Michaels Companies Inc
Q4 2017 Earnings Call Transcript

Published: 22 Mar 2018

[Operator:]

Good morning. My name is Phil and I will be your conference operator today. At this time, we would like to welcome everyone to the Michaels Company’s Fourth Quarter Earnings Conference Call. All lines have been placed on mute [Operator Instructions]. Please note this event is being recorded. Thank you. Now, I’d like to turn the call over to your host, Kiley Rawlins, Vice President of Investor Relations and Communications. Ms. Rawlins, you may begin the conference.

[Kiley Rawlins:]

Thank you, Phil. Good morning everyone and thank you for joining us today. Earlier this morning, we released our fourth quarter and fiscal 2017 financial results. A copy of the press release is available in the Investor Relations section of our Web site at www.michaels.com. Before we begin our discussion, let me remind you that today’s press release and the presentations made by our executives on this call may constitute forward-looking statements and are made pursuant to and within the meaning of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995, as amended. While these statements address plans or events, which we expect will or may occur in the future, a number of factors as set forth in our SEC filings and press releases could cause actual results to differ materially from our expectations. We refer you to and specifically incorporate the cautionary and risk statements contained in today’s press release and in our SEC filings. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of today, March 22, 2018. We have no obligation to update or revise our forward-looking statements except as required by law, and you should not expect us to do so. On today’s call, we will reference non-GAAP financial measures, including adjusted EBITDA as defined in our credit agreement, adjusted operating income, adjusted net income and adjusted diluted earnings per share. A reconciliation of these measures to the corresponding GAAP measures are detailed in today’s earnings release. We’ll begin this morning with highlights from Chuck Rubin, Chairman and CEO, and then Denise Paulonis, our CFO, will review our financial results and outlook in more detail. Following our prepared remarks, we will open the call for questions. As this is our year end call, our prepared comments will take longer than usual to help us accommodate as many question as possible, please let yourself to one question and then queue for any follow up questions. Thank you. And now I’ll turn the call over to Chuck Rubin. Chuck?

[Chuck Rubin:]

Thank you, Kiley. Good morning everyone. I want to start this morning with a review of our fourth quarter results, highlight what we accomplished in 2017 and then discuss our priorities for 2018. As expected, we continue to build momentum in the fourth quarter. Total sales for the quarter increased to 8% to $1.9 billion inclusive of the extra week. Comp store sales increased 2.5% driven by increases in both average ticket and customers transactions and adjusted diluted earnings per share increased 24% to $1.19. Denise will discuss the quarters financials in more detail later in the call. Our Q4 results were driven by strong performance in the November and December holiday period, offset partially by a softer January. From a category prospective, seasonal kids and paper crafting tools and technology were our strongest categories this quarter while readymade frames, yarn and jewelry were more challenged. After many quarters of negative trends, custom framing was slightly positive this quarter. The assortment and pricing changes we made in Q3, combined with testing of new management models, are having a positive impact on the business. As expected, sales for Michaels.com was strong, while still a very small part of our overall revenues, online sales in Q4 were approximately double the level of online sales in Q4 last year, driven by increased traffic, higher conversion rates and a higher order value. Unfortunately, our third-party fulfillment provider struggled to meet planned customer demand. As a result, many online orders were filled across multiple fulfillment methods, including our ship from store, ship from DC and vendor drop ship notes. As a consequence, we saw an unexpected increase in split shipments, which drove higher than planned fulfillment cost during the quarter. As I will outline in a moment, we had planned on bringing e-commerce fulfillment in-house in the next couple of years. But our experience this holiday season has caused us to accelerate our efforts. Turning out the full year. I am generally pleased with what we accomplished in fiscal 2017. From a financial perspective, we delivered 2017 results in line with the outlook we previously provided. Total net sales for the year, which was a 53 week year, increased 3% and comp store sales increase 0.9%, driven both by increased ticket and transactions. Leveraging our sourcing efforts, we delivered $46 million of cost savings, which enabled us to overcome $38 million of expense headwind related to incentive compensation. We delivered record operating income of $735 million. Adjusted diluted earnings per share increased 15% to $2.17 compared to adjusted diluted earnings per share of $1.88 in fiscal 2016. We generated $396 million in free cash flow and purchased 12.7 million shares of our common stock, returning more than $250 million to shareholders. And we reduced our EBITDA leverage defined as total debt divided by adjusted EBITDA to 3.1 times. We also made meaningful progress in pursuit of Vision 2020, our long-term strategy to increase market share and deliver shareholder value. In fiscal 2017, we strengthened our omni-channel offering. We refreshed and expanded existing e-commerce sites, including Michaels.com and consumercrafts.com and also introduce new platforms, including the Michael app and an online framing solution. In total, sales from our consumer facing online site doubled from fiscal 2016 to about $100 million in fiscal 2017. We supported the growth of these are e-commerce businesses by diversifying how we deliver product to customers. In 2017, we launched ship from store and hundreds of stores strategically distributed across the United States to help us reduce shipping costs and shorten delivery times. We also tested buy online pickup in-store in a number of markets. We expanded our offering of free classes and make breaks, continuing to make shopping in the Michaels store more experiential. This past year, more than 1.7 million people made something special with their family or friends in a Michaels’ store. This was nearly 60% more participation than in fiscal 2016. We upgrade our POS system in all U.S. stores, providing customers with a faster check out experience and creating a platform to support new promotional capabilities, which will help us target our discount dollars better. We strengthened our channel leading assortment with exclusive partnerships, including Martha Stewart, Disney and Caron cakes and we led the industry and trends like slime and cricket technology and rock painting. We reinforced our value position with the expansion of our Everyday Value or EDV program. Also the increased use of Clear, even dollar price points for key items and finally, the introduction of new price match guarantee program. We expanded our loyalty program, Michaels Rewards, to more than 24 million customers at the end of 2017, up from 14 million at the end of 2016 and increased our penetration to 57% of sales compared to 39% at the end of 2016. We expanded our make campaign with marketing, more exclusive digital content and more media integrations and we increased our digital engagement, expanding our number one position in social media platforms like Facebook, Instagram and Pinterest. We generated approximately $46 million in sourcing savings from our product cost efforts and supported these efforts with the expansion of our Darice Global Sourcing team in China. Our China offices comprised of more than 100 team members enable us to double our percentage of direct imports as a percentage of total receipts as compared to fiscal 2016, helping us to eliminate middlemen and increase our control over the products we buy. Finally, but importantly in 2017, we increased team member engagement across the company and reduced employee turnover. As we begin fiscal 2018, our commitment to our Vision 2020 strategy has not changed. In addition, the benefits from tax reform give us flexibility and opportunity to accelerate previously planned initiatives to support our long-term profitable growth. This year, we are keenly focused on three key objectives; one, create a more seamless omni-channel experience for customers; two, continue to differentiate Michaels brand with exclusive newness and value; and three, investor support additional capabilities and drive increased productivity. Retail continues to evolve and customer expectations for convenience, simplicity and value continue to increase. We are committed to making it easier for customers to shop whenever and however they want. Last year, we successfully launched ship from store, which helped us begin to reduce our dependency on third party fulfillment and enable us to leverage our in-store inventory ownership. This year, we will further expand our ship from store distribution points. And for those customers who want their purchases sooner, this spring we will offer buy online pick up in-store in all U.S stores. While e-commerce sales are growing quickly, in-store transactions continue to account for the vast majority of our transactions. To deliver a better customer experience in stores, we are making investments to make it easier for customers to get what they need and easier for our team members to help them. To improve consistency across stores for customers and team members, we will continue our efforts to reduce the number store layouts or snowflakes as we call them and expand the number of stores with our flexible merchandising area, often we refer to as FMA stores. As context, in 2016, we introduced this new FMA store layout the creative space in the front of the store to showcase newness and seasonal statements. Although, this new layout delivered strong sales of seasonal product, our initial results were more disruptive to core basic categories than expected, as customers acclimated to the new design and category adjacencies. Additionally, we initially underestimated the inventory sell through, resulting in sporadic seasonal out of stocks that missed sales opportunities. In 2017, we improved how we allocate afloat seasonal inventory to these stores also increased how we refreshed the space for the customer. As a result of these changes, the FMA stores outperformed their control group in the second half of 2017. Building on lessons learned, we have made adjustments to the FMA layout to maintain space for newness and seasonally relevant stories, while also reducing the impact on basic categories. This improved approach will enable us to minimize disruption of the customer and reduce complexity for our team members. Therefore, in Q2, we plan to make these layout changes in approximately 235 additional stores, further reducing the number of formats we manage. With these changes added to the approximately 400 stores that already have the FMA layout, about one half of our chain will be positioned to present stronger, more cohesive seasonal statements to customers. As I discussed earlier, we have begun to see some stabilization in our custom framing results. In 2018, we will make additional changes to our custom framing business to drive stronger performance. First, reflecting our commitment to investing in growth businesses. Last June, we indicated that we would undertake a strategic review of our Aaron Brothers division, which is a small specialty retail chain, primarily focused on custom framing, ready-made frames, wall art and art supplies. After our comprehensive review, we determined that the cost infrastructure is unsustainable, given current prospects and the best path forward is to leverage the Aaron Brothers custom framing expertise and name recognition in Michael stores and online. At the end of fiscal 2017, we operated 97 Aaron Brothers’ stores, 94 which where full size or about 6,500 square feet and three of which were smaller custom frame only stores. Over the next few months, we will close all 94 full-size Aaron Brothers stores and leverage this 70-year old brand within the Michaels footprint as our store-within-a-store custom framing service. We will maintain the three custom framing-only stores as a learning laboratory. The custom framing industry is very fragmented still and these labs stores, which average about 2,000 square feet, will help us learn how we can better compete against independent custom framing shops. I am grateful for the work our Aaron Brothers’ team members have done over the last several years and we expect to retain many of these team members as we value their custom framing expertise. Secondly, we will rebrand Framerspointe.com as our aaronbrothers.com both a standalone site but also with the tab on Michaels.com. We will integrate the platform with the in-store custom framing service to make digital custom framing easier and later this year customers will be able to leverage a Michaels store to drop off, pick up or return projects framed online. Finally, we will invest to strengthen the custom framing sales focus in our Michaels stores. Compared to other categories, custom framing is a high touch personalized service that requires strong relationship building and selling skills. For the last several months, we’ve tested a new management approach based on learnings from Aaron Brothers, which focuses on creating a stronger selling culture within the custom framing team and the sales results have been very encouraging. In fiscal 2018, we will expand this effort to additional markets and expect to impact about 50% of our custom framing sales with this new approach. With the abundance of SKUs in the store we know shopping arts and craft stores can be confusing. To help make it less overwhelming in 2017, we refreshed and re-launched the Michaels app, making it easier for customers to find product, search projects and determine in-store inventory availability. Since launching the new app in August, more than 5 million customers have downloaded the apps and we’ve seen a nice ramp up in utilization with more customers using the app to find product and new project ideas. This year, we’ll continue to enhance the Michaels app to improve the customer shopping experience, adding new functionality like visual search, improving coupon management and developing other enhancements to improve the in-store checkout experience. We will continue to invest in technology in our stores to make it easier for our customers and to empower our team members. Last year, we refreshed our POS system in all U.S stores and rolled out a new task management tool in all stores. This year, we will refresh our POS system in our Canadian stores and we will provide new tablets to all stores. Customers can use these tablets to place online orders while in a Michaels store and team members can use the tablets to leverage Michaels’ app, Michaels.com and work side-by-side with customers to help look for projects and search our expanded online assortment or place an online order. Since launching e-commerce in 2014, we have learned much about how customers use online platforms to support their personalization and making needs. The tactile nature of the product, the general lack of national brands and a low average item price, make it unlikely that e-commerce will grow to be the double-digit penetration of sales in arts and crafts as it is for many other retail formats. However, we do believe online is an attractive complement to the brick-and-mortar experience. Given our low sales penetration today, this is an attractive sales growth opportunity for us over the next couple of years. In 2017, we expanded our SKU assortment of Michaels.com by nearly 30% to include more of the seasonal and core basic products that are available in our brick-and-mortar stores, as well as more online only SKUs as part of our endless aisle efforts. We also made improvements in our online search capabilities and provided visibility to in-store product availability. A few weeks ago, we refreshed Michaels.com to deliver more current cleaner look that is more reflective of our Michaels brand. We simplified the look and feel and added a new preferred store functionality so customers automatically see in-store product availability and local coupon offers for their preferred store. And we made it easier for customers to find what they want. We know that browsing through thousands of items can be overwhelming. So we redesigned our product navigation and menu functionality to improve discoverability by providing better visibility to more categories and subcategories. We also redesigned our coupon page to make it easier for customers to access their coupons by reducing the number of clicks to retrieve and redeem coupons, an enhancement that is especially helpful on mobile and should make the in-store checkout process faster. As we look to the rest of the year, we intend to offer new ways to provide more personalized experiences and product recommendations, and we’ll leverage the flexibility of the digital space to create solutions for unique shopping missions. For example, weddings are multifaceted events. In our brick-and-mortar stores, we showcased product by category, not necessarily to the customers lens of what she's trying to accomplish. A customer planning a wedding might need to shop floral, paper, party and frames, which are all separate categories within a Michaels’ store. We are limited by space constraints in the physical stores but online, we can bring multiple categories together in a more intuitive way. This frame customer who will be able to shop on Michaels’ Weddings, a new micro site on Michaels.com; this micro site will be a new cross category platform with new trend right exclusive merchandise and partners, more value and more assortment breadth to help customers bring the unique vision to life. We will also connect Michaels’ Weddings in our stores experience. Finally, we know leveraging our scale to facilitate customer communities, particularly in the digital arena can drive customer engagement and a brand differentiation. To this end, we are focused on two exciting platforms for 2018. First, a few weeks ago we launched a new social tool on Michaels.com to give new makers the opportunity to ask more experienced makers questions about products and projects. We've only been live for about two months but we've already seen more than 21,000 questions posted. This community is maker talking to maker and is hosted on the Michaels.com site. Our second focus this year will come to light later in the year when we launch Michaels marketplace, a selling platform that will connect makers with customers who want to purchase completed handmade items. Building on progress made in 2017, this year we will continue to leverage our size and scale to offer customers more merchandising exclusives, product and category newness and a strong commitment to value. Exclusive brands and products help us differentiate Michaels from other arts and crafts players. Last year, through the successful efforts of our Darice team, we secured the exclusive development and distribution rights for Martha Stewart Crafts and launched Martha Stewart Paint. Building on their success, we have just launched Martha Stewart Party, a fully coordinated party program designed by Martha and her team and only available in Michaels' stores and on Michaels.com. In addition, we’ve recently partnered with Drew and Jonathan Scott, HDTV personalities and design gurus, more commonly known as the Scott brothers, to create a new custom framing collection, again exclusive to Michaels. Last year, we began testing fabric and notions and Pat Catan's brick-and-mortar stores and also introduced an assortment of fabric on Michaels.com. Building on these efforts, this quarter, we will refresh and rebrand our fabric program as the Hancock Fabric Shop on Michaels.com. Through this new program, we will offer customers thousands of fabric choices, cut to order by our Pat Catan team and ship directly to the customer and all available at great everyday values. We view this entry into fabric as an attractive added sale for Michaels. In total, we expect to have around 100,000 SKUs available on Michaels.com by the end of fiscal 2018, about twice the average number of SKUs in a Michaels’ store, furthering our merchandise leadership. Finally, we will accelerate our investments to support future sales and profit growth. We will accelerate our efforts to bring e-commerce fulfillment in-house earlier than initially planned. Our e-commerce business continues to grow in line with the original plan we laid out three years ago. And as we experienced in the most recent quarter, our dependence on a third party for order fulfillment is a constraint creating operational volatility and resulting in higher fulfillment costs. In 2018, we will invest in technology and in our supply chain to build the foundation to enable us to fully in source e-commerce fulfillment in 2019. We will accelerate our investment in data analytics to drive additional actionable insights. Today, we can link about 70% of our transactions to a specific customer. In between the Michaels app, Michaels.com and in-store transactions, we collect billions of customer interactions. This year, we will invest in new data analytical capabilities help us harvest this customer data to identify actionable insights and create more effective customer communications. We will also invest in new promotional capabilities facilitated by our recent POS refresh to manage discounts more effectively through the use of targeted offers in serialized coupons. In summary, in 2017 we delivered against our financial goals and made progress in every facet of our Vision 2020 strategy, and I want to thank each of our nearly 50,000 team members across the company for their hard work and dedication to serving customers. In 2018, we will build in these efforts and proactively invest some of the benefits from tax reform to accelerate investment for our long-term growth. While this choice will result in temporarily elevated operating expense in 2018, we are confident that our investments to create a more seamless omni-channel experience for customers, to expand our FMA stores, to bring ecommerce fulfillment in house and to strengthen our data analytics, will result in increasing our sales, earnings and free cash flow over the longer term. Now, let me turn the call over to Denise for a more detailed discussion of our financial performance. Denise?

[Denise Paulonis:]

Thanks, Chuck and good morning everyone. Before I discuss our results, I want to provide additional context on our GAAP versus non-GAAP metrics. Adjusted net income and adjusted diluted EPS for Q4 and fiscal 2017 excludes two one-time charges related to tax reform; first, approximately $11 million related to the one-time repatriation tax on the accumulated earnings of foreign subsidiaries; and second, approximately $4 million resulting from the revaluation of our net deferred tax assets as the lower corporate statutory rate. Adjusted net income and adjusted diluted EPS for Q4 and fiscal 2016 excludes losses on early extension of debt and non-recurring adjustments associated with the February 2016 acquisition of Lamrite West. My discussion this morning will focus on adjusted results for both years. A full reconciliation of the GAAP to adjusted metrics is included in our earnings release. As a reminder, fiscal 2017 was a 53 week year. For the full-year, the extra week contributed approximately $79 million in sales, approximately $27 million in operating income and approximately $0.09 in adjusted diluted earnings per common share. Now, let's talk about our fourth quarter results versus last year. Fourth quarter net sales increased 8% to $1.89 billion. The increase in net sales was primarily due to sales from the extra week, a 2.5% increase in comparable store sales, which was at the high end of the guidance we provided last quarter and the operation of 15 net additional Michaels stores opened since the fourth quarter of fiscal 2016. Our customer messaging to support Holiday décor and creative gifting, combined with our ongoing efforts to strengthen our value message with simple, clear even dollar price point, resonate with customers and delivered results. In addition, the changes we made to better flow seasonal inventory into the stores with the flexible merchandize area as we sometimes call our SMA stores, helped to drive our stronger seasonal sales. Finally, custom framing, which was slightly positive for the quarter, was less of a headwind on our overall results. Gross profit dollars for the quarter increased 9.7% to $775 million. As a percentage of sales, our gross profit rate for the quarter was 41% versus 40.3% last year, an increase of about 70 basis points. The increase in the Q4 gross profit rate was primarily a result of the increase in our product margin, driven by benefits from our ongoing sourcing efforts. Additionally, we saw benefit from occupancy cost to leverage, resulting from the extra week of sales, less discounting activity during the quarter as we made progress in better targeting discount dollars and the anniversarying of $1.1 million of net non-recurring purchase accounting adjustment related to the acquisition of Lamrite West. We can see benefits were partially offset by higher supply chain cost and higher inventory strength. In regard to trucking cost, we had two headwinds in the quarter. First, as we discussed in our last call, we’ve experienced higher than expected supply chain cost as domestic trucking capacity have tightened. In addition, we are experiencing higher international freight rate. We expect these headwinds will continue in 2018. Second, we incurred higher than expected e-commerce fulfillment cost due to challenges with our third-party fulfillment provider, which as Chuck discussed, lead to more split shipments as many of our customer orders were filled across other fulfillment methods, including ship from store, ship from DC and vendor drop ship. While we’re accelerating plans in 2018 to bring e-commerce fulfillment in-house in 2019, we do expect e-commerce fulfillment cost to increase in 2018, reflecting planned e-commerce growth. Total store rent expense for the quarter was $101 million versus $98 million last year with the increase primarily due to net 15 additional Michaels’ stores. SG&A expense, including store preopening costs, increased 14% to $420 million or 22.2% of sales from $369 million or 21.1% of sales last year. The increase in SG&A experience was primarily due to $23 million increase in incentive-based compensation. Recall that in the fourth quarter last year we’d a $28 million decrease in incentive-based compensation compared to the fourth quarter of fiscal 2015. Additionally, this year we have higher expenses during the quarter due to extra week. As a result, operating income increased 5% to $354 million or 18.7% of sales. While our fourth quarter operating income result was solid, it was at the low end of our expectations, largely due to higher-than-expected supply chain related costs, including e-commerce fulfillment cost. For the quarter, interest expense was $35 million, about $4 million higher than the fourth quarter of last year. This increase was primarily due to interest related to the extra week and higher interest rates during the quarter. Excluding the one-time charges I discussed in my opening comments, the effective tax rate for Q4 was approximately 32% compared with 36.2% last year. The lower effective tax rate was a result of the benefits of our global sourcing initiative, which has lowered our consolidated effective tax rate. As we’ve previously discussed, our global sourcing operations give us more control over the manufacturing process and an opportunity to initiate lower costs and deliver more value to our customers. In addition, we realized benefits from lower corporate tax rate for the month of January due to tax reform changes, which resulted in the benefit of $6 million. And we recognized $2 million of excess tax benefit associated with the adoption of the new accounting requirement related to the tax impact of share-based compensation. For the quarter, adjusted net income increased 11% to $218 million from adjusted net income of $196 million last year. Adjusted diluted earnings per share increased 24% to $0.19 compared to adjusted earnings diluted per share of $0.96 last year. Now turning to the full year. Net sales increased 3% to $5.4 billion and comp sales increased 0.9% or 0.7% on a constant currency basis. For the full year, operating income increased to 1% to $735 million or 13.7% of sales compared to adjusted operating income of $727 million or 14% of sales last year. As Chuck mentioned earlier, this year we generated approximately $46 million in sourcing savings from our first cost efforts, which help to offset $38 million increase in incentive based compensation and higher inventory shrink. Of note as we look to 2018, we expect to generate approximately $40 million in additional sourcing benefits. Finally, adjusted net income for the year increased 4% to $405 million compared $390 million in fiscal 2016 and adjusted diluted EPS increased 15% to $2.17 per diluted common share, up from $1.88 per diluted common share in fiscal 2016. Turning to the balance sheet. Total merchandise inventory was $1.1 billion, down $4 million from the end of 2016. Average inventory per Michaels' store, including e-commerce and distribution centers at the end of 2017, was 2% lower than at year-end last year. At the end of the year, cash on the balance sheet was $426 million, total debt was $2.7 billion and revolver availability was $717 million. Total debt to adjusted EBITDA decreased to 3.1 times. As it relates to capital allocation, our approach has not changed from what we outlined at our Analyst Day in June. Our strategy is to fund operations and investments, including potential acquisition and then to return excess free cash flow over time to shareholders through share repurchases while targeting total debt of 2.5 to 3 times adjusted EBITDA. In fiscal 2017, we generated free cash flow defined as cash flow from operations less capital expenditures of $396 million. Cash capital expenditures for the year were $128 million. For the full year, we purchased 13 million shares of our common stock for approximately $249 million. At the end of the year, we had approximately $350 million left under our current repurchase authorization. Reflecting our commitment to investing in businesses with sales and profit growth potential, we plan to close 94 freestanding Aaron Brothers’ stores and reposition Aaron Brothers as a store-within-a-store within all Michaels stores providing custom framing services. Aaron Brothers is a respected brand. The comp sales have been challenging for multiple years. For reference, net sales for Aaron Brothers’ was approximately $110 million and operating income was approximately breakeven in 2017. The business was on track to be unprofitable in 2018 and continuing to operate the stores which require significant infrastructure investment. We expect the after-tax cost of implementing these changes will be in the range of $37 million to $42 million, driven primarily by expense associated with the remaining lease obligations. We expect the vast majority of the cost will be recognized in the first quarter of fiscal 2018. We expect the after-tax cash impact of the changes to be minimal. The benefits of tax reform provide a unique opportunity to accelerate key initiatives to support our long-term profitable growth. The reduction in corporate tax rate equates to a total 2018 net income benefit of between $50 million and $55 million, of which we expect to flow through about two-thirds to net income. We've decided to proactively reinvest for the remainder into the business to drive longer-term benefit, which in the near-term will pressure 2018 operating margins by 40 to 50 basis points. We expect the timing of this spend will be weighted more towards the first half of the year so that we are well positioned for the holiday season. As Chuck mentioned earlier, our investments include converting approximately 235 additional stores to our FMA layout, bringing e-commerce fulfillment in-house, strengthening our data analytics and enhancing the customer experience in-store and online. With that as context, let me walk you through our fiscal 2018 guidance. As a reminder, fiscal 2018 will have 52 weeks versus 53 weeks in fiscal 2017. Also, our 2018 guidance assumes the Aaron Brothers’ stores were closed as of the start of the fiscal year and exclude any restructuring charge. For fiscal 2018, we expect total sales will be between $5.2 billion and $5.3 billion and comp store sales will be flat to up 1.5%. This guidance includes our plans open 19 new Michaels stores and relocate 17 Michaels stores. Operating income for the year is expected to be between $677 million and $710 million. This guidance includes a temporary headwind of $23 million of investment facilitated by the tax reform benefit I just discussed and $10 million to $15 million of increased transportation cost. Excluding these two items on a 52 week basis, the implied operating income growth at the upper end of our guidance range would be about 5%, in line with the longer-term operating income growth guidance we provided at our Investor Day last June. We expect interest expense will be approximately $144 million, reflecting the expectation of three additional rate increases as implied by the current LIBOR curve. Today, most of our debt is impacted by rising interest rate. Given the current rate environment and expectations to rate increases, we’ll be looking at how we can create more balanced mix of fixed and floating debt. We’ll share more information with you on our progress as appropriate. Our earnings outlook assumes an effective tax rate of approximately 24% for the year, reflecting the full benefit of a lower and corporate tax rate. I would note that the cash benefit from the lower corporate tax rate will be relied in 2019 as we defer a majority of our cash tax payments in the current year to May of the following year, a practice commonly known as the annualized income installment method. These assumptions translate to an adjusted diluted EPS range of $2.19 to $2.32 for fiscal 2018 on approximately 185 million diluted weighted average common shares for the full-year. This range represents an increase of 5% to 12% when adjusted for Aaron Brothers’ store closing and compared to adjusted earnings per share of $0.208 for fiscal 2017 on a 52-week basis. As a reminder, this guidance this does not include any potential stock repurchases or debt pay down. Our fiscal 2018 capital expenditures plan is to invest $160 million to $170 million, which is at the higher end of our longer-term guidance for CapEx of around 2% to 3% of sales. Turning to Q1, we expect total sales will be between $1.14 billion and $1.15 billion include store sales will be flat to up 1%. As a reminder, Easter is earlier in 2018 than in 2017, which result in a shorter selling season and as a sales headwind for us. We plan to open eight net new Michaels’ stores and relocate nine stores in the quarter. For comparison purposes, in Q1 last year, we opened three new Michael stores and relocated seven stores. We expect operating income for the first quarter will be between $121 million and $127 million. This guidance include the expectation of a higher supply chain cost, higher occupancy cost, reflecting the timing of new stores and modest expense deleverage, resulting from our investment agenda, partially offset by sourcing benefits. Our Q1 guidance for adjusted diluted earnings per common share is $0.36 to $38, assuming a diluted weighted average common share count of 184 million shares. In closing, in 2017, we made meaningful progress against all of our objectives and delivered another year of solid performance. In 2018, we intend to roll on this foundation and accelerate key initiatives, which we are confident will position us to drive profitable growth over the longer term. Now, I would like to open up call to take your question. Operator?

[Operator:]

We will now begin the question-and-answer session [Operator Instructions]. The first question comes from Steve Forbes with Guggenheim Securities. Please go ahead.

[Steve Forbes:]

May be to start here, can you provide some additional color around the comp guidance. I guess as I think about it couple of things come to mind, you think about the FMA format conversions. Is that a potential headwind to the comp profile given any disruption? Are you assuming that you capture a transfer of revenue from the Aaron Brothers’ store closures? I mean the e-commerce channel is still performing really well. I mean, all of these things could be potential drivers. I guess just curious about your thoughts about the underlying performance of the business, given the implied comp guide and these likely tailwinds that you have in ’18?

[Chuck Rubin:]

Steve, I think there’s some headwinds and tailwinds. So you talked about the FMA, we don't see that as an overall headwind for the full year. And in fact in the back half of the year should be a tailwind. The Aaron Brothers component of it, on the one hand, we expect that we’re going to be able to capture some of the business from Aaron Brothers in Michael stores, we’re certainly going to target those Aaron Brothers customers. At the same time, we have to liquidate inventory that starting today in those Aaron Brothers store. So that there's a tailwind and then there's a headwind as well. You've got other situations, you have the Toys 'R' Us liquidation, we’re not heavily in the toy business necessary, but we have a good-size kids business that does have some degree of overlap. Underlying all of it though is when you break out our business, we continue to do very well with our seasonal product, it’s a much wider playing field, everybody from home improvement to discount to the Michaels, plays in that arena and we’re doing very well with that. When it comes to the core arts and crafts business though, as we talked before, there's no great third-party data to track this but all the data that we can put together and the pieces that we have to compile together would suggest that the industry as a whole right now is flattish. So when you throw all that together and then as many of you on the call today coming from the Northeast, clearly the northeast has had more than its fair share of weather problems in the first quarter when you throw it all together, we believe that it was wise to take this kind of view on comp. We planned our expense structure to this conservative view and we’re working to make it better than this. But at this early stage given all those dynamics we thought it was wiser to be conservative.

[Operator:]

Thank you. The next question comes from Christopher Horvers with JP Morgan. Please go ahead.

[Christopher Horvers:]

Can you talk about cash, at this morning's stock price, $426 million and that stock price is in the teens, low teens on relative to the market cap. You didn't buyback any shares or no material shares in the fourth quarter. Why? Does any of that have to do with a potential debt refinancing as you look to lock in some fixed rates? And any thoughts about how you plan to deploy the cash going forward, more than just normal here's our capital allocation priority. So I can front run your answer.

[Chuck Rubin:]

You may be disappointed, Chris.

[Denise Paulonis:]

Chris, I don't think that -- our strategy really has not changed since what we discussed at the Analyst Day in June. We view being disciplined with our cash is a high priority for us and we have a focus on returning capital to shareholders, and while we prudently manage the balance sheet. So when we think about what we do, we focus on investing in the business and strategic acquisitions that might drive growth and then think about how to return capital through either share repurchases or debt pay down. We haven't changed that. When we think about buyback activity in a given quarter, it's impacted by both our ability and willingness to execute the buybacks at a given time. And a lot of factors can influence that. We want to maintain flexibility right now and our overall approach to capital allocation hasn't changed.

[Christopher Horvers:]

So was there a 10b5-1 in place to where the stock price of that and that limited the ability to buy?

[Denise Paulonis:]

I don't think we can comment on that now, just that our overall approach hasn't changed.

[Operator:]

The next question comes from Simeon Gutman with Morgan Stanley. Please go ahead.

[Joshua Siber:]

I'm curious the investments that you outlined they tend to be longer tailed for most retailers. Can you talk about the timeframe for some of these initiatives and when they roll, and whether or not they roll off in 2019?

[Chuck Rubin:]

Well, the FMA pads will be put in place in the latter part of Q2. So there's work going on now for those, but the significant impact is in Q2. Supply chain work to bring e-commerce fulfillment in-house from a third party provider, a lot of that work runs through the year. But as Denise said, most of the spending that we're going to be doing is in the front half of the year. Like most retailers we try to limit a lot of extraneous activity in the back half of the year as we focus on sales. The work on the supply chain to bring e-commerce fulfillment in-house, while that work is taking place this year, the actual in-sourcing won't fully take effect until next year. As part of the analytical investments that we're making, here again that's happening that's mostly frontloaded in the front half of the year. Although, there'll be some trickle to that in the back half.

[Operator:]

The next question comes from Seth Sigman with Credit Suisse. Please go ahead.

[Seth Sigman:]

I want to talk a little bit about the custom framing business. So it’s obviously nice to see that improvement this quarter. Can you elaborate a little bit more on what you think is driving that improvement? And also remind us how is that category performed I guess on a full year basis? Obviously, it was better in the fourth quarter, but it was a drag I think prior to that, just as we're trying to assess the opportunity in 2018. Thank you.

[Chuck Rubin:]

Well as we said, it was better in the fourth quarter. It was overall, for the company, a drag in 2017. This is a radically different operating model than the rest of the store. So remember in the rest of the Michaels store, just to make the math somewhat simplified, we do about $4 million per store the average item we sell sales for about $4. So there is million units of product that have got to be moved through the store. There is a lot of operational work that goes into running a Michaels store. The custom frame counter though is a true selling environment, and it's a different approach, it's a different time spam that you spend with the customer. So the progress that we made -- we've done a lot of things, but one of the most exciting things that we've seen is the Aaron Brothers selling model was a bit different than what we had in the Michaels store and we leverage that and we've put in a different management model. So again to simplify this a bit, we've got kind of a district management staff focused only on the custom frame counter. There is a lot of rule playing that goes on between that new management staff and the teams within the individual Michael store there is a lot of additional training that's provided to them. So we think the progress that we're seeing is through, while result of many things, it's largely driven by just an improved experience between our own certified custom framer and the customer through this changed selling model that we put in place. And we've expanded that management model into the Michael stores such that about 50% of our sales volume in custom frame this year will be working under this new selling model.

[Operator:]

The next question comes from Matt Fassler with Goldman Sachs. Please go ahead.

[Matt Fassler:]

Can you talk about the consequences of the growing loyalty program and the data capture, both what you've been able to achieve so far commercially and with the additional investment that you said you are going to make in 2018. What kind of outcomes you are hoping for?

[Chuck Rubin:]

All along we've talked about that this is a really long process. There is a tremendous amount of data and we've made good progress on leveraging that data. So we saw, in 2017, really good scan margin or what we call our product margin improvements, and lot of that was driven through our sourcing effort. But we've made continued progress on managing our discounts better, such that we’re able to send different discount levels to different customers based on the historical profile. In our prepared comments, we've talked about one enhancement to our new POS systems where we can put out a serialized coupon. Up to this point when we put a coupon out there, it's the same coupon. If somebody wanted to share with their friend then they could. Serialized coupons are one-time use coupons. So we've made good progress on targeting different discount levels to individual customers. But we have a lot of data and analyzing that data like other companies, it becomes an ocean of data to work through. So leveraging additional technology, leveraging additional resources, the ability to target discounts, the ability to target marketing communications, the ability to glean additional merchandise insights out of what people are buying already, whether that's things around color or size of an item, those are all things that we get really excited about. But Matt we've talked to you and we've talked to others about this that this is running on the trajectory that we believed it would when previously asked about where we were in this game of analytics, I had said we were in the very early innings. We’re still in the second innings, but we've made progress. I'm pleased with the progress we've made, but we've got to become more sophisticated. And 2018 is one step along the way I promise you than the years to come there will be additional enhancements to be made on this analytics.

[Matt Fassler:]

Is there a third party module that you’re importing in 2018 or is it more of an incremental iterative change over time?

[Chuck Rubin:]

We’re using third parties to help us as well as internal resources combination.

[Operator:]

The next question comes from Curtis Nagle with Bank of America. Please go ahead.

[Liz Suzuki:]

Actually this is Liz Suzuki from BoA. So the expansion of your fabric offerings online is actually a pretty interesting development, especially since traditionally I think this is a category that many have considered to be pretty difficult to view online, it’s packed out the weight and feel is very important. So what have you found in your analysis as this category that led you to the decision to expand your fabric program online?

[Chuck Rubin:]

Well, it’s a low risk, low investment offering that we can put out there where we put. So remember, we have a division of stores in the upper Midwest, called Pat Catan and its small division about 35, 36 stores. They are larger footprint stores and last year we put fabric into those stores. And what we’ve discovered is that the selling on that fabric in the notion to go with fabric in the Pat Catan stores is pretty good. Now, it’s lower productivity than a Michaels store is, so that it's unlikely that you’re going to see a big fabric presentation in Michael stores; although, we are testing a couple of interest models, but that's very much in test mode. But we viewed being able to sell fabric online and leveraging that Pat Catan back in and leveraging the Hancock Fabrics name that we purchased about 24 months ago, I guess. We viewed this as an interesting combination to play in an area that we are not a player in today. We have very realistic expectations on the financial results, I don't see this as being at least initially, not a huge sales mover but we know our customer has looked to us to provide fabric in this arena. So we’re going to test this is and see what we can do. As I say, it’s low risk, low investment on our side.

[Operator:]

The next question comes from Laura Champine with Loop Capital Markets. Please go ahead.

[Laura Champine:]

Could you quantify the headwind from the earlier Easter, because your Q1 comp guidance looks very conservative, given the momentum you had coming out of Q4. Is there anything we might not understand happening in your sales trend quarter-to-date and if you can quantify that Easter headwind that would be great. Thanks.

[Chuck Rubin:]

We’re not going to quantify the Easter headwind, but Easter is two weeks earlier. And earlier Easter is not good for us. The guidance that we gave reflects other things that I commented on before. It’s a recognition that the Northeast is on its fourth nor'easter and like many retailers, our northeastern stores tend to be higher volume. So we've had that impact. You’ve got a lot of things in the marketplace. You’ve Toys R Us liquidation. But most importantly, when you look at our seasonal business, which has been so good for us, the first quarter seasonal is a smaller percent of our overall revenue and with Easter being earlier it’s an even smaller percent of our overall revenue. And when you look at the balance of our craft business, we think the industry right now is in a flattish environment. So put all that together and that's provided the guidance we provided.

[Denise Paulonis:]

And I’d add one more item. Once choice we did make this year is every year we do a certain amount of product reset or changes in our stores. We last year did more of that in Q1 and this year, we are doing a bit more of that in Q2. It was really in effort to balance more of the workload for our team members in our stores and be able to be a bit more efficient in our stores. But that delay and a bit of the newness coming in for the customer is also reflected in how we thought about Q1.

[Operator:]

The next question comes from Cristina Fernández with Telsey Advisory Group. Please go ahead.

[Cristina Fernández:]

I wanted to ask about the promotional landscape. I know you talked that you're able to be more efficient on lower promotions. So what are you seeing from your peers and what is your expectations over the course of 2018?

[Chuck Rubin:]

As we’ve talked before, Christina, this industry is a portfolio of businesses and we compete with everybody. So people sometimes look at us in the pure play perspective of us and Jo-Ann's and A.C. Moore and Hobby Lobby. We compete with Walmart and Amazon and Target and the Dollar Stores and now you’ve got Home Improvement, expanding into pieces of what we do as well. It's a very promotional environment. There is no doubt about it. Its high margin low price point kinds of stuff and the promotional environment continues to be intense. We don't see it changing. And the number of distribution points if anything will increase in 2018 compared to 2017. So we're pleased that we're getting smarter in how we use our discount dollars, but we're continuing to be aggressive in the promotion and we planned for that this year as well.

[Operator:]

The next question comes from Mike Baker with Deutsche Bank. Please go ahead.

[Mike Baker:]

A question on some of the reinvestment math and maybe it’s one question in three parts. So you said a third of the $50 million to $55 million of tax savings will be reinvested, so that's $17 million or $18 million at the midpoint, which is about 30, 33 basis points. You said 40 to 50 basis points. Is that -- I presume that that includes the transportation cost part of it, that 40 to 50 basis points?

[Denise Paulonis:]

Mike, I think it's a difference of if you're using 52 versus 53 week in the prior year and what the operating income rate would be. I think the key for you to think about is it $23 million of incremental expense dollars that we're investing pre tax.

[Mike Baker:]

And then CapEx is also up about the midpoint $30 million, $35 million. Is that step up -- I mean I presume that a lot of that is going to some of these initiatives that you’re talking about accelerating because of the tax windfall. Is that fair?

[Denise Paulonis:]

Some of it is certainly helping to support that. When you think about us bringing e-commerce fulfillment in-house there will be capital costs associated with doing that that are both physical costs as well as IT cost. There is also some natural cadence in how we were just planning some regular investment coming through as we continue to evolve our digital capabilities and those types of activities, we are just a little bit more elevated this year as well. The other part to remember is that in Canada we are rolling out POS this year and investing in our stores behind that.

[Mike Baker:]

Third part of the same question, in India reinvestments, you didn't really mention anything about labor or wages. I presume you think your labor and wage rates are consistent with industry standards. But a lot of retailers have talked about increases there. Do you feel like there will be any pressure on margins but need to do that as well?

[Chuck Rubin:]

I think in the near term, Mike, we feel good. So we've made investments in our team. We continue to make investments in our team. They are reflected in the numbers that we guided on this morning. And we're generally pleased with where we are. I mentioned we had incredibly high engagement. We do companywide engagement survey, every year we had the highest engagements maybe ever, but certainly that I recall, we've got low turnover amongst our team members. So we continue to invest to present both of the work environment and a good compensation scenario for our team and we’ll continue to do that.

[Operator:]

This concludes the question-and-answer session. I would like to turn the conference back over to Kiley Rawlins for any closing remarks.

[Kiley Rawlins:]

Thank you everyone for joining us today. I know we didn’t get to every question in the queue. As always, I will be available this week and in the next couple of weeks for any follow-up question. Again, thank you for your continued interest in the Michaels Company.

[Operator:]

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.