders - Diluted $378,159 $362,912 $217,395 (819) $375,854 $361,035 $216,576 (1,877) (2,305) Weighted-average common shares outstanding - Basic Effect of dilutive stock options and restricted stock units Weighted-average common shares outstanding - Diluted 204,735 1,619 206,354 206,845 2,501 209,346 203,229 3,872 207,101 Diluted earnings per common share $ 1.82 $ 1.72 $ 1.05 12. SEGMENTS AND GEOGRAPHIC INFORMATION We consider Michaels-U.S., Michaels-Canada, Aaron Brothers, Pat Catan’s and Darice to be our operating segments for purposes of determining reportable segments based on the criteria of ASC 280, Segment Reporting (“ASC 280”). We determined that Michaels-U.S., Michaels-Canada, Aaron Brothers and Pat Catan’s have similar economic characteristics and meet the aggregation criteria set forth in ASC 280. Therefore, we combine these operating segments F-29 Table of Contents into one reporting segment. Darice does not meet the materiality criteria in ASC 280 and, therefore, is not disclosed as a reportable segment. Our net sales and total assets by country are as follows (in thousands): 2016 Fiscal Year 2015 2014 Net Sales: United States Canada Total Total Assets: United States Canada Total $ 4,736,578 $ 4,473,454 $ 4,276,794 461,350 $ 4,738,144 439,328 $ 5,197,292 $ 4,912,782 460,714 $ 1,969,889 $ 1,895,580 135,707 $ 2,147,640 $ 2,031,287 177,751 $ 1,825,562 135,546 $ 1,961,108 We present assets based on their physical, geographic location. Certain assets located in the U.S. are also used to support our Canadian operations but are not allocated to Canada. Our net sales by major product categories are as follows (in thousands): General crafts Home décor and seasonal Framing Papercrafting Total 2016 Fiscal Year 2015 $ 2,630,398 $ 2,487,288 1,003,436 927,588 494,470 $ 5,197,292 $ 4,912,782 1,088,989 903,143 574,762 2014 $ 2,409,136 971,176 902,934 454,898 $ 4,738,144 Our chief operating decision makers evaluate historical operating performance and forecast future periods’ operating performance based on operating income and earnings before interest, income taxes, depreciation, amortization and losses on early extinguishments of debt and refinancing costs (“EBITDA (excluding losses on early extinguishments of debt and refinancing costs)”). We believe these metrics more closely reflect the operating effectiveness of factors over which management has control. A reconciliation of EBITDA (excluding losses on early extinguishments of debt and refinancing costs) to net income is presented below (in thousands): Net income Interest expense Losses on early extinguishments of debt and refinancing costs Income taxes Depreciation and amortization Interest income EBITDA (excluding losses on early extinguishments of debt and refinancing costs) 13. CONTINGENCIES Rea Claim Fiscal Year 2015 2016 378,159 $ 362,912 139,405 126,270 $ 2014 $ 217,395 198,409 7,292 203,614 115,801 (820) 8,485 209,208 114,756 (615) 74,312 133,639 110,858 (363) $ 830,316 $ 834,151 $ 734,250 On September 15, 2011, MSI was served with a lawsuit filed in the California Superior Court in and for the County of Orange (“Superior Court”) by four former store managers as a class action proceeding on behalf of themselves and certain former and current store managers employed by MSI in California. The lawsuit alleged that MSI improperly F-30 Table of Contents classified its store managers as exempt employees and as such failed to pay all wages, overtime and waiting time penalties and failed to provide accurate wage statements. The lawsuit also alleged that the foregoing conduct was in breach of various laws, including California’s unfair competition law. On December 3, 2013, the Superior Court entered an order certifying a class of approximately 200 members. MSI successfully removed the case to the U.S. District Court for the Central District of California and on May 8, 2014, the class was decertified. Three of the four named plaintiffs’ claims were resolved in September 2014, but the individual claims of 26 former class members remain pending in the Central District of California. In addition, a separate representative action brought on behalf of store managers throughout the state is pending in the California Superior Court, County of San Diego. We believe we have meritorious defenses and intend to defend the lawsuits vigorously. We do not believe the resolution of the lawsuits will have a material effect on our consolidated financial statements. Fair Credit Reporting Claim On December 11, 2014, MSI was served with a lawsuit, Christina Graham v. Michaels Stores, Inc., filed in the U.S. District Court for the District of New Jersey by a former employee. The lawsuit is a purported class action, bringing plaintiff’s individual claims, as well as claims on behalf of a putative class of applicants who applied for employment with Michaels through an online application, and on whom a background check for employment was procured. The lawsuit alleges that MSI violated the Fair Credit Reporting Act (“FCRA”) and the New Jersey Fair Credit Reporting Act by failing to provide the proper disclosure and obtain the proper authorization to conduct background checks. Since the initial filing, another named plaintiff joined the lawsuit, which was amended in February 2015, Christina Graham and Gary Anderson v. Michaels Stores, Inc., with substantially similar allegations. The plaintiffs seek statutory and punitive damages as well as attorneys’ fees and costs. Following the filing of the Graham case in New Jersey, five additional purported class action lawsuits with six plaintiffs were filed, Michele Castro and Janice Bercut v. Michaels Stores, Inc., in the U.S. District Court for the Northern District of Texas, Michelle Bercut v. Michaels Stores, Inc., in the Superior Court of California for Sonoma County, Raini Burnside v. Michaels Stores, Inc., in the U.S. District Court for the Western District of Missouri, Sue Gettings v. Michaels Stores, Inc., in the U.S. District Court for the Southern District of New York, and Barbara Horton v. Michaels Stores, Inc., in the U.S. District Court for the Central District of California. All of the plaintiffs alleged violations of the FCRA. In addition, the Castro, Horton and Janice Bercut lawsuits also alleged violations of California’s unfair competition law. The Burnside, Horton and Gettings lawsuits, as well as the claims by Michele Castro, have been dismissed. The Graham, Janice Bercut and Michelle Bercut lawsuits were transferred for centralized pretrial proceedings to the District of New Jersey. On January 25, 2017, the Company’s motion to dismiss was partially granted. On February 23, 2017, the plaintiffs filed a notice of appeal, appealing a portion of the ruling. The Company intends to defend the remaining lawsuits vigorously. We cannot reasonably estimate the potential loss, or range of loss, related to the lawsuits, if any. Data Security Incident Five putative class actions were filed against MSI relating to the January 2014 data breach. The plaintiffs generally alleged that MSI failed to secure and safeguard customers’ private information including credit and debit card information, and as such, breached an implied contract and violated the Illinois Consumer Fraud Act (and other states’ similar laws). The plaintiffs are seeking damages including declaratory relief, actual damages, punitive damages, statutory damages, attorneys’ fees, litigation costs, remedial action, pre and post judgment interest, and other relief as available. The cases are as follows: Christina Moyer v. Michaels Stores, Inc., was filed on January 27, 2014; Michael and Jessica Gouwens v. Michaels Stores, Inc., was filed on January 29, 2014; Nancy Maize and Jessica Gordon v. Michaels Stores, Inc., was filed on February 21, 2014; and Daniel Ripes v. Michaels Stores, Inc., was filed on March 14, 2014. These four cases were filed in the U.S. District Court for the Northern District of Illinois, Eastern Division. On March 18, 2014, an additional putative class action was filed in the U.S. District Court for the Eastern District of New York, Mary Jane Whalen v. Michaels Stores, Inc., but was voluntarily dismissed by the plaintiff on April 11, 2014 without prejudice to her right to re‑file a complaint. On April 16, 2014, an order was entered consolidating the Illinois actions. On July 14, 2014, the Company’s motion to dismiss the consolidated complaint was granted. On December 2, 2014, Whalen filed a new lawsuit against MSI related to the data breach in the U.S. District Court for the Eastern District of New York, Mary Jane Whalen v. Michaels Stores, Inc., seeking damages including F-31 Table of Contents declaratory relief, monetary damages, statutory damages, punitive damages, attorneys’ fees and costs, injunctive relief, pre and post judgment interest, and other relief as available. The Company filed a motion to dismiss which was granted on December 28, 2015, and judgment was entered in favor of the Company on January 8, 2016. Plaintiff filed a notice of appeal on January 27, 2016, appealing the judgment to the U.S. Court of Appeals for the Second Circuit. The Company intends to defend this lawsuit vigorously. We cannot reasonably estimate the potential loss, or range of loss, related to the lawsuit, if any. Consumer Product Safety Commission Claim On April 21, 2015, the U.S. Department of Justice, on behalf of the Consumer Product Safety Commission (the “CPSC”), filed a complaint against MSI and Michaels Stores Procurement Company, Inc. (“MSPC”) in the U.S. District Court for the Northern District of Texas. The complaint seeks civil penalties for an alleged failure to timely report a potential product safety hazard to the CPSC related to the breakage of certain glass vases. The complaint also alleges the report contained a material misrepresentation and seeks injunctive relief requiring MSI and MSPC to, among other things, establish internal recordkeeping and compliance monitoring systems. We believe we have meritorious defenses and intend to defend the lawsuit vigorously. We do not believe the resolution of the lawsuit will have a material effect on our consolidated financial statements. General In addition to the litigation discussed above, we are now, and may be in the future, involved in various other lawsuits, claims and proceedings incident to the ordinary course of business. The results of litigation are inherently unpredictable. Any claims against us, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of management time and result in diversion of significant resources. For some of the matters disclosed above, as well as other lawsuits involving the Company, we are able to estimate a range of losses in excess of the amounts recorded, if any, in the accompanying consolidated financial statements. As of January 28, 2017, the aggregate estimated loss was approximately $13 million, which includes amounts recorded by the Company. 14. RETIREMENT PLANS We sponsor a 401(k) Savings Plan for our eligible employees and certain of our subsidiaries. Participation in the 401(k) Savings Plan is voluntary and available to any employee who is at least 21 years of age and has completed three months of full-time service or one year of part-time service. Participants may elect to contribute up to 80% 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) Savings Plan, we make a matching cash contribution to the account of each participant in an amount equal to 50% of the participant’s pre-tax contributions that do not exceed 6% of the participant’s compensation for the year. Matching contributions vest to the participants based on years of service, with 100% vesting after three years. Our matching contribution expense was $4.4 million, $4.8 million, and $4.1 million in fiscal 2016, fiscal 2015 and fiscal 2014, respectively. During fiscal 2016, the Company established a nonqualified deferred compensation plan for certain executives and other highly compensated employees. The deferred compensation plan provides participants with the opportunity to defer up to 75% of their base salary and up to 100% of their annual earned bonus. Participants are 100% vested in these deferrals and the associated investment returns. The Company does not currently make any matching cash contributions to the participant accounts. There were no significant assets or liabilities related to the deferred compensation plan in the consolidated balance sheet as of January 28, 2017. 15. RELATED PARTY TRANSACTIONS Affiliates of, or funds advised by, Bain Capital Partners, LLC (“Bain Capital”) and The Blackstone Group L.P. (“The Blackstone Group”, together with Bain Capital and their applicable affiliates, the “Sponsors”) owned approximately 38% of our outstanding common stock as of January 28, 2017. Prior to our IPO on July 2, 2014, the Sponsors and another F-32 Table of Contents common stockholder, Highfields Capital Management LP (“Highfields”), received annual management fees of $12.0 million and $1.0 million, respectively. In connection with the IPO, the management agreement was terminated and the Company paid the Sponsors and Highfields an aggregate $30.2 million termination fee. During fiscal 2014, we recognized expense of $35.7 million related to management fees and reimbursement of out-of-pocket expenses. The Blackstone Group owns a majority equity position in RGIS, a vendor we utilize to count our store inventory. Payments associated with this vendor totaled $6.0 million, $5.9 million and $5.8 million during fiscal 2016, fiscal 2015 and fiscal 2014, respectively, and are included in SG&A in the consolidated statements of comprehensive income. The Blackstone Group owns an equity position in Vistar, a vendor we utilize for all of the candy-type items in our stores. Payments associated with this vendor during fiscal 2016, fiscal 2015 and fiscal 2014 were $26.8 million, $28.6 million and $25.6 million, respectively, and are recognized in cost of sales and occupancy expense in the consolidated statements of comprehensive income as the sales are incurred. The Blackstone Group owns a majority equity position in Excel Trust, Inc., Blackstone Real Estate DDR Retail Holdings III, LLC and Blackstone Real Estate RC Retail Holdings, LLC, vendors we utilize to lease certain properties. Payments associated with these vendors during fiscal 2016, fiscal 2015 and fiscal 2014 were $5.2 million, $3.5 million and $1.7 million, respectively. These expenses are included in cost of sales and occupancy expense in the consolidated statements of comprehensive income. Certain affiliates of The Blackstone Group have significant influence over US Xpress Enterprises, Inc., a vendor we utilize for transportation services. Payments associated with this vendor during fiscal 2016 and fiscal 2015 were $1.1 million. Payments associated with this vendor during fiscal 2014 were $0.4 million. These expenses are recognized in cost of sales and occupancy expense in the consolidated statements of comprehensive income as the sales are incurred. Four of our current directors, Joshua Bekenstein, Nadim El Gabbani, Lewis S. Klessel and Peter F. Wallace, are affiliates of Bain Capital or The Blackstone Group. As such, some or all of such directors may have an indirect material interest in payments with respect to debt securities of the Company that have been purchased by affiliates of Bain Capital and The Blackstone Group. As of January 28, 2017, affiliates of The Blackstone Group held $83.6 million of our Amended Term Loan Credit Facility. 16. CONDENSED CONSOLIDATED FINANCIAL INFORMATION Our debt covenants restrict MSI, and certain subsidiaries of MSI, from various activities including the incurrence of additional debt, payment of dividends and the repurchase of MSI’s capital stock (subject to certain exceptions), among other things. The following condensed consolidated financial information represents the financial information of MSI and its wholly-owned subsidiaries subject to these restrictions. The information is presented in accordance with the requirements of Rule 12-04 under the SEC’s Regulation S-X. F-33 Table of Contents Michaels Stores, Inc. Condensed Consolidated Balance Sheets (in thousands) ASSETS Current assets: Cash and equivalents Merchandise inventories Prepaid expenses and other current assets Total current assets Property and equipment, net Goodwill Other assets Total assets LIABILITIES AND STOCKHOLDERS’ DEFICIT Current liabilities: Accounts payable Accrued liabilities and other Current portion of long-term debt Other current liabilities Total current liabilities Long-term debt Other liabilities Total stockholders’ deficit Total liabilities and stockholders’ deficit January 28, January 30, 2017 2016 $ 116,072 294,054 $ 404,650 1,127,777 1,002,607 95,583 1,537,903 1,502,840 378,507 94,290 56,004 $ 2,143,342 $ 2,031,641 413,164 119,074 73,201 $ 457,704 517,268 $ 384,002 395,745 24,900 31,125 89,996 123,258 956,602 1,067,396 2,723,187 2,744,942 95,400 (1,751,213) (1,765,303) $ 2,143,342 $ 2,031,641 103,972 Michaels Stores, Inc. Condensed Consolidated Statements of Comprehensive Income (in thousands) Net sales Cost of sales and occupancy expense Gross profit Selling, general and administrative Other operating expense Operating income Interest and other expense Income before income taxes Income taxes Net income 2014 2016 Fiscal Year 2015 $5,197,292 $4,912,782 $4,738,144 2,836,965 2,944,431 1,901,179 1,968,351 1,230,639 1,241,876 40,749 4,786 629,791 721,689 213,697 138,662 416,094 583,027 156,976 217,428 $ 379,701 $ 365,599 $ 259,118 3,169,476 2,027,816 1,305,855 4,484 717,477 133,529 583,948 204,247 Other comprehensive income, net of tax: Foreign currency translation adjustment and other Comprehensive income 7,832 (10,251) (12,003) $ 387,533 $ 355,348 $ 247,115 F-34 Table of Contents Michaels Stores, Inc. Condensed Consolidated Statements of Cash Flows (in thousands) Cash flows from operating activities: Net cash provided by operating activities Cash flows from investing activities: Additions to property and equipment Acquisition of Lamrite West, net of cash acquired Purchases of long-term investments Net cash used in investing activities Cash flows from financing activities: Net repayments of debt Net borrowings of debt Payment of dividend to Michaels Funding, Inc. Other financing activities Net cash used in financing activities Net change in cash and equivalents Cash and equivalents at beginning of period Cash and equivalents at end of period Fiscal Year 2016 2015 2014 $ 577,088 $ 507,806 $ 521,109 (114,462) (151,100) (1,325) (266,887) (123,920) — (5,000) (128,920) (137,780) — — (137,780) (60,675) 42,000 (400,823) (1,299) (420,797) (219,947) 45,047 (188,046) 15,151 (347,795) (1,100,889) 1,123,750 (255,552) (11,239) (243,930) (110,596) 404,650 31,091 373,559 139,399 234,160 $ 294,054 $ 404,650 $ 373,559 17. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) Unaudited quarterly results of operations for fiscal 2016 and fiscal 2015 were as follows (in thousands, except per share data): Fiscal 2016 (1) First Quarter Second Quarter Third Quarter Fourth Quarter Net sales Cost of sales and occupancy expense Gross profit Selling, general and administrative Operating income Losses on early extinguishments of debt and refinancing costs Net income Diluted earnings per common share $ 1,158,880 $ 1,060,353 $ 1,227,206 $ 1,750,854 1,045,093 705,761 368,960 336,556 669,656 390,697 302,712 87,077 694,129 464,751 317,800 145,325 760,598 466,608 318,580 146,324 — 70,765 405 35,617 6,887 76,459 — 195,318 0.95 0.37 $ $ 0.34 $ 0.17 $ F-35 Table of Contents Net sales Cost of sales and occupancy expense Gross profit Selling, general and administrative Operating income Losses on early extinguishments of debt and refinancing costs Net income Diluted earnings per common share Fiscal 2015 First Quarter Second Quarter Third Quarter Fourth Quarter $ 1,077,600 $ 984,270 $ 1,168,423 $ 1,682,489 994,854 687,635 362,987 324,188 610,949 373,321 275,699 96,582 702,825 465,598 308,704 155,852 635,803 441,797 295,571 143,982 — 66,738 6,072 35,711 — 76,797 $ 0.32 $ 0.17 $ 0.37 $ 2,413 183,666 0.87 (1) Fiscal 2016 results of operations includes the impact of the acquisition of Lamrite on February 2, 2016, including non-recurring purchase accounting adjustments and integration costs of $11.4 million. Lamrite’s net sales totaled $232.3 million in fiscal 2016. We report on the basis of a 52-week or 53-week fiscal year, which ends on the Saturday closest to January 31. Our interim periods each contain 13 weeks ending on the Saturday closest to April 30, July 31 and October 31. F-36 Table of Contents SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Date: March 7, 2017 THE MICHAELS COMPANIES, INC. By: /s/ Denise A. Paulonis Denise A. Paulonis Executive Vice President & Chief Financial Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. /s/ Carl S. Rubin Carl S. Rubin Chief Executive Officer and Director (Principal Executive Officer) March 7, 2017 /s/ Denise A. Paulonis Denise A. Paulonis /s/ James E. Sullivan James E. Sullivan /s/ Joshua Bekenstein Joshua Bekenstein /s/ Monte E. Ford Monte E. Ford /s/ Nadim El Gabbani Nadim El Gabbani /s/ Karen Kaplan Karen Kaplan /s/ Lewis S. Klessel Lewis S. Klessel /s/Matthew S. Levin Matthew S. Levin /s/ John J. Mahoney John J. Mahoney /s/James A. Quella James A. Quella /s/ Beryl B. Raff Beryl B. Raff /s/ Peter F. Wallace Peter F. Wallace Executive Vice President and Chief Financial Officer March 7, 2017 (Principal Financial Officer) Chief Accounting Officer and Controller March 7, 2017 (Principal Accounting Officer) Director Director Director Director Director Director Director Director Director Director March 7, 2017 March 7, 2017 March 7, 2017 March 7, 2017 March 7, 2017 March 7, 2017 March 7, 2017 March 7, 2017 March 7, 2017 March 7, 2017 Table of Contents Exhibit Number 2.1 3.1 3.2 4.1 4.2 4.3 4.4 4.5 4.6 4.7 4.8 10.1* 10.2* 10.3* EXHIBIT INDEX Description of Exhibit Agreement and Plan of Merger, dated as of July 22, 2013, by and among Michaels Stores, Inc., The Michaels Companies, Inc., Michaels FinCo Holdings, LLC, Michaels Funding, Inc., and Michaels Stores MergerCo, Inc. (previously filed as Exhibit 2.1 to Form 10-Q filed by Michaels Stores, Inc. on August 30, 2013, SEC File No. 001-09338). Second Amended and Restated Certificate of Incorporation of The Michaels Companies, Inc. (previously filed as Exhibit 3.2 to Form S-1 filed by the Company on June 9, 2014, SEC File No. 333-193000). Amended and Restated Bylaws of The Michaels Companies, Inc. (previously filed as Exhibit 3.4 to Form S-1 filed by the Company on June 2, 2014, SEC File No. 333-193000). Form of Specimen Common Stock Certificate of The Michaels Companies, Inc. (previously filed as Exhibit 4.1 to Form S-1 filed by the Company on June 16, 2014, SEC File No. 333- 193000). Form of Amended and Restated Registration Rights Agreement (previously filed as Exhibit 4.2 to Form S-1 filed by the Company on June 2, 2014, SEC File No. 333-193000). Form of Investor Agreement (previously filed as Exhibit 4.3 to Form S-1 filed by the Company on June 2, 2014, SEC File No. 333-193000). Indenture, dated as of December 19, 2013, by and among Michaels Stores, Inc., the guarantors named therein and Wells Fargo Bank, National Association, as trustee (previously filed as Exhibit 4.1 to Form 8-K filed by Michaels Stores, Inc. on December 19, 2013, SEC File No. 001-09338). Supplemental Indenture, dated as of June 16, 2014, by and among Michaels Stores, Inc., the guarantors named therein and Wells Fargo Bank, National Association, as trustee (previously filed as Exhibit 4.11 to Form S-1 filed by the Company on June 16, 2014, SEC File No. 333- 193000). Indenture, dated as of July 29, 2013, among Michaels FinCo Holdings, LLC, Michaels FinCo, Inc. and Law Debenture Trust Company of New York, as trustee (previously filed as Exhibit 4.12 to Form S-1 filed by the Company on June 16, 2014, SEC File No. 333-193000). Registration Rights Agreement, dated as of October 31, 2006, among Michaels Stores, Inc. and certain stockholders thereof (previously filed as Exhibit 4.7 to Form 10-Q filed by Michaels Stores, Inc. on December 7, 2006, SEC File No. 001-09338). Registration Rights Agreement, dated as of September 27, 2012, by and among Michaels Stores, Inc., the guarantors named therein and the Initial Purchasers named therein (previously filed as Exhibit 4.2 to Form 8-K filed by Michaels Stores, Inc. on October 2, 2012, SEC File No. 001-09338). Michaels Stores, Inc. 2006 Equity Incentive Plan (previously filed as Exhibit 10.1 to Form 8-K filed by Michaels Stores, Inc. on February 21, 2007, SEC File No. 001-09338). Form of Stock Option Agreement under the Michaels Stores, Inc. 2006 Equity Incentive Plan (previously filed as Exhibit 10.2 to Form 8-K filed by Michaels Stores, Inc. on February 21, 2007, SEC File No. 001-09338). Amended Form of Stock Option Agreement under the Michaels Stores, Inc. 2006 Equity Incentive Plan (previously filed as Exhibit 10.1 to Form 10-Q filed by Michaels Stores, Inc. on September 4, 2009, SEC File No. 001-09338). Table of Contents Exhibit Number 10.4* 10.5* 10.6* 10.7* 10.8* 10.9* 10.10* 10.11* 10.12* 10.13* 10.14* 10.15* 10.16* 10.17* Description of Exhibit Form of Restricted Stock Award Agreement under the Michaels Stores, Inc. 2006 Equity Incentive Plan (previously filed as Exhibit 10.3 to Form 10-Q filed by Michaels Stores, Inc. on June 6, 2008, SEC File No. 001-09338). The Michaels Companies, Inc. Equity Incentive Plan (previously filed as Exhibit 10.1 to Form 10-Q filed by Michaels Stores, Inc. on August 30, 2013, SEC File No. 001-09338). Form of Stock Option Agreement under The Michaels Companies, Inc. Equity Incentive Plan (previously filed as Exhibit 10.2 to Form 10-Q filed by Michaels Stores, Inc. on August 30, 2013, SEC File No. 001-09338). Form of Restricted Stock Award Agreement under The Michaels Companies, Inc. Equity Incentive Plan (previously filed as Exhibit 10.3 to Form 10-Q filed by Michaels Stores, Inc. on August 30, 2013, SEC File No. 001-09338). Form of Restricted Stock Award Agreement for Independent Directors under The Michaels Companies, Inc. Equity Incentive Plan (previously filed as Exhibit 10.1 to Form 10-Q filed by Michaels Stores, Inc. on December 10, 2013, SEC File No. 001-09338). Amended and Restated 2014 Omnibus Long-Term Incentive Plan (previously filed as Exhibit 10.1 to Form S-1 filed by the Company on June 16, 2014, SEC File No. 333-193000). Form of Stock Option Agreement under the Amended and Restated 2014 Omnibus Long-Term Incentive Plan (previously filed as Exhibit 10.2 to Form S-1 filed by the Company on June 2, 2014, SEC File No. 333-193000). Form of Stock Option Agreement under the Amended and Restated 2014 Omnibus Long-Term Incentive Plan (previously filed as Exhibit 10.11 to Form 10-K filed by the Company on March 17, 2016, SEC File No. 001-36501). Form of Restricted Stock Award Agreement under the Amended and Restated 2014 Omnibus Long-Term Incentive Plan (previously filed as Exhibit 10.3 to Form S-1 filed by the Company on June 2, 2014, SEC File No. 333-193000). Form of Restricted Stock Award Agreement for Independent Directors under the Amended and Restated 2014 Omnibus Long-Term Incentive Plan (previously filed as Exhibit 10.4 to Form S- 1 filed by the Company on June 2, 2014, SEC File No. 333-193000). Form of Restricted Stock Unit Agreement under the Amended and Restated 2014 Omnibus Long-Term Incentive Plan (previously filed as Exhibit 10.1 to Form 10-Q filed by the Company on August 29, 2014, SEC File No. 001-36501). Form of Restricted Stock Unit Agreement for Independent Directors under the Amended and Restated 2014 Omnibus Long-Term Incentive Plan (previously filed as Exhibit 10.1 to Form 10-Q filed by the Company on December 7, 2016, SEC File No. 001-36501). The Michaels Companies, Inc. Annual Incentive Plan (previously filed as Exhibit 10.14 to Form S-1 filed by the Company on June 2, 2014, SEC File No. 333-193000). Employment Agreement, dated February 13, 2013, between Michaels Stores, Inc. and Carl S. Rubin (previously filed as Exhibit 10.1 to Form 10-Q filed by Michaels Stores, Inc. on May 24, 2013, SEC File No. 001-09338). Table of Contents Exhibit Number 10.18* 10.19* 10.20* 10.21* 10.22 10.23 10.24 10.25 10.26 10.27 Description of Exhibit Restricted Stock Award Agreements, dated March 18, 2013, between Michaels Stores, Inc. and Carl S. Rubin (previously filed as Exhibit 10.2 to Form 10-Q filed by Michaels Stores, Inc. on May 24, 2013, SEC File No. 001-09338). Stock Option Agreement, dated March 18, 2013, between Michaels Stores, Inc. and Carl S. Rubin (previously filed as Exhibit 10.1 to Form 10-Q filed by Michaels Stores, Inc. on May 24, 2013, SEC File No. 001-09338). Letter Agreement, dated September 15, 2010, between Michaels Stores, Inc. and Charles M. Sonsteby (previously filed as Exhibit 99.2 to Form 8-K filed by Michaels Stores, Inc. on September 17, 2010, SEC File No. 001-09338). Michaels Stores, Inc. Amended and Restated Officer Severance Pay Plan (previously filed as Exhibit 10.26 to Form S-1 filed by the Company on January 12, 2015, SEC File No. 333- 201444). Form of Director and Officer Indemnification Agreement (previously filed as Exhibit 10.29 to Form S-1 filed by the Company on June 9, 2014 SEC File No. 333-193000). Second Amended and Restated Credit Agreement, dated as of September 17, 2012, among Michaels Stores, Inc., the other borrowers from time to time party thereto, the facility guarantors from time to time party thereto, the lenders from time to time party thereto, Wells Fargo Bank, National Association, as administrative agent and collateral agent, and the other agents named therein (previously filed as Exhibit 10.1 to Form 8-K filed by Michaels Stores, Inc. on September 18, 2012, SEC File No. 001-09338). Exhibits and Schedules to Second Amended and Restated Credit Agreement, dated as of September 17, 2012, among Michaels Stores, Inc., the other borrowers from time to time party thereto, the facility guarantors from time to time party thereto, the lenders from time to time party thereto, Wells Fargo Bank, National Association, as administrative agent and collateral agent, and the other agents named therein (previously filed as Exhibit 10.21 to Form 10-K filed by Michaels Stores, Inc. on March 15, 2013, SEC File No. 001-09338). First Amendment to Second Amended and Restated Credit Agreement, dated June 6, 2014, to the Second Amended and Restated Credit Agreement, dated September 17, 2012, among Michaels Stores, Inc., the other borrowers named therein, the facility guarantors named therein, the lenders named therein, Wells Fargo Bank, National Association, as administrative agent, collateral agent, lender, swingline lender and issuing bank (previously filed as Exhibit 10.2 to Form 8-K filed by Michaels Stores, Inc. on June 11, 2014, SEC File No. 001-09338). Third Amended and Restated Credit Agreement, dated as of May 27, 2016, by and among Michaels Stores, Inc., the other borrowers party thereto, the facility guarantors party thereto, Wells Fargo Bank, National Association, as administrative agent, collateral agent, issuing bank and swingline lender, the other lenders party thereto and the other agents named therein (previously filed as Exhibit 10.1 to Form 8-K filed by the Company on May 27, 2016, SEC File No. 001-36501). Amended and Restated Credit Agreement, dated as of January 28, 2013, among Michaels Stores, Inc., Deutsche Bank AG New York Branch, as administrative agent, and Barclays Bank, PLC, Credit Suisse Securities (USA), LLC, Goldman Sachs Bank USA, J.P. Morgan Securities, LLC, Merrill Lynch, Pierce, Fenner & Smith Incorporated, Morgan Stanley Senior Funding, Inc. and Wells Fargo Securities, LLC, as co-documentation agents, and Deutsche Bank Securities Inc., Barclays Bank PLC, Credit Suisse Securities (USA), LLC, Goldman Sachs Bank USA, J.P. Morgan Securities, LLC, Merrill Lynch, Pierce, Fenner & Smith Incorporated, Morgan Stanley Senior Funding, Inc. and Wells Fargo Securities, LLC, as co-lead arrangers and joint bookrunners (previously filed as Exhibit 10.1 to Form 8-K filed by Michaels Stores, Inc. on February 1, 2013, SEC File No. 001-09338). Table of Contents Exhibit Number 10.28 10.29 10.30 Description of Exhibit Exhibits and Schedules to Amended and Restated Credit Agreement, dated as of January 28, 2013, among Michaels Stores, Inc., Deutsche Bank AG New York Branch, as administrative agent, and Barclays Bank PLC, Credit Suisse Securities (USA), LLC, Goldman Sachs Bank USA, J.P. Morgan Securities, LLC, Merrill Lynch, Pierce, Fenner & Smith Incorporated, Morgan Stanley Senior Funding, Inc. and Wells Fargo Securities, LLC, as co-documentation agents, and Deutsche Bank Securities Inc., Barclays Bank PLC, Credit Suisse Securities (USA), LLC, Goldman Sachs Bank USA, J.P. Morgan Securities, LLC, Merrill Lynch, Pierce, Fenner & Smith Incorporated, Morgan Stanley Senior Funding, Inc. and Wells Fargo Securities, LLC, as co-lead arrangers and joint bookrunners (previously filed as Exhibit 10.29 to Form 10- K filed by Michaels Stores, Inc. on March 15, 2013, SEC File No. 001-09338). First Amendment to Amended and Restated Credit Agreement, dated June 10, 2014, to the Amended and Restated Credit Agreement, dated January 28, 2013, among Michaels Stores, Inc., Deutsche Bank AG New York Branch, as administrative agent, and the guarantors named therein (previously filed as Exhibit 10.3 to Form 8-K filed by Michaels Stores, Inc. on June 11, 2014, SEC File No. 001-09338). Second Amendment to Amended and Restated Credit Agreement, dated as of September 28, 2016, among Michaels Stores, Inc., Michaels Funding, Inc., various subsidiary of Michaels Stores, Inc., Deutsche Bank AG New York Branch, as administrative agent and collateral agent, the 2016 Converting Replacement Term B-1 Loan Lenders (as defined therein), the 2016 New Replacement Term B-1 Loan Lenders (as defined therein), the 2016 Converting Replacement Term B-2 Loan Lenders (as defined therein), the 2016 New Replacement Term B-2 Loan Lenders (as defined therein), certain lenders constituting the New Required Lenders (as defined therein) and the other agents named therein (previously filed as Exhibit 10.1 to Form 8-K filed by the Company on September 30, 2016, SEC File No. 001-36501). 10.31* Michaels Stores, Inc. Employees 401(k) Plan, effective March 1, 2009 (previously filed as Exhibit 10.30 to Form 10-K filed by Michaels Stores, Inc., on April 2, 2009, SEC File No. 001- 09338). 21.1 23.1 31.1 31.2 32.1 Subsidiaries of the Company (filed herewith). Consent of Ernst & Young LLP (filed herewith). Certifications of Carl S. Rubin pursuant to §302 of the Sarbanes-Oxley Act of 2002 (filed herewith). Certifications of Denise A. Paulonis pursuant to §302 of the Sarbanes-Oxley Act of 2002 (filed herewith). Certification pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002 (filed herewith). 101.INS XBRL Instance Document 101.SCH XBRL Taxonomy Extension Schema 101.CAL XBRL Taxonomy Extension Calculation Linkbase 101.DEF XBRL Taxonomy Extension Definition Linkbase 101.LAB XBRL Taxonomy Extension Label Linkbase 101.PRE XBRL Taxonomy Extension Presentation Linkbase * Management contract or compensatory plan or arrangement. Exhibit 21.1 Subsidiaries of The Michaels Companies, Inc. Aaron Brothers, Inc., a Delaware corporation Aaron Brothers Card Services, LLC, a Virginia limited liability company ADMACO, Inc., a Delaware corporation Artistree, Inc., a Delaware corporation Artistree of Canada, ULC, a Nova Scotia unlimited liability company Darice Global Sourcing, S.à r.l., a “société à responsabilité limitée” organised under the laws of the Grand-Duchy of Luxembourg Darice Holdings Company Ltd., a Hong Kong company Darice Holdings I S.à r.l., a “société à responsabilité limitée” organised under the laws of the Grand- Duchy of Luxembourg Darice Holdings II S.à r.l., a “société à responsabilité limitée” organised under the laws of the Grand- Duchy of Luxembourg Darice Imports, Inc., an Ohio corporation Darice, Inc., an Ohio corporation Darice International Sourcing Group, a Chinese business trust Darice International Sourcing Holdings, S.à r.l., a “société à responsabilité limitée” organised under the laws of the Grand-Duchy of Luxembourg Darice (Ningbo) Business Consulting Co. Ltd., a Chinese company Lamrite West, Inc., an Ohio corporation Michaels Finance Company, Inc., a Delaware corporation Michaels FinCo Holdings, LLC, a Delaware limited liability company Michaels FinCo, Inc., a Delaware corporation Michaels Funding, Inc., a Delaware corporation Michaels of Canada Holdings LP No. 1, an Alberta limited partnership Michaels of Canada Holdings LP No. 2, an Alberta limited partnership Michaels of Canada, ULC, a Nova Scotia unlimited liability company Michaels of Luxembourg S.à r.l., a “société à responsabilité limitée” organised under the laws of the Grand-Duchy of Luxembourg Michaels Stores Card Services, LLC, a Virginia limited liability company Michaels Stores, Inc., a Delaware corporation Michaels Stores Procurement Company, Inc., a Delaware corporation Michaels U.S. Holdings 1, LLC, a Delaware limited liability company Michaels U.S. Holdings 2, LLC, a Delaware limited liability company Tiny Crafts, LLC, an Ohio limited liability company Exhibit 23.1 Consent of Independent Registered Public Accounting Firm We consent to the incorporation by reference in the following Registration Statements: 1) Registration Statement (Form S-3 No. 333-205583) of The Michaels Companies, Inc. and the related Prospectus and 2) Registration Statement (Form S-8 No. 333-197218) pertaining to the Amended and Restated 2014 Omnibus Long-Term Incentive Plan of The Michaels Companies, Inc.; of our reports dated March 7, 2017, with respect to the consolidated financial statements of The Michaels Companies, Inc., and the effectiveness of internal control over financial reporting of The Michaels Companies, Inc. included in this Annual Report (Form 10-K) for the year ended January 28, 2017. /s/ Ernst & Young LLP Dallas, TX March 7, 2017 Exhibit 31.1 I, Carl S. Rubin, certify that: CERTIFICATIONS 1. I have reviewed this annual report on Form 10-K of The Michaels Companies, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and 5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. Date: March 7, 2017 /s/ Carl S. Rubin Carl S. Rubin Chairman and Chief Executive Officer (Principal Executive Officer) Exhibit 31.2 I, Denise A. Paulonis, certify that CERTIFICATIONS 1. I have reviewed this annual report on Form 10-K of The Michaels Companies, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and 5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. Date: March 7, 2017 /s/ Denise A. Paulonis Denise A. Paulonis Executive Vice President and Chief Financial Officer (Principal Financial Officer) CERTIFICATION PURSUANT TO 18 U.S.C. § 1350, AS ADOPTED PURSUANT TO § 906 OF THE SARBANES-OXLEY ACT OF 2002 Exhibit 32.1 In connection with the filing of the Annual Report on Form 10-K of The Michaels Companies, Inc., a Delaware corporation (the “Company”), for the year ended January 28, 2017, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), each of the undersigned officers of the Company certifies, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that, to such officer’s knowledge: 1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. 6 Date: March 7, 2017 /s/ Carl S. Rubin Carl S. Rubin Chairman and Chief Executive Officer (Principal Executive Officer) /s/ Denise A. Paulonis Denise A. Paulonis Executive Vice President and Chief Financial Officer (Principal Financial Officer) The foregoing certification is being furnished solely pursuant to 18 U.S.C. § 1350 and is not being filed as part of the Report or as a separate disclosure document. 

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