Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)

Executives

Tom Lido - Director, Treasury Operations

Brian Cornell - Chief Executive Officer

Todd Vogensen - Vice-President of Finance

Lisa Klinger - Senior Vice-President Finance and Treasure

Analysts

Karen Aldrich

Grant Jordan - Bowles Hollowell

Emily Shanks - BoA

Jeff Stines

Colleen Burns - CIBC

Karru Martinson - Deutsche Bank

Roland Bridge

Mike Schrekat

Michaels Stores, Inc. (MIK-OLD) F4Q07 Earnings Call March 18, 2008 5:00 PM ET

Operator

Ladies and gentlemen, my name is Vanessa and I will be your conference operator today. At this time, I would like to welcome everyone to Michaels Stores Fourth Quarter and Fiscal 2007 Earnings Conference Call. All lines have been place on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer period. (Operator Instructions). Thank you.

It is now my pleasure to turn the floor over to your host, Mr. Tom Lido. Sir, you may begin your conference.

Tom Lido

Thank you, Vanessa. Good afternoon everyone and welcome to our fourth quarter and fiscal 2007 earnings conference call. I am Tom Lido, Director, Treasury Operations for Michaels Stores and I’m here with Brian Cornell, Chief Executive Officer and Todd Vogensen, Vice-President of Finance, our speakers for today’s call. Also joining us on the call today is Lisa Klinger, Senior Vice-President Finance and Treasure and Richard Jablonski, Vice President Controller.

Earlier today, we released our fourth quarter and fiscal 2007 financial results. We are pleased to be here to discuss our performance with you. In just a moment, I will turn the call over to Brian, who will provide you with a brief overview of our fourth quarter performance. I will then give you a financial review of the fourth quarter and fiscal year results. Brian will then complete the call with a discussion on the progress we’ve made on our strategic and operational initiatives after which we will open up the call and take the questions.

For those of you who have not already seen a copy of this morning’s press release, it is available on our website under Corporate Information section. This call is also being webcast from our corporate website. For those who could not listen to the entire live broadcast, a replay will be available for 30 days and maybe access at www.michaels.com, or by phone at 800-642-1687, pin number 943-0836.

I need to remind you that comments made today may include forward-looking statements, which are subject to the Safe Harbor statement found in our SEC filings. These statements reflect our expectations about future events and therefore are subject to risks and uncertainties because actual events could differ from our current expectations; you are urged to view our forward-looking statements with caution. I would also like to point out the company has presented adjusted EBITDA to provide investors with additional information to evaluate our operating performance and our ability to service our debt. As adjusted EBITDA is not a measure of operating performance or liquidity calculated in accordance with US Generally Accepted Accounting Principles, this measure should not be considered in isolation of or to substitute for net income as an indicator of operating performance or net cash provided by operating activities as an indicator of liquidity.

It should be noted that our computation of adjusted EBITDA may differ from similar type of measures used by other companies. Adjusted EBITDA excludes certain financial information compared with net income and net cash provided by operating activities. Most directly comparable GAAP financial measures and uses of this financial information should consider the tactile events and transactions which are excluded.

Now I will turn the call over to Brian.

Brian Cornell

Thank you, Tom and thank you all for joining us this afternoon. Before I discuss our fourth quarter performance I would like to note that the company also announced this morning that Jeff Boyer will be leaving the company as of April 4th. Jeff advised us of his resignation plans over the weekend and we regret his decision to leave to pursue other interests. While we will miss the Jeff’s contribution I have great confidence in the finance and accounting organizations, and the continuing leadership that will be provided in those areas by Lisa Klinger our SVP of Finance and Treasury. Todd Vogensen, our VP of Merchandising and Marketing Finance, and Richard Jablonski, our Vice President of Finance and Corporate Controller. As reflected in the news release, we will probably commence a search for a new CFO looking at both internal and external candidates.

Now, I would like take just a few minutes to share four key points regarding our fourth quarter performance. First, while we certainly made excellent progress on a number of our key strategic initiatives and made solid stride in managing cost. We were disappointed with the overall business performance for the quarter. From a sales perspective total sales decreased 4.4% or $60 million. However, please keep in mind that the extra week of fiscal 2006 did contribute $59 million to total net sales.

Our same store sales were down 70 basis points through the year and down 3.4% for the fourth quarter. Wile we were not alone, we were not pleased with our performance. 2007 was challenging year due to a number of economic factors and specific business challenges. Many retailers have reported reduced traffic and transaction trends during the recent holiday season.

We experienced a Q4 transaction decrease of about 5%, as consumer reduced spending on many discretionary holiday items. As you know consumer shop later and purchase less during this holiday season. So after some certain categories, such as fashion yard have lingered. Additionally, the performance of our holiday and seasonal lines showed significant softness in the fourth quarter.

My second point is one of the discretionary spending on higher ticket seasonal chronic suffered many of our core business categories remained solid. A number of our largest categories such as framing, wall décor, kids craft, and fine arts, all realized positive comp sale performance. And we are excited to see bay work continue its strong upper trend.

Third, we demonstrated solid financial management by continuing our aggressive cost control efforts. In many areas of the company at both the corporate and store level, we also effectively managed our inventory levels and ended the year with average inventory levels for store at $830,000 or 4.5 % below last year’s level. So, we taste the tough quarter, we were still able to improve our financial condition. Generating significant free cash flow and hay downed almost $100 million of debt.

My first and perhaps most important point is that our transformation towards becoming a demand base in customer driven retailer continues, as we made significant progress on many of our key strategic initiatives. I will be revealing this in greater detail later in the call along with our outlook for fiscal 2008.

But now I will turn it over to Todd, who will share with you our financial performance for the fourth quarter and our results for the past year. Todd.

Todd Vogensen

Thank you, Brian. Starting with sales, as Brian mentioned we are facing significant challenges during the fourth quarter with a 4.4% decrease in total sales for the quarter to $100,301,000. However, as Brian noted last year’s fourth quarter included an additional week of sales totaling $59 million. In addition same store sales for the period decreased 3.4% over the same period last year with declining sales and our Christmas décor and home accents department accounting for significant portion of our same store sales decrease.

Continued Canadian dollar appreciation has added approximate 1.0% to the company’s same store sales for the fourth quarter. Total gross margin including occupancy cost decreased $49 million to $520 million for the fourth quarter fiscal 2007. In part due to the absence this year of the extra week of sales reported in fiscal 2006. As a percentage of sales our total gross margin rate was 40.0% in the fourth quarter of fiscal 2007 versus 41.8% in fiscal 2006, and 38.8% in fiscal 2005.

Gross margin rate for the fourth quarter was driven by do leveraging and occupancy cost and the contraction in our merchandize margin rate. Our merchandize margin rate contracted 130 basis points from our record 2006 level as a higher portion of our seasonal product was sold on clearance and markdown, which is partially offset by the benefits from our global sourcing efforts.

For the fourth quarter sound, general and administrative expense was $292 million a decrease of $13 million over the fourth quarter of fiscal 2007. As a percentage of sales, our SG&A expense was flat when compared to the same period last year at 22.4%. Followed SG&A cost control effort and lower incentive cost we offset by additional consulting and advertising costs, which supported the strategic initiatives that Brian mentioned earlier.

Fourth quarter operating income increased to $158 million to $200 million as a percent of sale, operating income increase from 3.1% in the fourth quarter of 2006, to 15.4% in the fourth quarter of 2007. The growth and operating income was primarily due to the absence of transaction related expenses from 2006.

For the quarter net interest and another expenses totaled approximately $93 million. The effective tax rate for the fourth quarter was 46.2% and the income tax cost was $48 million. As a result we reported net income of $53 million dollars for the quarter, which compares to our net loss of $67 million in 2006. As Tom mentioned in his introductory comments the company presents adjusted EBITDA to provide investors with additional information to evaluate our operating performance and our ability to service our debt. Adjusted EBITDA for the quarter was $266 million a decreases $34 million dollars from $300 million in the fourth quarter of 2006.

The decline in fourth quarter adjusted EBITDA is due to the absence of the extra week in the fourth quarter of this year, as well as the contraction or gross margin rate. With all the 53rd week in fiscal 2006 added an additional $59 million in sales. We estimated the flow through of conversion of sales to adjusted EBITDA for the week at approximately 35% to 40%. The reconciliation of adjusted EBITDA to the most closely related GAAP measure may be found at the end of today’s press release on our website.

Total sales for full year of fiscal 2007 were $300,862,000, a 0.5 % increase over last year. Resource added $89 million in sales for the year, but were mostly offset by the absence of this year $59 million dollars in sales for 2006’s 53rd week and the same store sales decline at 0.7%. A favorable Canadian currency translation added approximately 0.5% to the full year same store sales rate.

Total gross profit for fiscal 2007 was equal to last year’s $100,479,000 as a percent of sales our total gross margin rate decreased by 20 basis points to 38.3% from 38.5% last year. In 2007, we gained 30 basis points in merchandise margin offset by 50 basis point de-leveraging of occupancy costs, these lower comparable sales level. Fiscal 2007, SG&A expense was $100,460,000 an increase of $23 million from fiscal 2006. As a percent of sales SG&A expense increased 50 basis point year-over-year resulting primarily from consulting expenses and higher average, advertising expenses.

Operating income for the year increased to $146 million to $354 million largely due to lower transaction and related party costs. Full year interest expense was $378 million and income tax expense was $5 million. Net loss for fiscal 2007 was $32 million as compared to net income of $41million for fiscal 2006.

Adjusted EBITDA for fiscal 2007 was $587 million or 15.2% of sales versus $620 million or 16.1% for fiscal 2006. The decrease in adjusted EBITDA was due partly to the absence of the net economic related to the 53rd week of sales reported in fiscal 2006. Additional market driven cash compensation costs and consulting expenses related to the company’s strategic initiatives.

Looking at the balance sheet and cash flow, company’s cash balance at the end of the fourth quarter was $29 million, end of year debt level totaled $300,863,000 down $321 million from the end of the third quarter and down $96 million from fiscal 2006. During the quarter the company made a $5.9 million amortization payment on its term loan for a total of $23.5 million and principal reduction on a term loan for the year.

As Brian mentioned, average inventory from Michaels Stores at the end of the fourth quarter fiscal 2007 inclusive of distribution centers was down 4.5% to $830,000. Our automated replenishment system and hybrid distribution model continued to provide significant efficiencies in the management of our inventory investment. Cash flow from operation for fiscal 2007 was $268 million, up $111 million over prior year.

Capital spending for the year totaled approximately $100 million down $43 million from fiscal 2006, with $53 million attributable to real estate activities, and $18 million for distribution network expenses such as the Centralia Washington distribution center. The total capital spent for model activity was approximately $11 million as the company converted 40 existing stores to more productive layout.

As of February 3rd, we had a total of 963 Michaels Stores and 166 Aaron Brothers’ Stores. In 2007, Michaels opened 45, relocating 11, expanded two and closed three Michaels Stores. We also opened two in close to Aaron Brothers Stores and closed our revenue recollections in three star decorative sale set of stores. So, pre-opening costs were $6.3 million this year versus $5.2 million last year.

That concludes my comments regarding our financial performance for fiscal 2007. I will now turn the call back over to Brian.

Brian Cornell

Thank you, Todd. Despite the challenging macro economic environment, we have continued to work diligently on our key initiatives, as well as the number of operational improvements with a significant amount of work being completed in this regard. And as you know, Cramping is a rich and a motional process that involves passion, feelings with aspiration, inspiration and accomplishment. While independent retailers can deliver some creative inspiration, they are less convenient for our consumers. And customers are well gated to shopping several stores and channel.

We believe Michaels is in a unique position to target key customer segment and develop a strong relationship for our key consumer segment versus many of our competitors. They help this initiative we realigned our marketing organization around these efforts lead by our new Senior Vice President of Consumer Strategy and Marketing, Stewart Hagen, who joined us from Safeway.

Stewart has extensive experience in card and loyalty marketing, data mining, category management and target a consumer marketing. I had tremendous confidence in Stewart, and I am excited about what he can bring to this very important strategic initiative. In his roll, he will lead Michaels in developing our consumer insights, implementing category management discipline throughout the company, developing new strategic growth initiatives and leading our customer communication. Stewart will work closely with our merchandizing leaders, store operation teams, our external consultants to activate key insight and develop a rich customer loyalty program.

Our consumer insight studies are substantially complete. All our quality of work has been completed. We now have a much better definition of who our customers are, why they shop our stores and a clear understanding of the current consumer GAAP, we must address in order to better fulfill the future needs of our Michaels customers.

In addition, most... all the quantitative work has been ramped up. It is shown that Michaels can be successful by bringing newness and trend products for the right category, by creating an environment that enhances creativity and by providing more inspiration project ideas and solutions. Michaels must also improve the in store strength and while departmental resets can help rejuvenate a category, they are not transnational enough to drive a step function change in our company performance. To connect on a targeted basis for our customers, you may have seen that on March 6th, we announced the introduction of the Knack, a new in-store and online program designed for teachers and parents to help children discover their creativity.

The name of the program comes from Michaels’ belief that every child has a knack for something. The holistic art and crafts program helps children to discover what their knack is with in-store events, a monthly e-newsletter with project ideas and featured products, online project sheets and seasonal events that encourage instructional play.

In contrary with the launch of the knack, we introduced the Crayola store only at Michaels, which offers the largest assortment of Crayola in any store with more than 250 different Crayola products. Also in a Knack scene, we will be creating the knack faculty, our new teacher program that gives teachers classroom related ideas and projects for inspiring their students. Teachers who sign up to become members, who received access to online project ideas, information about upcoming events, teacher projects, monthly e-newsletters, exclusive offers and promotions and this is just a beginning.

Michaels will continue developing the knack, adding member benefits, in-store activities and projects to continue admission of helping children discover their creativity for having fun. As we have previously discussed, our global sourcing efforts and private brand development remain our largest area of long-term opportunities. In January, I spent several weeks traveling throughout China with Lisa Klinger our SVP of global sourcing and members of our sourcing team, I visited various manufacturers, our quality control partners and agents.

In addition to growing our sourcing network and establishing close direct relationship with our manufacturers, we continued to validate the significant opportunity this initiative presents. One of the benefits of being a leader to this import market is that in the space of significant commodity price increases and pressure on exchange rate there continues to be a substantial opportunity for margin enhancement by improving our sourcing program.

We’ve finished building our team around this initiative, and with our high rate distribution system initiative complete, we are now ready to begin filling the supply chain with directly sourced products. In 2007, we conducted a number of pricing and promotional steps. We altered our ad KV [ph] adjusted pricing structures, changed ad layouts and coupon offerings, what we have learned is that our customers have been trained to shop using our circular, and that the circular is a useful tool, when complimented with other marketing vehicles. We’ve been working on enhancing our ad formats, and in store add placement. In 2008, we will also begin testing new advertising mediums to select a direct mail and radio campaign.

Additionally, we’ve made significant progress on the implementation of the Oracle promote planning system. The promote system we will provide our category managers with the start to finish forecasting planning and execution tool. Promote to unable our buyers to run analysis on different products pricing combination. And better learn how promotions work to drive traffic. It will allow buyers to more accurately forecast purchases and plan for ads with pre-determined objectives, such as driving sales improving gross margin or managing inventory levels.

Operationally, we have continued to make great progress, we made numerous improvements in our expense savings efforts in many store and corporate functional areas. While we all already realize substantial savings, we fully expect to identify more areas of cost management. We recently completed an industrial engineering study of our countless work processes at store level. With re-engineering these processes we hope to further reduce our pay roll expenses as a percent of sales, while also affording our associates. The ability to focus on serving our customers first is simply performing task work. As you know, we exuded our unprofitable specially businesses, recollections and start for sale, which will not only benefit Michael’s financially but more importantly allow us undivided attention placed on improving our primary business. Michaels and Aaron Brothers.

Although most of the fourth quarter issues are behind us, we do anticipate that several challenges will continue throughout 2008. The economic outlook for 2008 indicates clear sign recession and some of the higher ticket categories such as custom framing and larger ticket holiday items may be impacted by a slowing economy, that being said we expect our core Michaels categories to remain strong and performed well despite the economic slowdown. Our challenge will be to leverage our counter cyclical products in order to maintain a strong base of category performance in the space of the difficult economy.

As we look forward, Michaels has decided that given a long-term strategic nature of our initiatives quarterly guidance will not be a productive measure of operation advancements and we will no longer provide short-term quarterly guidance. But, we will continue to provide fiscal year outlook.

For fiscal 2008, we believe a large component of our core business is a low ticket high value product offering and in conjunction with a relatively outlook, consumer provides some degree of retention in recessionary conditions. However, we feel it to be prudent to maintain our fiscally conservative view and therefore project same store sales for fiscal 2008 to be flat with cash flow from operations and adjusted EBITDA to be consistent year-over-year.

That concludes our prepared comments, and we are now ready to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) We will pause for a moment to compile the Q&A roster. Your first question is coming from Karen Aldrich. Please go ahead.

Karen Aldrich

Thank you. Could anyone of you give us CapEx allowance for this year?

Brian Cornell

Yeah, CapEx we are targeting about a $120 million for 2008.

Karen Aldrich

And how many new stores will that include?

Brian Cornell

We are looking at about 45 new stores, so very consistent with this year, and we are also looking at some very targeted remodel activities in the second half of 2008.

Karen Aldrich

Great. I know do, I appreciate now wanting to give quarterly guidance I am curious in terms of when we are looking our own model, you know, for the seasonal items a lot of retailers have highlighted the early Easter as a challenge for them is it fair to assume that that will be a challenge for you guys as well?

Brian Cornell

You know, obviously it’s a unprecedented early Easter for all retailers, it certainly something that we've planned for and are managing again, but we certainly expect in the early part of this year that some of the challenges we saw with seasonal and home décor items will continue, but we feel was done as we start the year many of our core categories are off to a very good start and as we continue to focus on these core categories and connecting with consumers, we think we have got the right plans in place for 2008.

Karen Aldrich

Great, and final question, as you mentioned with the core categories are there any new trends in classing to this year that you think could particularly take off?

Brian Cornell

Well as we sit here today, we are really focused on creating our own trends at Michaels, and as we both just reporting the news and in some ways being victims of similar trends in the category really bringing new news or consumers. Its one of the reasons we introduce in March our program called the Knack to bring new exciting ideas to many of our shoppers. This program obviously focused on parents and teachers and obviously the end consumer being children. But we think we can bring great new activities through the Knack program.

Karen Aldrich

Great, thank you very much

Operator

Thank you. Your next question is coming from Grant Jordan - Bowles Hollowell. Please go ahead.

Grant Jordan - Bowles Hollowell

Great, thank for taking the questions. Just a couple of questions here. You said on it already a little bit but just one of the drilled down or one of bit more into your guidance kind of how you see the year. You know, you talked about flat on an EBITDA performance were flat seems to sales. Is that you see some cost savers replacing some of their higher margin business is how you get to a flat EBITDA number?

Brian Cornell

So, I generally the way we do was flat comp store sales. We will expect to see a little bit of leverage out of SG&A and continue to focus on our margin enhancement activities and see all that that’s particularly how we get back to a flattish EBITDA.

Grant Jordan - Bowles Hollowell

Okay. And then is that is it back end loaded in the second half of the year, we are in to the number retailers they expect the consumer term proven in the third and fourth quarter and I just want to see how much that played into your outlook?

Brian Cornell

In sitting here today obviously it is difficult for us to forecast now for the full year, we certainly would expect to see some strengthening in the second half of the year. Obviously, we are going to be lapping some softer Q4 numbers as we overlap has been a very difficulty fourth quarter in 2007. So, we would certainly hope that as we looked to the second half of the year, and many of the initiatives that we’ve launched in 2008 begin to build traction and momentum that we do some fee strengthening in the business as we going to the second half of the year.

Grant Jordan - Bowles Hollowell

Great. My next question, may be if you can give us some color on how you did manage inventories down so much in the quarter or it was that a field that you got your early in December, the two started cutting back on some of your replenishment and then second how do you see inventories shaping up here in the first couple of quarters in the year?

Brian Cornell

Yeah for fiscal 2007 fourth quarter in particular, we really been leveraging our automated replenishment system. So I…two things I got, first automated replenishment has the ability to try and keep track of our trends we are going through and manage our inventories appropriately for sales, and we really leverage and then other benefit we are getting is to a hybrid at this point, if you think about what hybrid does for us, in the past all of our safety stock for direct ship product would have been held on store level as we have centralized that into distribution centers. Now, we are able to manage keep some stock more effectively, and we did an inventory benefit out of it. And then looking forward into the first couple quarters this year, we would expect to see similar flat to down slightly inventory levels for store so can you continue thing much the same trend.

Grant Jordan - Bowles Hollowell

Okay. And then my final question I think you touch on a little bit. But if you give us a little bit more in terms of what you are seeing on product to inflation on any sourced goods?

Brian Cornell

Yeah, certainly I think we’re all experiencing rising cost in China, as we look at the impact of currency we look at the adjustment in the DAT rates, and just the overall increases in China cost of goods, depending on the category first thing any where from 5% to 6% price increases into the mid teen. So, we are seeing across and numbered of category certainly those that are petroleum base, fairly significant price increases coming out of China.

Grant Jordan - Bowles Hollowell

Great. Thank you for the detail.

Operator

Thank you. Your next question is coming from Emily Shanks - BoA please go ahead.

Emily Shanks - BoA

Hi, good afternoon.

Brian Cornell

Good afternoon.

Emily Shanks - BoA

I had a couple of follow-up questions, as we work down what your exposure is on mix in your debt, can you comment on what that mix is on affording part if you are hedged or not?

Brian Cornell

Emily, I am going to try to turn this over to Lisa and apologize in advance, she is still on vacation. She is in a remote site and we sill see if Lisa can address her question otherwise then we will make sure we get back to you offline.

Emily Shanks - BoA

Sounds great.

Lisa Klinger

I am actually here I still have good bars as long as, you can all hear , right now all of our revolver and term loan is still variable rate and that is about 2.4 billion of our capital structure and that is not hedged to the current time. So we are receiving significant interest rate there favorability right now.

Emily Shanks - BoA

Great thanks.

Lisa Klinger

Thanks.

Emily Shanks - BoA

Thank you, just to be clear that there are I don’t know take the 6 to 14 slots on your bonds?

Lisa Klinger

That’s correct.

Emily Shanks - BoA

Okay thank you. And then if I could I just wanted to recapped it an expenditure asset earlier question on bond how are flat comps that you described EBITDA, I think and I missed it that you made the statements that you looking in to the leverage SG&A with that component, I was just trying to reconcile that was information that we put on the past few calls. Where I stopped that you need to see about the 3% comp growth to sell leveraging [inaudible]?

Todd Vogensen

Intuitive, a couple of different things we were looking at for next year, number one by knowing that we were going into the year looking at flat comp works throwing our cost structure accordingly. So, really looking at trying to leverage savings where we can and be prudent. The other thing to follow on to another things that Brian had mentioned, we have done a lot of work for ground where we stand in the store and understanding how we can get the most efficiency out of the store without sacrificing any customer facing activities and think that will generate the ability for us to keep appropriate leverage on our cost. We made a major store level initiative that we rolled out earlier this year and to really make sure that we are maximizing our efficiency and operating our source a number of different engineering studies that had been completed and we certainly think that’s going to help us better manage our store labor.

Emily Shanks - BoA

Great, thank you. And if I could just ask one final question?

Todd Vogensen

Sure.

Emily Shanks - BoA

Can you comment on all, if Jeff is looking for another job opportunity or not?

Todd Vogensen

Emily, he is. We are going to try to minimize the number of questions we answered about Jeff’s change, he is going to be leaving for a new opportunity. The company that he is going to be working for is not ready to make that announcement I do expect that that will be announced later this week. But we are not at liberty to disclose at this point. So, I check the blogs, I checked the internet and I would expect sometime between now and Friday other than announcement would be made.

Emily Shanks - BoA

Great, thank you.

Todd Vogensen

Thank you.

Operator

Thank you. Your next question is coming from Jeff Stines. Please go ahead.

Jeff Stines

Sure, question regarding strategy for the recently completed, how are their season. Going into the fourth quarter, did you invest more in your seasonal inventories than you did the prior year and was that a reason why you took such a heavy marked on season?

Todd Vogensen

We are on investment and the inventory for seasonal was pretty consistent this year with last year and it was more a matter of if you recall last year the customer came very late in the season, so we got very, very good seasonal margins very late this year, well that did not happen, which is primarily consistency in the cross I think retail, so as that big final push didn’t well materialize the way we have seen it in the past that just led to more clearance activity needs to take place. And to be very specific as we talk about our seasonal items in the fourth quarter. We really saw the slowdown in the higher ticket items, trees, dimensional lighting all those discretionary purchases that this year, the consumers simply walked away from. And that was not anticipated, surely not at the rates, we were very pleased with the start of our holiday season. We felt very good about the way the consumer reacted to Halloween and Fall seasonal decor. But it was a very different story when it came to Christmas, and the consumer clearly decided not to purchase some of those higher ticket discretionary items to decorate their home.

Jeff Stines

And I am just kind of wondering how you see yourself getting to flat comp, it sounds like transactions are down and at the same time in, you are kind of calling out the fact that you guys have a lot of low price value items in the store. How does that add up to kind of a flat comp earlier this year?

Todd Vogensen

Well, we’ve had a number of initiatives around some of our core trapping categories, we’ve got some great new products, I talked about the introduction of the clearer store at Michael’s, now we think that’s going to be a important support element to our kids offering. We’ve had a number of exciting new elements around our traditional trapping, whether it’s our new jewelry and beading set, and some innovation we’re bringing to other categories. And we really feel very good that based on some of the consumer insight work we have now completed, we are in a much better understanding of how to manage our core Michael’s categories and really going to work to stimulate traffic through much more targeted and relevant marketing efforts. And our focus right now is driving traffic around those core categories and really building a strong relationship with our core long term consumer.

Jeff Stines

Okay. And how are you just trying to traffic, how are you planning your inventories this year beginning obviously with the spring?

Todd Vogensen

Well, if you are looking at our plans for seasonal, we are taking a very conservative approach to managing our seasonal inventory. And are buying down not only the total inventory but are looking very carefully at the number of SKU’s, in our assortment. So, we are being very responsible as we manage inventory up seasonal items, that being said and we are taking a very strong stands in our key core categories and investing in innovation in newness as appropriate for our poor consumer.

Jeff Stines

So, this sounds it’s more like a inventory identification, more investment in kind of core categories?

Todd Vogensen

I think it’s a very fair statement.

Jeff Stines

Okay, thank you.

Operator

Your next question is coming from Colleen Burns - CIBC. Please go ahead.

Colleen Burns - CIBC

Hi. In terms of traffic, I think you said traffic and transactions were down about 5% if I heard it correctly?

Todd Vogensen

Yes, they were Colleen.

Colleen Burns - CIBC

Do you believe that you washed out with any other competitors or do you think it’s mostly related to the overall retail profit?

Todd Vogensen

It’s kind of one of the questions, I ask all the time and you know the challenge that we have in the sector is not having access to this indicative data. So mostly this is anecdotal with feedback we received through our vendor community and what we pick up from others in the call and it’s really … it is difficult for us to tell, obviously given tracking and watching closely as some of our competitors report their results. We feel like we held our own in the fourth quarter, but certainly were troubled by the overall decline in seasonal purchases.

Colleen Burns - CIBC

Have you seen that level of traffic decline continue?

Todd Vogensen

We have actually seen some very encouraging results as we move into the first quarter primarily driven by some of our core categories, I talked about, the initiatives we have behind our Kids offering and I am actually very encouraged with some of the trends that we are seeing in our core art and craft categories. And we are watching traffic very carefully and most of our focus from a marketing standpoint right now is driving traffic into our stores, so the much greater emphasis on what we believe are core destination categories.

Colleen Burns - CIBC

Okay, that’s great and then just a touch up for that advertising and promotion for 2008. What are your plans, do you expect to have to be more promotional to increase that budget?

Todd Vogensen

Well, we are actually taking our relatively conservative approach to advertising in 2008. I think we are going to see levels very consistent with what we had planned for 2007, although, the shape of that advertising plan is changing as we look much more closely at targeted marketing elements as we look at e-news letters and much more targeted and relevant marketing promotions, and we’ve recently tested radio and I think we will continue to keep radio into the next around key drive periods but we think radio maybe another way to drive traffic into our stores as we put together new exciting promotions.

Colleen Burns - CIBC

Okay, that’s great and just lastly on the net initiatives, do you have any plans to target teachers specifically?

Todd Vogensen

We do Colleen in fact a very important part of the program is targeted around teachers and I talked briefly in my prepared comments about the Knack Faculty, which is all about providing teachers creative project solution for their students and a way to really connect with our teacher community and bring them great creative solutions for Michaels. So, teachers are very important part of the Knack, its an important part of the Knack Faculty and you could actually see some of the information on our website.

Colleen Burns - CIBC

All right, great. That’s great, thanks a lot guys.

Todd Vogensen

Thank you.

Operator

Thank you. Your next question is coming from Karru Martinson - Deutsche Bank. Please go ahead.

Karru Martinson - Deutsche Bank

Good morning. I mean good afternoon sorry about that. In terms of the consulting fees that you referenced, what was the amount that was not excluded from your adjusted EBITDA?

Todd Vogensen

For the full year, it was about $9 million.

Karru Martinson - Deutsche Bank

And for the quarter?

Todd Vogensen

For the quarter, it was about $2 million.

Karru Martinson - Deutsche Bank

Okay. In terms of the what interest rate you had … you don’t have interest rate hedges, interest rates are coming down, it seems like you should be generating a decent free cash flow here even you are keeping EBITDA consistent with 2007 levels, where do you see cash flow usage going here?

Lisa Klinger

I will say our first choice in investing in all these strategic initiatives that Brian has articulated on the phone to the extent we have excess funding above those needs our next choice is to pay down debts.

Karru Martinson - Deutsche Bank

Okay. And in terms of the … if you could kind of…for housekeeping purposes the rent for the full year?

Todd Vogensen

Yes, I have that, one second. $294 million for the year.

Karru Martinson - Deutsche Bank

And in terms of the upcoming years, its more than the new store contribution, with those stores coming in are we looking at more of a back half or you know, are they going to coming in evenly throughout year?

Todd Vogensen

I think they are going to be spread through the first three quarters of the year.

Karru Martinson - Deutsche Bank

Thank you very much guys.

Todd Vogensen

Thank you.

Operator

Thank you. Your next question is coming from [inaudible]. Please go ahead.

Unidentified Analyst

Hi, my question relates to branded versus private label, you mentioned that trailer initiative and in the past you talked about going sourcing more direct, I am wondering if your review has changed in terms of how much you expect Crayola store of your own label versus exclusive versus brand?

Todd Vogensen

Right now we are building a very strong proprietary brand architecture, I would expect it over the next the year to 18 months you will see many new brands coming from Michaels brands are exclusive to our stores, but even though we are clearly focused and believe our global sourcing and proprietary brand is a huge initiative for the company. We continue to partner closely with branded manufacturers, those suppliers that bring great value and equity behind their brand. We think Crayola is a great example of that and a brand that clearly brings value to our consumers as terrific consumer insight and have been great partners and will be great partners as we go forward. So, while we continue to dial up our focus on building our phone, direct sourcing model beginning to develop great proprietary brands that are right for our consumers, we certainly are going to continue to partner with value added vendors, who bring great consumer insight to bring great innovation and can work with us in building our franchisee.

Unidentified Analyst

Okay, great. Are you fully file a labor is in custom trend or a pure separate (indiscernible)?

Todd Vogensen

I will think from a consumer’s standpoint, they will look at it as a Michaels brand.

Unidentified Analyst

Right, right. Exactly.

Todd Vogensen

Sure.

Unidentified Analyst

Okay and then two financial questions. One, do you have to make a free cash flow pre payment to the term loan in 2008 based on your strong cash flow generated in ’07?

Lisa Klinger

Actually we do not ironically with them all of the defined adjustments, we are not in a position, where we have to be that. We certainly are looking at doing that and see what may come from a capital perspective that we are not required.

Unidentified Analyst

Okay, great and then. It looks like the EBITDA includes a line item that is carried below interest expense or other income expense, what’s in that outline item?

Todd Vogensen

In the adjusted EBITDA add back?

Unidentified Analyst

Yes. It’s actually not an add back but in the income statement there is outline below interest expense, it is called other income or expense?

Todd Vogensen

Yes, currency…foreign currency translation adjustment. So, it is pretty clear balance sheet translation adjustment that we do and with the strengthening of Canadian dollar that has turned into income for us through this year.

Unidentified Analyst

Okay. But in the fourth quarter, I think it was an expense job correct? The $3.8 million and $7 million income for the year?

Todd Vogensen

That sounds right, yeah.

Unidentified Analyst

Okay. Great, thank you.

Todd Vogensen

Thank you.

Operator

Thank you. Your next question is coming from Roland Bridge (ph). Please go ahead.

Roland Bridge

Hi, good afternoon. Firstly a general question, when you compare material stores and stores that are recently have not been opened can you give us a sense for the magnitude of what could be attributed to the grand opening sale distortion? If you could just analyze up?

Todd Vogensen

No. I think it’s a great question. I don’t know if we have looked at that out recently, I rather take sometime and get back to you offline with that answer.

Roland Bridge

Okay. On team source sales, if looking at the variance in the past fourth quarter and that was attributable to seasonal high ticket items. If we see from down course going forward during tough Macro would we expect that variation to be less given, less emphasis on may be high tech in items Q1, Q3?

Todd Vogensen

We would certainly expect that, and that’s poorly how we are beginning to plan our activity across the year.

Roland Bridge

Okay. So, when you are looking forward and you are thinking flat seems for sales you are bullish on the second half. But if you would have a view that the Macro is going to continue to accumulate if that would come to provision we could expect down, same store sales?

Todd Vogensen

Well, again as we said here today is very had for us to predict how deep, and how long the current debt, economic down term continues. So and we certainly hopeful that we see some vacancy in the second half of the year, we are planning inventory around seasonal very consciously as we think about that up coming fourth quarter. I believe also we got some perfect plans in place to re stimulate traffic and to focus in on our core categories. Which we think even during times and retention often the consumer great value and we think that we got some wonderful product focused on kids with the Knack program, we think we will bring some great new innovation to some of our traditional Knack categories. And we are really counting on those businesses and those investments to drive traffic and stimulate additional purchases once we get people in our stores.

Roland Bridge

Okay. With regard to margin initiatives, should we expect that to net flowed through in 2008 and if sold to what magnitude?

Lisa Klinger

You know I think when we were on the road show, we talked about the fact that all of our various initiative survive there, they are stayed throughout the next, you know 4, 5, 6 years. That can be expecting some more between 50 and 75 basis point of margin expansion each year.

Roland Bridge

Okay. But if you would see declining seem store sales that might be offset by lower over absorption?

Lisa Klinger

Ostensibly I’m talking about merchandise margin.

Roland Bridge

Okay.

Todd Vogensen

You would expect to see little bit of de-leverage across occupancy but you know.

Roland Bridge

But still, there should be some benefit.

Todd Vogensen

Exactly.

Roland Bridge

Okay. That’s great. Could you know I can guess Lisa had spoken about excess cash flow, you said you wouldn’t be obligated to make that sweep determines whether you give never have to make that sweep is that always…?

Lisa Klinger

It’s a calculation that is determined in the agreement, how do make that calculation at the end of the each fiscal year. So, we’ve done that now for fiscal 2007 and based on that calculation we do not have to make excess cash payment down payments in ’08. We will go to the same exercise of the end of 2008 and determine if we have to have the mandatory pre-payment or not. My comment was surrounding the discount cash flow that we are seeing in the business, we are always evaluating whether we could make a voluntary prepayment an any of our, any of our debt expansions to see if that make sense and we will continue to evaluate that.

Roland Bridge

Okay. In terms of cash taxes, in ’08 versus ‘07 is there any other way that you can provide guidance and how do you think about that?

Lisa Klinger

You know, I think our normalized tax rate of in a 38-40%, again kind of given of flow through of the top level guidance that we gave. I am sure, you would get you close.

Roland Bridge

Okay, alright. Thanks so much.

Todd Vogensen

Well, thank you,

Operator

Thank you. Your next question is coming from [inaudible]. Please go ahead.

Unidentified Analyst

Well, my questions have been answered. Thank you.

Todd Vogensen

Thank you.

Operator

Thank you. Your next question is coming from Jeff [inaudible]. Please go ahead.

Jeff

Hi. Good afternoon, I was curious about the direct sourcing and can you just elaborate more about where you stand with the direct sourcing initiatives as far as staffing and flow of products?

Todd Vogensen

I think we’ve talked in prior calls about the fact that Wilson Zoo is now been in place for a approximately 11 months, we built a team around him, as the ex-capability is from outsourcing standpoint a product design standpoint, of packaging standpoint, a quality management standpoint. We had our quality control agents in place and certainly relationships now with our two primary sourcing agents. And we are accelerating rapidly and making terrific progress. And I mentioned during my prepared comments, I spent several weeks in China with Wilson in January visiting a number of our direct manufacturing partners working with our quality control agents and I feel like we are making very, very strong strides. And at the same time, as we look to begin to import more products directly and we are also building our own brand portfolio, a portfolio of proprietary brands that we think will help differentiate Michaels going forward. So, I am extremely pleased with the progress we’ve made that quality of talent that we have attracted and the future potential that are global sourcing and branding team will bring to Michaels. So, I feel very, very good and I think right now we are in a terrific position to continue accelerating as we going to 2008.

Jeff

Okay, and Lisa mentioned of 50 to 75 basis points proved in margin that was suppose to come from this and I believe the hybrid imitative in, is that still so going to show up this year or that could be upset by cost inflation you are seeing?

Todd Vogensen

I think it’s fair to say, continue to expect that 50 to 75 basis points what we are expecting for 2008, merchandized margin expansion from those initiatives.

Jeff

Okay, alright and then you count about the seasonal business were percentage of your total revenues that represents in a non-Christmas period a roughly was that percentage is?

Todd Vogensen

In a non-Christmas period, yes I think it feel business when you get out of the Christmas tree gets down into the low single digit for us, so, certainly not as significant as when we get into the main Christmas period.

Lisa Klinger

And just, you know, the other significant piece of that is direct of the fall business, so right now we will not have significant seasonal sale coming until really the fall period.

Jeff

Right, Okay, and then lastly you said that the consumer studies that you been working over the past year that they are completed now, can you give any insight about what the consumer is little bit more reluctant in this economy times why they are not standing as much as they have back in 2000 and 2001?

Todd Vogensen

Well, I think again some of this is just a confluent of very challenging consumer issues as they look at rising mortgage payments unprecedented energy and fuel cost and I thin an overall loss of consumer confidence in the US today. So we got many consumer and your talking and listening to many other retailers talk about big patterns, patterns of there seeing I think consumer are being very, very cautious today and certainly that is questionnaire items that they have back to way from that we talk about earlier in the call or higher ticket item. We certainly think as we talked to our consumers and get a much better sense for fair demand drivers what they are looking for from Michael I feel very confident that our core categories will continue to deliver you know, the inspiration, the purpose that our consumers are traveling to Michaels define and you know we are going to continue to build upon those insights and make sure that our product offering, our communication, and our in-store experience begins to match up better with their expectations. So, I’d really separate you know, what we are seeing with seasonal certainly I think that’s very highly correlated to some of the economic challenges that many retailers are seeing. But we think we got an opportunity to really leverage our insight much more effectively going forward around these low ticket high value items that give our consumer a very high sense of accomplishment and we are going to continue to focusing on those core categories in 2008.

Jeff

Okay. Thanks for you help.

Todd Vogensen

Operator, I think we are going to take one more call today.

Operator

Your last question is coming is from Mike Schrekat. Please go ahead.

Mike Schrekat

Yes, I was just wondering, what was [inaudible] at the end of the quarter?

Todd Vogensen

It was 106 million.

Mike Schrekat (ph)

106, okay.

Todd Vogensen

I am sorry, it is 96 million.

Mike Schrekat

96, okay. And then one of the comments Brian made at the beginning was that you can’t depend on resets to be a big enough traffic driver you know, what have been said I thought previously would don’t really doing that framing resets and taper resets that were going to be traffic drivers, can you just comment on you know, what makes you think differently now?

Todd Vogensen

Well, I certainly think that resets are an important part of our mix and they certainly help to reenergize certain categories. We don’t believe and as we have talked to consumers that individual category resets alone are going to dramatically change traffic patterns and we are looking at making a number of changes in our overall merchandising mix and we are certainly looking very specifically of how we evolve the total in-store experience. So, it’s not just one side counter or one category that refresh but they represents the consumer with the right in-store experience every single time they shop at Michaels. So, you know, we are working diligently on some changes to our overall store merchandising and I mentioned earlier in the call that we will be testing some new remodels in the second half of the year. And we want to make sure that we are continuing to listen to the consumer and evolve not only our product offering but the in-store experience to drive more traffic and meet more of their needs. So, we are going to continue to look fresh and update categories but we are looking much more holistically as how we refresh the entire in-store experience and get a lot more credit from our shoppers with a great products and product solutions and ideas that we offer.

Mike Schrekat

Okay and then just if the comp is down 3.4% and seasonal is 11% of your total sales on an annual basis, so is seasonal I guess around 20% of sales?

Todd Vogensen

Its actually even much larger than that might during the fourth quarter, seasonal becomes a very big part of our business and beside acres of directionally not quiet quality but this is significant part of business and I think we can do the best back version as and figure out that seasonal was really be anchored behind the disappointing comps in the fourth quarter.

Mike Schrekat

Okay, thank you very much.

Todd Vogensen

Alright, operator I appreciate every one dialing in today and operator, we thank you for your assistance.

Operator

You are welcome. This concludes today’s Michaels Stores conference call you may now disconnect and have a great day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

This Transcript
All Transcripts