-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, ICH/9R/cT0QHQY2kEaHaVxz4v+DAgEZNdALwtgr64H1WlrjqHjNs6O+jvPtKUA05 ywJyaIvTFrY3Xyxk69Raww== 0000912057-01-526149.txt : 20010802 0000912057-01-526149.hdr.sgml : 20010802 ACCESSION NUMBER: 0000912057-01-526149 CONFORMED SUBMISSION TYPE: S-4 PUBLIC DOCUMENT COUNT: 13 FILED AS OF DATE: 20010801 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MICHAELS STORES INC CENTRAL INDEX KEY: 0000740670 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-HOBBY, TOY & GAME SHOPS [5945] IRS NUMBER: 751943604 STATE OF INCORPORATION: DE FISCAL YEAR END: 0201 FILING VALUES: FORM TYPE: S-4 SEC ACT: SEC FILE NUMBER: 333-66462 FILM NUMBER: 1695284 BUSINESS ADDRESS: STREET 1: 8000 BENT BRANCH DR STREET 2: PO BOX 619566 CITY: IRVING STATE: TX ZIP: 75063 BUSINESS PHONE: 2147147000 MAIL ADDRESS: STREET 1: PO BOX 619566 CITY: DFW STATE: TX ZIP: 75261 S-4 1 a2055355zs-4.txt S-4 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON AUGUST 1, 2001 REGISTRATION NO. 333- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 -------------------------- FORM S-4 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 -------------------------- MICHAELS STORES, INC. (Exact name of registrant as specified in its charter) DELAWARE 5945 75-1943604 (State or Other Jurisdiction of (Primary Standard (I.R.S. Employer Incorporation or Organization) Industrial Identification Number) Classification Code Number)
8000 BENT BRANCH DRIVE IRVING, TEXAS 75063 P.O. BOX 619566 DFW, TEXAS 75261-9566 (972) 409-1300 (Address, including zip code, and telephone number, including area code, of registrant's principal executive offices) BRYAN M. DECORDOVA EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER 8000 BENT BRANCH DRIVE IRVING, TEXAS 75063 (972) 409-1300 (Name, address, including zip code, and telephone number, including area code, of agent for service) -------------------------- COPIES TO: Mark V. Beasley, Esq. Mark V. Minton, Esq. Michaels Stores, Inc. Jones, Day, Reavis & Pogue 8000 Bent Branch Drive 2727 North Harwood Street Irving, Texas 75063 Dallas, Texas 75201-1515 (972) 409-1300 (214) 220-3939
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as practicable following the effective date of this registration statement. If the securities being registered on this form are being offered in connection with the formation of a holding company and there is compliance with General Instruction G, check the following box. / / If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. / / If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. / / -------------------------- CALCULATION OF REGISTRATION FEE
PROPOSED MAXIMUM PROPOSED MAXIMUM TITLE OF EACH CLASS OF AMOUNT TO OFFERING PRICE AGGREGATE AMOUNT OF SECURITIES TO BE REGISTERED BE REGISTERED PER UNIT OFFERING PRICE REGISTRATION FEE 9 1/4% Senior Notes Due 2009......... $200,000,000(1) 100% $200,000,000 $50,000
(1) Represents the maximum principal amount at maturity of 9 1/4% Senior Notes due 2009 that may be issued pursuant to the exchange offer described in this registration statement. -------------------------- THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- The information in this prospectus is not complete. Michaels Stores, Inc. may not sell or offer these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and Michaels Stores is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted. SUBJECT TO COMPLETION, DATED AUGUST 1, 2001 PROSPECTUS $200,000,000 [LOGO] OFFER TO EXCHANGE ALL OUTSTANDING 9 1/4% SENIOR NOTES DUE 2009 FOR 9 1/4% SENIOR NOTES DUE 2009 OF MICHAELS STORES, INC. THIS EXCHANGE OFFER WILL EXPIRE AT 5:00 P.M., NEW YORK CITY TIME, ON , 2001. -------------- The Exchange Notes - The terms of the notes to be issued are substantially identical to the outstanding notes that Michaels Stores issued on July 6, 2001, except for transfer restrictions, registration rights and liquidated damages provisions relating to the outstanding notes that will not apply to the notes. - Interest on the notes accrues at the rate of 9 1/4% per year, payable in cash every six months on January 1 and July 1, with the first payment on January 1, 2002. - The notes are senior, unsecured obligations of Michaels Stores and rank equally with our other senior indebtedness and are effectively subordinated to the obligations of our subsidiaries. Material Terms of the Exchange Offer - Expires at 5:00 p.m., New York City time, on , 2001, unless extended. - The exchange offer is not subject to any condition other than that it must not violate applicable law or any applicable interpretation of the Staff of the Securities and Exchange Commission. - All outstanding notes that are validly tendered and not validly withdrawn will be exchanged for an equal principal amount of notes which are registered under the Securities Act of 1933. - Tenders of outstanding notes may be withdrawn at any time prior to the expiration of the exchange offer. - Michaels Stores will not receive any cash proceeds from the exchange offer. ------------------- PLEASE CONSIDER CAREFULLY THE "RISK FACTORS" BEGINNING ON PAGE 12 OF THIS PROSPECTUS. ----------------- NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES COMMISSION HAS APPROVED THE NOTES TO BE DISTRIBUTED IN THE EXCHANGE OFFER, NOR HAVE ANY OF THESE ORGANIZATIONS DETERMINED THAT THIS PROSPECTUS IS ACCURATE OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. ------------------- The date of this prospectus is , 2001. REFERENCES TO ADDITIONAL INFORMATION This prospectus incorporates important business and financial information about Michaels Stores that is not included in or delivered with this prospectus. You may obtain documents that are filed by Michaels Stores with the Securities and Exchange Commission and incorporated by reference in this prospectus by requesting the documents, in writing or by telephone, from the Securities and Exchange Commission or: Michaels Stores, Inc. 8000 Bent Branch Drive Irving, Texas 75063 Attention: Investor Relations Telephone: (972) 409-1300 If you would like to request copies of these documents, please do so by , 2001 in order to receive them before the expiration of the exchange offer. See "Where You Can Find More Information." TABLE OF CONTENTS Forward-Looking Statements.............. i Where You Can Find More Information..... i Incorporation of Certain Documents by Reference............................. ii Industry and Market Data................ ii Summary................................. 1 Risk Factors............................ 12 Use of Proceeds......................... 18 Capitalization.......................... 18 Selected Consolidated Financial and Operating Data........................ 19 Management's Discussion and Analysis of Financial Condition and Results of Operations............................ 21 Industry Overview....................... 29 Business................................ 30 Management.............................. 40 Description of Other Indebtedness....... 42 The Exchange Offer...................... 44 Description of the Notes................ 54 Plan of Distribution.................... 86 Legal Matters........................... 86 Experts................................. 86 Index to Consolidated Financial Statements and Supplementary Data..... F-1
------------------------ FORWARD-LOOKING STATEMENTS Some of our statements contained in this prospectus are forward-looking statements that reflect our plans, estimates, and beliefs. Words such as "anticipates," "plans," "estimates," "expects," "believes," and similar expressions often identify forward-looking statements. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of the risk factors set forth below and other factors set forth in or incorporated by reference in this prospectus. These factors include: - customer demand and trends in the arts and crafts industry, - impact of competitor's locations, pricing and products, - related inventory risks due to shifts in customer demand, - impact of economic conditions, - availability of acceptable locations for new stores, - difficulties in implementing information system technologies, - supply constraints, - results of financing efforts, and - effectiveness of advertising strategies. All subsequent written and oral forward-looking statements attributable to us and persons acting on our behalf are qualified in their entirety by the cautionary statements contained in this section and elsewhere in this prospectus. You should carefully review the risks detailed in "Risk Factors," which may also impact our forward-looking statements. WHERE YOU CAN FIND MORE INFORMATION We file periodic reports, proxy statements and other information with the SEC in accordance with the requirements of the Securities and Exchange Act of 1934. Our filings with the SEC are available to the public over the Internet at the SEC's web site at http://www.sec.gov. You may also read and copy any document we file with the SEC at the SEC's Public Reference Room at 450 Fifth Street, N.W., Room 1024, Washington, D.C. 20549. You may obtain information on the operation of the Public i Reference Room by calling the SEC at 1-800-SEC-0330. You may also read copies of reports, proxy statements and other documents at the offices of the Nasdaq National Market at 1735 K Street, N.W., Washington, D.C. 20006. ------------------------ INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE We "incorporate by reference" into this prospectus the information we file with the SEC, which means that we can disclose important information to you by referring you to those documents. The information incorporated by reference is an important part of this prospectus. Information we later file with the SEC prior to the consummation of the offering under this prospectus will automatically modify, update or supersede information in this prospectus, in an amendment or supplement to this prospectus, or in a document incorporated or deemed to be incorporated by reference herein. Any statement so modified, updated, or superseded shall not be deemed, except as so modified, updated, or superseded, to constitute a part of this prospectus. We incorporate by reference the documents listed below and any filings we make with the SEC under Sections 13(a), 13(c), 14 or 15(d) of the Exchange Act after the date of this prospectus and before the exchange of the exchange notes for the outstanding notes: - our annual report on Form 10-K for the fiscal year ended February 3, 2001, - our quarterly report on Form 10-Q for the fiscal quarter ended May 5, 2001, - our current report on Form 8-K filed with the SEC on June 19, 2001, - our current report on Form 8-K filed with the SEC on July 6, 2001, - our current report on Form 8-K filed with the SEC on July 9, 2001, and - our current report on Form 8-K filed with the SEC on July 27, 2001. You may request a copy of these filings at no cost by writing to or telephoning our Investor Relations Department at the following address: Michaels Stores, Inc. 8000 Bent Branch Drive Irving, Texas 75063 Telephone: (972) 409-1300 The information relating to Michaels Stores contained in this prospectus should be read together with the information in the documents incorporated by reference. ------------------------ INDUSTRY AND MARKET DATA The industry and market data presented in this prospectus are inherently estimates and are based upon third-party data, including information compiled by the Hobby Industry Association, industry analysts, and reports filed by other market participants with the SEC, discussions with our customers and suppliers, and our own internal estimates. While we believe that these data are reasonable, in some cases these data are based on our or others' estimates and cannot be verified by us. Accordingly, readers are cautioned not to place undue reliance on these industry and market data. ii SUMMARY THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY THE MORE DETAILED INFORMATION INCLUDED ELSEWHERE OR INCORPORATED BY REFERENCE IN THIS PROSPECTUS. YOU SHOULD READ THE MORE DETAILED INFORMATION AND CONSOLIDATED FINANCIAL STATEMENTS AND THE RELATED NOTES APPEARING ELSEWHERE IN THIS PROSPECTUS AND INCORPORATED BY REFERENCE INTO THIS PROSPECTUS. AS USED IN THIS PROSPECTUS, ALL REFERENCES TO "MICHAELS STORES," "MICHAELS," "WE," "US" AND ALL SIMILAR REFERENCES ARE TO MICHAELS STORES, INC., A DELAWARE CORPORATION, AND ITS CONSOLIDATED SUBSIDIARIES, UNLESS OTHERWISE EXPRESSLY STATED OR THE CONTEXT OTHERWISE REQUIRES. OUR FISCAL YEAR INCLUDES 52 OR 53 WEEKS AND ENDS ON THE SATURDAY CLOSEST TO JANUARY 31. REFERENCES TO FISCAL YEAR MEAN THE YEAR IN WHICH THAT FISCAL YEAR BEGAN. OUR FISCAL YEAR 1996 ENDED ON FEBRUARY 1, 1997 AND FISCAL YEAR 2000 ENDED ON FEBRUARY 3, 2001 AND EACH CONTAINED 53 WEEKS. OUR FISCAL YEAR 1997 ENDED ON JANUARY 31, 1998, FISCAL YEAR 1998 ENDED ON JANUARY 30, 1999 AND FISCAL YEAR 1999 ENDED ON JANUARY 29, 2000 AND EACH CONTAINED 52 WEEKS. MICHAELS STORES, INC. We are the largest national specialty retailer providing materials, ideas, and education for creative activities in home decor, art, and craft projects. As of May 5, 2001, we operate 644 Michaels retail stores in 48 states, as well as Canada and Puerto Rico, averaging 18,100 square feet of selling space. Through our Michaels stores, we offer more than 40,000 stock keeping units, or SKUs, including: - products for the do-it-yourself home decorator, including picture framing materials and custom framing services, silk and dried floral products, and seasonal decor items, - art supplies, including memory books, surfaces and pads, brushes, paints, adhesives, and finishes, and - craft supplies, including beads, jewelry, needlework and knitting supplies, and kids' craft materials. In addition, through Aaron Brothers, our wholly-owned subsidiary, we operate 123 stores, averaging 5,900 square feet of selling space as of May 5, 2001. Through our Aaron Brothers stores, we offer an average of 7,900 SKUs including photo frames, a full line of ready-made frames, custom framing services, and a wide selection of art supplies. For the latest 53 weeks ended May 5, 2001, we generated approximately $2.3 billion in revenues and approximately $215.9 million in Adjusted EBITDA, which excludes the effects of unusual, non-recurring charges. Since 1996, under the leadership of Michael Rouleau, our President and Chief Executive Officer, we have improved profitability while experiencing significant growth, resulting in an improvement in Adjusted EBITDA margins from 4.6% in fiscal 1996 to 9.7% in fiscal 2000. Through June 2, 2001, we reported 28 months of consecutive comparable store sales growth. Our performance has been the result of a variety of initiatives, including: - chain-wide installation of a point-of-sale, or POS, system to record item-level sales, - implementation of plan-o-grams for increased coordination and centralization, including elimination of non-core merchandise, - reduction of costs through centralized negotiated pricing, - development and use of a new store prototype and store opening process, - increased SKUs replenished from Michaels distribution centers thereby decreasing direct shipments from suppliers, which lowers our overall inventory costs and improves store merchandise in-stock position, and 1 - strengthening the quality and depth of our management team. INDUSTRY As the leading specialty retailer providing materials, ideas, and education for creative activities in home decor, art, and craft projects, we believe that we are well positioned to benefit from several favorable consumer trends. Based on our historical sales trends, we believe demographic changes, particularly an aging baby boomer population, and a favorable economic environment have led to increases in investment in the home and purchases of new homes, an increasing focus on home-based, family activities, and the trend towards making, rather than buying, gift items. According to the most recently published industry study, a 1997 report by the Hobby Industry Association, 65% of United States households surveyed had at least one member who engaged in a craft activity within the prior year. We compete across several industries in addition to arts and crafts, including home decor, party supplies, candles, photo frames, and custom framing. For example, approximately 46% of our sales are derived from three decorative categories--silk and dried flowers, picture framing, and seasonal products. When this broader focus is considered, a recently published research report estimates the markets in which our products are sold at over $30 billion. COMPETITIVE STRENGTHS We believe that we have the following competitive strengths within our industry: - CATEGORY LEADER IN A FRAGMENTED INDUSTRY. The market in which we compete is highly fragmented and is comprised of thousands of stores nationwide operated primarily by small, independent retailers. We are the largest and only national specialty retailer dedicated to serving the arts and crafts market. We believe that there are only four other major specialty arts and crafts retailers in the United States and Canada with annual sales in excess of $200 million. Moreover, we believe that our fiscal 2000 sales were more than twice as large as those of our largest direct competitor. - STRONG BRAND NAMES AND LOYAL CUSTOMER BASE. Our Michaels and Aaron Brothers brand names are identified with arts and crafts and custom framing throughout our market areas in the United States and Canada. From fiscal 1996 through fiscal 2000, we have spent approximately $414.4 million on advertising, which has strengthened and reinforced our brand names. Additionally, our strong brand names enhance our ability to open new stores economically as our target customers are generally familiar with us. Through our broad, in-stock product assortments, friendly, knowledgeable and well-trained sales associates, educational in-store events, project instruction displays, MICHAELS CREATE! magazine, and our Internet site, www.michaels.com, we offer an interactive shopping experience. As a result, we have built a loyal customer base of arts and crafts enthusiasts. - SIGNIFICANT PURCHASING POWER AND LIMITED VENDOR CONCENTRATION. We purchase merchandise from over 1,400 suppliers. We believe that our buying power enables us to acquire products on favorable terms. Centralized merchandising management teams for Michaels and Aaron Brothers negotiate with vendors on behalf of all their stores to obtain the lowest net merchandise costs and improve control over product mix and inventory. In fiscal 2000, our top 10 vendors accounted for approximately 19% of total purchases with no single vendor accounting for more than 4% of total purchases. - POS AND REORDERING SYSTEMS. Each of our stores is supported by our POS and reordering systems. Our POS systems provide us with valuable data regarding sales trends that permit us to adjust our merchandise ordering in response to customer demands. We intend to use this information to further track customer spending habits and product correlations. Our Michaels stores' reordering system utilizes in-store radio frequency, or RF, guns, which provide per item historical 2 sales trend feedback to facilitate the reordering process. In addition, RF guns are connected to our distribution centers allowing for easy and accurate merchandise reordering. Our Aaron Brothers stores utilize a perpetual inventory and automated replenishment system. These in-store technologies are closely integrated with our distribution centers, which utilize computerized warehouse management systems and radio frequency terminals. - FAVORABLE REAL ESTATE. We believe our stores' locations in high-traffic "power centers" is integral to our success. We generally obtain store sites in shopping centers with other nationally recognized retailers that draw similar customer demographics as our stores. As market demographics change, we often relocate stores to remain in high-traffic areas. - HIGHLY EXPERIENCED MANAGEMENT TEAM WITH A PROVEN TRACK RECORD. Our management team is composed of seasoned retail executives, with an average of more than 30 years of retail industry experience among our senior management team. Our management team has achieved consistent growth and profitability over the past four years. From fiscal 1996 through fiscal 2000, our sales and Adjusted EBITDA have grown at a compound annual rate of 13.0% and 36.5%, respectively. BUSINESS STRATEGY We intend to increase our revenues and profits by strengthening our position as the leading national retailer within the arts and crafts and home decor sector through the following strategies: - INCREASE SALES AND PRODUCTIVITY OF MICHAELS STORES. Our Michaels stores that have been open for more than 12 months currently average $3.5 million in sales per store. We believe we can increase average sales per store to $5.0 million. We intend to achieve this objective by increasing the dollar amount per sale and by creating additional demand for our products. - INCREASING DOLLAR AMOUNT PER SALE. We believe if a customer consistently finds the desired product in-stock, the customer will view Michaels stores as a store-of-choice and purchase additional merchandise while in the store. We intend to enhance each store's in-stock position of key merchandise by improving our supply chain. Our distribution centers allow us to leverage our price negotiations with our suppliers by ordering significant quantities, while also providing us the ability to break large orders into smaller quantities to allow for a timely and economical response to stores' in-stock demands. Through our distribution initiatives in fiscal 2001 and 2002, we will add distribution capacity of 1.1 million square feet to our existing 1.8 million square feet. We are also testing a perpetual inventory system, with an expected roll-out starting in fiscal 2002, to further enhance our capability to monitor and manage our in-store inventories. - CREATING ADDITIONAL DEMAND FOR OUR PRODUCTS. We are currently targeting increased demand for our products through traditional retail and advertising and multimedia channels. We are implementing this strategy by: u holding in-store classes, demonstrations, and other educational events utilizing merchandise available in our stores, u promoting craft ideas and projects in our recently launched bi-monthly MICHAELS CREATE! magazine, which has become the second most popular arts and crafts publication in its debut issue. The magazine will be carried by other major retailers, including K-mart and Target, u promoting craft ideas on our www.michaels.com website, and u participating in industry-wide promotion campaigns. 3 - ENHANCE MERCHANDISE OPERATING MARGINS. We intend to enhance operating margins through additional leverage of our consolidated purchasing activities. We plan to leverage our technology systems to improve margins on seasonal products through our implementation of allocation technologies that more efficiently allocate merchandise among stores, and to maximize margins on promotional sales by determining more accurately the most profitable promotional price for each product. We continue to seek value-added opportunities to complement our core businesses, such as our recent expansion into art prints and Michaels-manufactured framing products, which extends and enhances our custom framing business. In addition, we continue to evaluate opportunities to further reduce our merchandise costs and ensure adequate supplies through vertical integration. - GROW THROUGH NEW MICHAELS STORE OPENINGS. We believe the United States and Canadian markets can support up to 1,100 Michaels stores. We plan to open approximately 75 new Michaels stores each year beginning in fiscal 2001 and extending into the foreseeable future, funded primarily through operating earnings and seasonal borrowings. Since the beginning of fiscal 1998, we have opened or relocated 268 Michaels stores using our standardized opening procedures, which contain more than 500 steps to ensure a smooth opening with a merchandise assortment and presentation consistent with our existing stores. We have developed and are refining our Michaels store prototype to constantly incorporate improved merchandising techniques and store layouts. - EXPAND AARON BROTHERS NATIONWIDE. We plan to open approximately 20 new Aaron Brothers stores in fiscal 2001, also funded primarily through operating earnings and seasonal borrowings. Assuming successful openings in new markets, we plan to roll out this concept nationwide and open 25 to 75 new Aaron Brothers stores per year in each of the subsequent three fiscal years. We believe the United States and Canadian markets can support up to 600 Aaron Brothers stores. RECENT EVENTS In May 2001, we entered into a new senior unsecured bank credit facility, which replaced our previous $100 million senior unsecured bank credit facility. Our new bank credit facility provides for a $200 million revolving line of credit with a $25 million competitive bid loan feature and a $70 million letter of credit sub-facility. See "Description of Other Indebtedness." ------------------------ Our principal executive offices are located at 8000 Bent Branch Drive, Irving, Texas 75063. Our telephone number is (972) 409-1300. Our website address is www.michaels.com. Information on our website is not part of this prospectus. 4 THE EXCHANGE OFFER The Exchange Offer................... Michaels Stores offers to exchange $200.0 million in principal amount of its 9 1/4% Senior Notes due July 1, 2009, which have been registered under the federal securities laws, for $200.0 million principal amount of its outstanding unregistered 9 1/4% Senior Notes due July 1, 2009 which Michaels Stores issued on July 6, 2001 in a private offering. You have the right to exchange your outstanding notes for exchange notes with substantially identical terms. In order for your outstanding notes to be exchanged, you must properly tender them prior to the expiration of the exchange offer. All outstanding notes that are validly tendered and not validly withdrawn will be exchanged. Michaels Stores will issue the exchange notes on or promptly after the expiration of the exchange offer. Registration Rights Agreement........ Michaels Stores sold the outstanding notes on July 6, 2001 to a limited number of initial purchasers. At that time, Michaels Stores signed a registration rights agreement with those initial purchasers, which requires Michaels Stores to conduct this exchange offer. This exchange offer is intended to satisfy those rights set forth in the registration rights agreement. After the exchange offer is complete, you will no longer be entitled to registration rights with respect to outstanding notes you do not exchange. If You Fail to Exchange Your Outstanding Notes.................. If you do not exchange your outstanding notes for exchange notes in the exchange offer, you will continue to be subject to the restrictions on transfer provided in the outstanding notes and the indenture governing those notes. In general, you may not offer or sell your outstanding notes unless they are registered under the federal securities laws or are sold in a transaction exempt from or not subject to the registration requirements of the federal securities laws and applicable state securities laws. Expiration Date...................... The exchange offer will expire at 5:00 p.m., New York City time, on , 2001 unless Michaels Stores decides to extend the expiration date. See "The Exchange Offer--Expiration Date; Extensions; Amendments." Conditions to the Exchange Offer.............................. The exchange offer is subject to conditions which Michaels Stores may waive. The exchange offer is not conditioned upon any minimum amount of outstanding notes being tendered for exchange. See "The Exchange Offer--Conditions." Michaels Stores reserves the right, subject to applicable law, at any time and from time to time: - to delay the acceptance of the outstanding notes;
5 - to terminate the exchange offer if specified conditions have not been satisfied; - to extend the expiration date of the exchange offer and retain all tendered outstanding notes subject to the right of tendering holders to withdraw their tender of outstanding notes; and - to waive any condition or otherwise amend the terms of the exchange offer in any respect. See "The Exchange Offer--Expiration Date; Extensions; Amendments." Procedures for Tendering Notes....... If you wish to tender your outstanding notes for exchange, you must: - complete and sign the enclosed letter of transmittal by following the related instructions; and - send the letter of transmittal, as directed in the instructions, together with any other required documents, to the exchange agent, either (1) with the outstanding notes to be tendered or (2) in compliance with the specified procedures for guaranteed delivery of the outstanding notes. Brokers, dealers, commercial banks, trust companies and other nominees may also effect tenders by book-entry transfer. Please do not send your letter of transmittal or certificates representing your outstanding notes to Michaels Stores. Those documents should only be sent to the exchange agent. Questions regarding how to tender and requests for information should be directed to the exchange agent. See "The Exchange Offer--Exchange Agent." Special Procedures for Beneficial Owners.................. If your outstanding notes are registered in the name of a broker, dealer, commercial bank, trust company or other nominee, Michaels Stores urges you to contact that person promptly if you wish to tender your outstanding notes pursuant to the exchange offer. See "The Exchange Offer--Procedures for Tendering." Withdrawal Rights.................... You may withdraw the tender of your outstanding notes at any time prior to the expiration date of the exchange offer by delivering a written notice of your withdrawal to the exchange agent. You must also follow the withdrawal procedures as described under the heading "The Exchange Offer--Withdrawal of Tenders." Resale of Exchange Notes............. Michaels Stores believes that you will be able to offer for resale, resell or otherwise transfer exchange notes issued in the exchange offer without compliance with the registration and prospectus delivery provisions of the federal securities laws, provided that: - you are acquiring the exchange notes in the ordinary course of business;
6 - you are not participating, and have no arrangement or understanding with any person to participate, in the distribution of the exchange notes; and - you are not an affiliate of Michaels Stores. An affiliate of Michaels Stores is a person that "controls or is controlled by or is under common control with" Michaels Stores. Michaels Stores' belief is based on interpretations by the Staff of the SEC, as set forth in no-action letters issued to third parties unrelated to Michaels Stores. The Staff has not considered this exchange offer in the context of a no-action letter, and Michaels Stores cannot assure you that the Staff would make a similar determination with respect to this exchange offer. If Michaels Stores' belief is not accurate and you transfer an exchange note without delivering a prospectus meeting the requirements of the federal securities laws or without an exemption from these laws, you may incur liability under the federal securities laws. Michaels Stores does not and will not assume or indemnify you against this liability. Each broker-dealer that receives exchange notes for its own account in exchange for outstanding notes which were acquired by such broker-dealer as a result of market-making or other trading activities must agree to deliver a prospectus meeting the requirements of the federal securities laws in connection with any resale of the exchange notes. See "The Exchange Offer--Resale of the Exchange Notes." Exchange Agent....................... The exchange agent for the exchange offer is The Bank of New York. The address, telephone number and facsimile number of the exchange agent are set forth in "The Exchange Offer--Exchange Agent" and in the letter of transmittal. See "The Exchange Offer" for more detailed information concerning the exchange offer.
THE EXCHANGE NOTES Exchange Notes....................... $200.0 million principal amount of Michaels Stores' 9 1/4% Senior Notes due July 1, 2009. Interest Payment Dates............... January 1 and July 1, beginning on January 1, 2002. Ranking.............................. The exchange notes will not be secured debt of Michaels Stores and the exchange notes will rank equally with our senior indebtedness and will be effectively subordinated to the obligations of our subsidiaries.
7 As of May 5, 2001, after giving effect to the offering of the notes and the use of proceeds from the outstanding notes to redeem our 10 7/8% senior notes due 2006, we would have had $200.6 million of senior debt outstanding and, except for the guarantee by Aaron Brothers of our bank credit facility, our subsidiaries would have had no debt outstanding. We have no subordinated indebtedness except for intercompany debt. Optional Redemption.................. We may redeem some or all of the notes at any time on or after July 1, 2005, at the redemption prices described in this prospectus. Public Equity Offering Optional Redemption......................... Before July 1, 2004, we may redeem up to 35% of the aggregate principal amount of the notes with the net Redemption proceeds of one or more public equity offerings at 109.25% of the principal amount of the notes, plus accrued interest, if at least 65% of the aggregate principal amount of the notes originally issued remains outstanding after the redemption. Change of Control.................... When a change of control occurs, each holder of notes may require us to repurchase some or all of its notes at a purchase price equal to 101% of the principal amount of the notes, plus accrued interest. Covenants............................ The indenture governing the notes contains covenants that, among other things, limits our ability, and the ability of our restricted subsidiaries, to: - incur additional indebtedness, - make restricted payments, - create certain liens or enter into sale and leaseback transactions, - issue or sell preferred stock of our restricted subsidiaries, - sell assets, - restrict dividend or other payments to us, - engage in transactions with affiliates, and - consolidate, merge or transfer all or substantially all of our assets and the assets of our subsidiaries on a consolidated basis. These covenants are subject to important exceptions and qualifications, which are described under the heading "Description of the Notes." To the extent we achieve and maintain investment grade ratings on the notes, many of these covenants will no longer be in effect.
8 See "The Exchange Notes" for more detailed information concerning the exchange notes. Risk Factors......................... See "Risk Factors" and the other information in this prospectus for a discussion of factors you should carefully consider. Use of Proceeds...................... We will not receive any cash proceeds from the issuance of the exchange notes.
9 SUMMARY CONSOLIDATED FINANCIAL AND OPERATING DATA The results of operations, balance sheet and other financial data below for fiscal years 1996, 1997, 1998, 1999 and 2000 has been derived from our audited consolidated financial statements and related notes. Audited consolidated financial statements as of January 29, 2000 and February 3, 2001 and for each of the three fiscal years ended February 3, 2001 appear elsewhere in this prospectus. References to fiscal year mean the year in which that fiscal year began. Our fiscal year 1996 ended on February 1, 1997 and fiscal year 2000 ended on February 3, 2001 and each contained 53 weeks. Our fiscal year 1997 ended on January 31, 1998, fiscal year 1998 ended on January 30, 1999 and fiscal year 1999 ended on January 29, 2000 and each contained 52 weeks. The results of operations, balance sheet and other financial data below for the 13 weeks ended April 29, 2000 and May 5, 2001 and for the 53 weeks ended May 5, 2001 is derived from our unaudited financial statements and reflects only normal recurring adjustments and other items as disclosed in the footnotes to this summary which, in the opinion of our management, are necessary for the fair presentation of this information. You should not expect the consolidated results of operations data, other financial data or other operating data of interim periods to be an indication of results for a full year. You should read the following information together with our consolidated financial statements and related notes included elsewhere in this prospectus and "Management's Discussion and Analysis of Financial Condition and Results of Operations" in this prospectus.
FISCAL YEAR -------------------------------------------------------------- 1996(1) 1997 1998 1999(2) 2000(3) ---------- ---------- ---------- ---------- ---------- (IN THOUSANDS EXCEPT PER SHARE AND STORE DATA) RESULTS OF OPERATIONS DATA: Net sales(5)............ $1,378,277 $1,456,524 $1,573,965 $1,882,522 $2,249,440 Operating income (loss)................ (20,987) 68,942 89,112 122,672 148,417 Interest expense........ 21,038 23,448 22,678 22,654 18,026 Net income (loss)....... (31,233) 30,077 43,601 62,301 78,589 Diluted earnings (loss) per common share...... (1.35) 1.05 1.43 2.01 2.29 BALANCE SHEET DATA: Cash and equivalents.... $ 59,069 $ 162,283 $ 96,124 $ 77,398 $ 28,191 Merchandise inventories........... 351,208 385,580 501,239 615,065 663,700 Total current assets.... 437,543 573,183 621,928 722,987 729,816 Total assets............ 784,435 908,494 962,650 1,096,703 1,158,436 Working capital......... 239,812 358,691 391,227 452,011 440,808 Long-term debt(6)....... 238,608 234,889 230,896 224,635 125,145 Total debt.............. 242,823 239,551 236,869 230,988 125,876 Total liabilities....... 451,633 466,583 481,671 529,905 453,790 Stockholders' equity.... 332,802 441,911 480,979 566,798 704,646 OTHER FINANCIAL DATA: Ratio of earnings to fixed charges(7)...... -- (8) 1.8x 2.0x 2.2x 2.4x Cash flow from operating activities............ $ 29,749 $ 77,907 $ 6,038 $ 60,770 $ 146,758 Cash flow from investing activities............ (32,312) (38,988) (59,567) (90,759) (120,084) Cash flow from financing activities............ 58,762 64,295 (12,630) 11,263 (75,881) EBITDA(9)............... 21,694 117,589 143,255 184,251 218,042 EBITDA margin(10)....... 1.6% 8.1% 9.1% 9.8% 9.7% Adjusted EBITDA(11)..... $ 62,887 $ 117,589 $ 143,255 $ 185,751 $ 218,042 Adjusted EBITDA margin(12)............ 4.6% 8.1% 9.1% 9.9% 9.7% Total rental expense.... $ 92,293 $ 96,320 $ 109,251 $ 129,547 $ 157,824 OTHER OPERATING DATA: Average net sales per Michaels store(13).... $ 2,919 $ 3,122 $ 3,095 $ 3,310 $ 3,513 Comparable store sales increase (decrease)(14)........ (1)% 6% 1% 7% 5% Total selling square footage............... 7,821 8,082 8,981 10,411 12,063 13 WEEKS ENDED ----------------------- 53 WEEKS ENDED APRIL 29, MAY 5, MAY 5, 2000(3) 2001(4) 2001(4) ---------- ---------- --------------- (IN THOUSANDS EXCEPT PER SHARE AND STORE DATA) RESULTS OF OPERATIONS DATA: Net sales(5)............ $ 474,152 $ 524,720 $2,300,008 Operating income (loss)................ 21,338 16,084 143,163 Interest expense........ 5,520 3,778 16,284 Net income (loss)....... 8,230 7,289 77,648 Diluted earnings (loss) per common share...... 0.25 0.22 2.26 BALANCE SHEET DATA: Cash and equivalents.... $ 99,300 $ 21,365 $ 21,365 Merchandise inventories........... 641,857 744,701 744,701 Total current assets.... 772,898 801,155 801,155 Total assets............ 1,147,645 1,234,718 1,234,718 Working capital......... 495,786 453,380 453,380 Long-term debt(6)....... 223,545 125,068 125,068 Total debt.............. 229,510 154,829 154,829 Total liabilities....... 535,635 514,327 514,327 Stockholders' equity.... 612,010 720,391 720,391 OTHER FINANCIAL DATA: Ratio of earnings to fixed charges(7)...... 1.7x 1.5x 2.4x Cash flow from operating activities............ $ 9,091 $ (24,825) $ 112,842 Cash flow from investing activities............ (17,196) (19,027) (121,915) Cash flow from financing activities............ 30,007 37,026 (68,862) EBITDA(9)............... 38,810 32,630 211,862 EBITDA margin(10)....... 8.2% 6.2% 9.2% Adjusted EBITDA(11)..... $ 38,810 $ 36,702 $ 215,934 Adjusted EBITDA margin(12)............ 8.2% 7.0% 9.4% Total rental expense.... $ 36,008 $ 42,794 $ 164,610 OTHER OPERATING DATA: Average net sales per Michaels store(13).... N/A N/A $ 3,537 Comparable store sales increase (decrease)(14)........ 7% 3% 4% Total selling square footage............... 10,769 12,401 12,401
(CONTINUED ON FOLLOWING PAGE) 10
13 WEEKS ENDED FISCAL YEAR ----------------------- -------------------------------------------------------------- APRIL 29, MAY 5, 1996 1997 1998 1999 2000 2000 2001 ---------- ---------- ---------- ---------- ---------- ---------- ---------- STORES OPEN AT END OF PERIOD: Michaels................ 453 452 496 559 628 585 644 Aaron Brothers.......... 72 74 78 95 119 97 123 Star Wholesale.......... -- -- -- -- 1 -- 1 ---------- ---------- ---------- ---------- ---------- ---------- ---------- Total stores open at end of period............. 525 526 574 654 748 682 768 ========== ========== ========== ========== ========== ========== ========== 53 WEEKS ENDED MAY 5, 2001 --------------- STORES OPEN AT END OF PERIOD: Michaels................ 644 Aaron Brothers.......... 123 Star Wholesale.......... 1 ---------- Total stores open at end of period............. 768 ==========
- ------------------------------ (1) Operating loss in fiscal 1996 includes the effect of an unusual pre-tax charge of $41.2 million for costs associated with the sale to liquidate merchandise that was eliminated following store resets, markdowns on discontinued furniture and other home decor merchandise, and reserves for the closure of four stores and the write-down of leasehold improvements in three stores. (2) Operating income for fiscal 1999 includes a $1.5 million charge for the settlement of litigation. (3) Net income and diluted earnings per common share in fiscal 2000 include the cumulative effect of a change in accounting principle related to recognizing sales of custom frames, net of tax, in the amount of $1.9 million, or $0.06 per diluted share. (4) Operating income for the 13 weeks and for the 53 weeks ended May 5, 2001 includes a $3.2 million charge for the settlement of litigation and a $1.0 million charge relating to executive severance costs. (5) Net sales represents gross sales less returns. (6) Long-term debt includes the long-term portion of capital lease obligations, convertible subordinated notes which we redeemed in June 2000, and our 10 7/8% senior notes due 2006 in the amount of $125 million, which we have called for redemption. In connection with the redemption of the 10 7/8% senior notes due 2006, we will incur an estimated after-tax extraordinary loss of $5.3 million in the third quarter of fiscal 2001. (7) For purposes of calculating the ratio of earnings to fixed charges, earnings consist of income (loss) before income taxes for such period plus fixed charges deducted in calculating income (loss) before income taxes for such period. Fixed charges consist of interest incurred, amortization of deferred financing fees and an amount representing the interest factor included in rental expense. (8) Earnings were insufficient to cover fixed charges in fiscal 1996. The deficiency for fiscal 1996 was $41.1 million. (9) EBITDA is calculated as income (loss) before income taxes plus interest, depreciation, and amortization. EBITDA is presented because it is a widely accepted financial indicator of a company's ability to incur and service debt, but is not a financial measurement recognized by generally accepted accounting principles, and therefore, may not be comparable to similarly titled measures used by other entities. EBITDA should not be considered by an investor as an alternative to net income as an indicator of our operating performance, or as an alternative to cash flow as a measure of liquidity. (10) EBITDA margin is calculated as EBITDA, as defined above, divided by net sales. (11) Adjusted EBITDA is calculated as income (loss) before income taxes plus interest, depreciation, amortization, and unusual, non-recurring charges. Adjusted EBITDA for fiscal 1996 excludes the effect of an unusual pretax charge of $41.2 million for costs associated with the sale to liquidate merchandise that was eliminated following store resets, markdowns on discontinued furniture and other home decor merchandise and reserves for the closure of four stores and the write-down of leasehold improvements in three stores. Adjusted EBITDA for fiscal 1999 excludes the effect of an unusual $1.5 million pretax charge for the settlement of litigation between us and a competitor. Adjusted EBITDA for the 13 and 53 weeks ended May 5, 2001 excludes the effect of a $3.2 million pretax charge for the settlement of litigation and a $1.0 million pretax charge for executive severance. (12) Adjusted EBITDA margin is calculated as Adjusted EBITDA, as defined above, divided by net sales. (13) The calculation of average net sales per Michaels store only includes sales for stores open for the full 12 months. (14) Comparable store sales increase (decrease) represents the increase or decrease in net sales for stores open the same number of months in the indicated and comparable period of the previous year, including stores that were relocated or expanded during either period adjusted for unusual circumstances year over year such as inclement weather, natural disasters and other adjustments. A store is deemed to become comparable in its 14th full month of operation. The calculation of comparable store sales increases or decreases excludes the effect of deferring the recognition of custom frame sales for orders that have not been picked up by the customer at the end of the period. 11 RISK FACTORS YOU SHOULD CAREFULLY CONSIDER THE RISK FACTORS DESCRIBED BELOW, TOGETHER WITH THE OTHER INFORMATION INCLUDED IN THIS PROSPECTUS, BEFORE YOU DECIDE TO EXCHANGE ANY OF THE NOTES. THE AMOUNT OF DEBT WE HAVE COULD ADVERSELY AFFECT US BY REDUCING OUR FLEXIBILITY TO RESPOND TO CHANGING BUSINESS AND ECONOMIC CONDITIONS As of May 5, 2001, after giving effect to the offering of the notes and the use of proceeds from the outstanding notes to redeem our 10 7/8% senior notes due 2006, we would have had $200.6 million of senior debt outstanding and, except for the guarantee by Aaron Brothers of our bank credit facility, our subsidiaries would have had no debt outstanding. The terms of our indenture and our credit agreement permit us to incur additional debt. See "Description of Other Indebtedness" and "Description of the Notes--Certain Covenants--Limitation on Indebtedness." Our debt could have important consequences to you, including the following: - our ability to obtain additional financing in the future for working capital, capital expenditures, acquisitions, or general corporate purposes may be impaired, - a substantial portion of our cash flows from operations may be dedicated to the payment of principal and interest on our debt, which would reduce the funds available to us for our operations, - the documents governing our debt contain financial and other restrictive covenants, including those restricting the incurrence of additional debt, - a portion of our borrowings is and will continue to be at variable rates of interest which exposes us to the risk of greater interest rates, and - we may be at a competitive disadvantage compared to our competitors with less debt and more vulnerable to changing economic conditions. Our needs for cash in the future will depend on many factors that are difficult to predict, including our results of operations and efforts to expand our existing operations. We believe, based on current circumstances, that our cash flow, together with available borrowing under the new credit agreement, and the notes, will be sufficient to meet our liquidity needs for the foreseeable future. However, we cannot assure you that our business will generate cash flow at or above current levels. If we are unable to generate sufficient cash flow from operations in the future to repay our debt as it becomes due and make necessary investments, we may be required to restructure or refinance all or a portion of our existing debt, seek new borrowings, reduce or delay capital expenditures, sell assets, seek additional equity capital or delay, scale back or eliminate some aspects of our operations, including delaying our plans for new store openings. Moreover, it is possible that we may not be able to satisfy all of the conditions and covenants of our debt. In addition, to the extent we seek to replace or refinance our current debt, replacement financing may not be available on terms that are favorable or acceptable to us. In addition, we may not be able to obtain acceptable financing upon the expiration of our credit agreement. Our ability to obtain additional or replacement financing will be significantly impacted by, among other things, any change in the ratings assigned to us by nationally recognized ratings agencies. Any of these events, if they were to occur, could have a material adverse effect on our business, financial condition, or results of operations. SECURED INDEBTEDNESS AND BORROWINGS BY SUBSIDIARIES THAT DO NOT BECOME GUARANTORS WILL BE EFFECTIVELY SENIOR TO THE NOTES The notes are senior unsecured obligations and therefore will be effectively subordinated to any of our or any of our subsidiaries' secured obligations to the extent of the value of the assets securing such 12 obligations. The indenture permits us and our subsidiaries to incur additional indebtedness, subject to limitations, including limitations on the amount of secured indebtedness. See "Description of the Notes--Certain Covenants--Limitation on Indebtedness" and "--Limitation on Liens." We conduct a portion of our operations through subsidiaries, and in the future, we may create additional subsidiaries. Contractual provisions, laws, or regulations, as well as any subsidiary's financial condition and operating requirements, may limit our ability to obtain cash from a subsidiary to pay our debt service obligations, including payments on the notes. The notes will be structurally subordinated to all existing and future obligations of our subsidiaries (unless such subsidiaries guarantee the notes), including claims with respect to trade payables and our Aaron Brothers subsidiary's guarantee of our credit facility. Our Aaron Brothers subsidiary constituted approximately 5.0% of our revenue for the first quarter of fiscal 2001. In addition, the guarantee of any subsidiary will be structurally subordinated to all existing and future obligations of its subsidiaries (unless such subsidiaries also guarantee the notes), including claims with respect to trade payables. Our subsidiaries are limited in the amount of indebtedness they are permitted to incur pursuant to the covenant described under "Description of the Notes--Certain Covenants--Limitation on Indebtedness." This covenant is subject to important exceptions described under such heading. OUR GROWTH DEPENDS ON OUR ABILITY TO OPEN NEW STORES Our key business strategy is to expand our base of Michaels and Aaron Brothers stores. If we were unable to implement this strategy, our ability to increase our sales, profitability and cash flow could be impaired significantly. To the extent that we are unable to open new stores as we anticipate, our sales growth would come only from increases in comparable store sales. Growth in profitability in that case would depend significantly on our ability to reduce our costs as a percentage of our sales. We may be unable to implement our strategy if we cannot identify suitable sites for additional stores, negotiate acceptable leases, access sufficient capital to support store growth, or hire and train a sufficient number of qualified associates. OUR SUCCESS WILL DEPEND ON HOW WELL WE MANAGE OUR GROWTH Even if we are able to implement, to a significant degree, our key business strategy of expanding our store base, we may experience problems, which may prevent any significant increase in profitability or negatively impact our cash flow. For example: - the costs of opening and operating new stores may offset the increased sales generated by the additional stores, - the closure of unsuccessful stores may result in the retention of liability for expensive leases, - a significant portion of our management's time and energy may be consumed with issues unrelated to advancing our core business strategy which could possibly result in a deterioration of our operating results, - our expansion may outpace our planned technological advances with the possible consequences of breakdowns in our supply chain management and increased weaknesses in our operational controls, - we may be unable to hire and train sufficient qualified managers and other associates, - our suppliers may be unable to meet timely the increased demand as a result of additional stores, and - we may be unable to expand our existing distribution centers, or employ third-party distribution services on a cost effective basis to provide merchandise for sale by our new stores. 13 WE MAY FAIL TO ANTICIPATE CUSTOMER DEMANDS Our success depends on our ability to anticipate and respond in a timely manner to changing customer demand and preferences for products and supplies used in creative activities. If we misjudge the market, we may significantly overstock unpopular products and be forced to take significant inventory markdowns, which would have a negative impact on our operating results and cash flow. Conversely, shortages of key items could have a materially adverse impact on our operating results. OUR SUPPLIERS MAY FAIL US Many of our suppliers are small firms that produce a limited number of items. Given their limited resources, these firms are susceptible to cash flow issues, production difficulties, quality control issues, and problems in delivering agreed-upon quantities on schedule. We cannot assure you that we would be able, if necessary, to return product to these suppliers and obtain refunds of our purchase price or obtain reimbursement or indemnification from them if their products prove defective. In addition, these suppliers may be unable to withstand a downturn in economic conditions. Significant failures on the part of our key suppliers could have a material adverse affect on our operating results. In addition, many of these suppliers require extensive advance notice of our requirements in order to supply products in the quantities we desire. This long lead time requires us to place orders far in advance of the time when certain products will be offered for sale, exposing us to shifts in demand. RISKS RELATING TO FOREIGN SUPPLIERS We rely to a significant extent on foreign manufacturers of various products that we sell. In addition, many of our domestic suppliers purchase a portion of their products from foreign sources. This reliance increases the risk that we will not have adequate and timely supplies of various products due to local political or economic conditions, transportation delays, restrictive actions by foreign governments or United States laws and regulations affecting imports. Reliance on foreign manufacturers also increases our exposure to fluctuations in exchange rates and trade infringement claims and reduces our ability to return product for various reasons. In addition, a significant portion of our inventory is manufactured in the People's Republic of China. Since adoption of an "open-door policy" in 1978, the Chinese government has been pursuing economic reform policies, including the encouragement of foreign trade and investment and greater economic decentralization. We cannot assure you, however, that China will continue to pursue these policies. All of our products manufactured overseas and imported into the United States are subject to duties collected by the United States Customs Service. We may be subjected to additional duties, significant monetary penalties, the seizure and the forfeiture of the products we are attempting to import or the loss of import privileges if we or our suppliers are found to be in violation of U.S. laws and regulations applicable to the importation of our products. OUR INFORMATION SYSTEMS MAY PROVE INADEQUATE We depend on our management information systems for many aspects of our business. We will be materially adversely affected if our management information systems are disrupted or we are unable to improve, upgrade, and expand our systems, particularly in light of our planned significant increase in number of stores. In addition, we are in the process of upgrading our information systems to provide us with perpetual inventory and automated replenishment capabilities, which we believe are extremely important in the management of a chain of hundreds of stores offering tens of thousands of SKUs. Delays in bringing these new capabilities on line, or disruptions from an imperfect introduction of these new capabilities, could have a materially adverse impact on our financial condition and operating results. 14 A WEAK FOURTH QUARTER WOULD MATERIALLY ADVERSELY AFFECT OUR OPERATING RESULTS Our business is highly seasonal. Our inventories and short-term borrowings grow in the second and third fiscal quarters as we prepare for our peak selling season in the third and fourth fiscal quarters. Our most important quarter in terms of sales, profitability, and cash flow historically has been the fourth fiscal quarter. If for any reason our fourth fiscal quarter results were substantially below expectations, our operating results for the full year would be materially adversely affected, and we could have substantial excess inventory, especially in seasonal merchandise that is difficult to liquidate. IMPROVEMENTS TO OUR SUPPLY CHAIN MAY NOT BE FULLY SUCCESSFUL An important part of our efforts to achieve efficiencies, cost reductions, and sales and cash flow growth is the identification and implementation of improvements to our supply chain, including merchandise ordering, transportation and receipt processing. Any failure to take full advantage of supply chain opportunities could have a material adverse impact on our operating results. COMPETITION COULD NEGATIVELY IMPACT OUR OPERATIONS The retail arts and crafts industry is competitive, which could result in the reduction of our prices and our loss of market share. We must remain competitive in the areas of quality, price, selection, and convenience. Our primary competition is comprised of specialty arts and crafts retailers, which include Hobby Lobby, A.C. Moore Arts & Crafts, Inc., Jo-Ann etc. (operated by Jo-Ann Stores, Inc.) and Garden Ridge Corporation. We also compete with mass merchants, who dedicate a portion of their selling space to a limited selection of craft supplies and seasonal and holiday merchandise, regional chains, and local merchants. Some of our competitors, particularly the mass merchants, are larger and have greater financial resources than we do. In addition, alternative methods of selling crafts, such as over the Internet, could result in additional competitors in the future and increased price competition since our customers could more readily comparison shop. Furthermore, we ultimately compete with alternative sources of entertainment and leisure for our customers. ENERGY SHORTAGES, NATURAL DISASTERS OR A DECLINE IN ECONOMIC CONDITIONS IN CALIFORNIA COULD INCREASE OUR OPERATING EXPENSES OR ADVERSELY AFFECT OUR SALES REVENUE As of May 5, 2001, we operate 176 stores in California. Because California is experiencing energy and electricity shortages, we may be subject to increased operating costs as a result of higher electricity and energy rates and may be subject to rolling blackouts which could interrupt our retail business. Any such impact could be material and adversely affect our profitability. A decline in the economic conditions in California, whether or not such decline spreads beyond California, could materially adversely affect our business. Furthermore, a natural disaster or other catastrophic event, such as an earthquake affecting California, could significantly disrupt our business. THE COVENANT RESTRICTIONS IN THE NOTES AND IN OUR OTHER DEBT RESTRICT OUR OPERATIONS We and our subsidiaries are subject to significant operating and financial restrictions contained in the instruments governing the notes and our other indebtedness. Those restrictions affect, and in many respects significantly limit or prohibit, among other things, our ability to: - incur additional indebtedness, - make various investments, - issue or sell our restricted subsidiaries' capital stock, - engage in transactions with affiliates, - make various distributions, - sell or securitize accounts receivables, 15 - provide negative pledges, - make capital expenditures beyond specific limitations, - engage in derivative transactions other than in the ordinary course of business, - create various liens, or - merge, consolidate, and sell assets. In addition, our bank credit agreement requires us to maintain specified financial ratios. These restrictions could also limit our ability to obtain financing in the future, make needed capital expenditures, withstand a future downturn in our business or the economy in general or conduct necessary corporate activities. If we or our subsidiaries fail to comply with these restrictions, we may be in default under the terms of our indebtedness, even if we are otherwise able to meet our debt service obligations. In the event of a default, the holders of the indebtedness could elect to declare all of that indebtedness, together with accrued interest, to be due and payable and a significant portion of our other indebtedness (including the notes) may become immediately due and payable as a result of cross-default clauses contained in documentation evidencing debt. We cannot assure you that we would be able to make those payments or borrow sufficient funds from alternative sources to make those payments. Even if we were to obtain additional financing, that financing may be on terms unfavorable to us. WE MAY NOT HAVE ENOUGH FUNDS TO REPURCHASE THE NOTES UPON A CHANGE OF CONTROL Should there be a change of control of Michaels, each holder of the notes will have the right to require us, subject to various conditions, to repurchase all or any part of that holder's notes at a price equal to 101% of the principal of those notes, plus accrued and unpaid interest, if any, to the date of repurchase. See "Description of the Notes--Change of Control." Existing senior indebtedness under our bank credit agreement includes, and our future indebtedness may include, change of control provisions. Under those provisions, should a specified change of control event occur, we would be required to repurchase, or the lender could demand the repayment of, that indebtedness. Subject to some limitations, we could, in the future, enter into various transactions, including acquisitions, refinancings or other recapitalizations that would not constitute a change of control under the indenture for the notes, but that could increase the amount of our debt outstanding at that time or otherwise affect our capital structure or credit rating. We have no present intention to engage in a transaction involving a change of control, although it is possible that we could decide to do so in the future. The term "Change of Control" with respect to the notes is defined in "Description of the Notes--Change of Control." We cannot assure you that we will have sufficient funds available or could obtain the financing necessary to repurchase the notes and any other outstanding indebtedness that rank equally with the notes tendered by holders of those obligations following a change of control. If a change of control occurred and we did not have the funds or financing available to pay for the notes and any other indebtedness ranking equally with the notes that are tendered for repurchase, an event of default would be triggered under the notes and under that other outstanding indebtedness. Each of these defaults could have a material adverse consequence for us and the holders of the notes. The ability of a holder of the notes to require us to repurchase its notes as a result of our sale or other disposition of less than all our properties and assets on a consolidated basis to another person or related group of persons may be uncertain. See "Description of the Notes--Change of Control." ANY SUBSIDIARY GUARANTEES OF THE NOTES MAY BE SUBORDINATED OR AVOIDED BY A COURT None of our subsidiaries will guarantee the notes initially. If any of our existing or future restricted subsidiaries guarantee any of our other indebtedness other than the guarantee from Aaron Brothers in favor of our bank lenders, those subsidiaries may be required to guarantee the notes on a senior basis. 16 See "Description of the Notes--Certain Covenants--Limitation on Indebtedness." Various applicable fraudulent conveyance laws have been enacted for the protection of creditors. A court may use those laws to subordinate or avoid any guarantee of the notes issued by any of our subsidiaries. It is also possible that under some circumstances a court could hold that the direct obligations of a subsidiary guaranteeing the notes could be superior to the obligations under that guarantee. A court could avoid or subordinate the guarantee of the notes by any of our subsidiaries in favor of that subsidiary's other debts or liabilities to the extent that the court determined either of the following were true at the time the subsidiary issued the guarantee: - the subsidiary incurred the guarantee with the intent to hinder, delay, or defraud any of its present or future creditors or that such subsidiary contemplated insolvency with a design to favor one or more creditors to the total or partial exclusion of others; or - the subsidiary did not receive fair consideration or reasonably equivalent value for issuing the guarantee and, at the time it issued the guarantee, the subsidiary: - was insolvent or rendered insolvent by reason of the issuance of the guarantee, - was engaged or about to engage in a business or transaction for which the remaining assets of the subsidiary constituted unreasonably small capital, or - intended to incur, or believed that it would incur, debts beyond its ability to pay these debts as they matured. Among other things, a legal challenge of a subsidiary's guarantee of the notes on fraudulent conveyance grounds may focus on the benefits, if any, realized by that subsidiary as a result of our issuance of the notes. To the extent a subsidiary's guarantee of the notes is avoided as a result of a fraudulent conveyance or held unenforceable for any other reason, the note holders would cease to have any claim in respect of that guarantee and would be creditors solely of us. THERE MAY NOT BE A PUBLIC MARKET FOR THE EXCHANGE NOTES. There is no existing trading market for the outstanding notes. If such a market were to develop, the outstanding notes and, if issued, the exchange notes could trade at prices that may be lower than the initial offering price depending on many factors, including prevailing interest and dividend rates, our operating results and the market for similar securities. IF YOU DO NOT EXCHANGE YOUR OUTSTANDING NOTES YOU MAY HAVE DIFFICULTY IN TRANSFERRING THEM AT A LATER TIME. Michaels Stores will issue exchange notes in exchange for the outstanding notes after the exchange agent receives your outstanding notes, the letter of transmittal and all related documents. You should allow adequate time for delivery if you choose to tender your outstanding notes for exchange. Outstanding notes that are not exchanged will remain subject to restrictions on transfer and will not have any rights to registration. If you do participate in the exchange offer for the purpose of participating in the distribution of the exchange notes, you must comply with the registration and prospectus delivery requirements of the Securities Act of 1933 for any resale transaction. Each broker-dealer who holds outstanding notes for its own account due to market-making or other trading activities and who receives exchange notes for its own account must acknowledge that it will deliver a prospectus in connection with any resale of the exchange notes. If any outstanding notes are not tendered in the exchange or are tendered but not accepted, the trading market for such outstanding notes could be negatively affected due to the limited amount expected to remain outstanding following the completion of the exchange offer. 17 USE OF PROCEEDS We will not receive any cash proceeds from the issuance of the exchange notes. Because we are exchanging the exchange notes for the outstanding notes, which have substantially identical terms, the issuance of the exchange notes will not result in any increase in the indebtedness of Michaels Stores. CAPITALIZATION The following table sets forth our capitalization as of May 5, 2001, on an actual basis and as adjusted to give effect to the offering of the outstanding notes and our use of proceeds thereof to redeem the 10 7/8% senior notes due 2006 and pay amounts outstanding under our credit agreement. The exchange notes exchanged for outstanding notes will not affect the amount of indebtedness outstanding. You should read this information together with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our consolidated financial statements and related notes included elsewhere in this prospectus.
AS OF MAY 5, 2001 ---------------------- ACTUAL AS ADJUSTED -------- ----------- (IN THOUSANDS) (UNAUDITED) Cash and equivalents........................................ $ 21,365 $ 52,942 ======== ======== Total debt: Bank line of credit....................................... $ 29,200 $ -- 9 1/4% Senior notes due 2009.............................. -- 200,000 10 7/8% Senior notes due 2006............................. 125,000 -- Capital lease obligations................................. 629 629 -------- -------- Total debt.............................................. 154,829 200,629 -------- -------- Stockholders' equity: Common stock, $.10 par value; 150,000,000 shares authorized; 32,172,812 shares issued and outstanding................ 3,217 3,217 Additional paid-in capital................................ 438,768 438,768 Retained earnings......................................... 278,406 273,088(1) -------- -------- Total stockholders' equity.............................. 720,391 715,073 -------- -------- Total capitalization........................................ $875,220 $915,702 ======== ========
- ------------------------ (1) Reflects the estimated after-tax extraordinary charge to earnings of approximately $5.3 million in connection with the redemption of our 10 7/8% senior notes due 2006. 18 SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA The results of operations, balance sheet and other financial data below for fiscal years 1996, 1997, 1998, 1999 and 2000 has been derived from our audited consolidated financial statements and related notes. Audited consolidated financial statements as of January 29, 2000 and February 3, 2001 and for each of the three fiscal years ended February 3, 2001 appear elsewhere in this prospectus. References to fiscal year mean the year in which that fiscal year began. Our fiscal year 1996 ended on February 1, 1997 and fiscal year 2000 ended on February 3, 2001 and each contained 53 weeks. Our fiscal year 1997 ended on January 31, 1998, fiscal year 1998 ended on January 30, 1999 and fiscal year 1999 ended on January 29, 2000 and each contained 52 weeks. The results of operations, balance sheet and other financial data below for the 13 weeks ended April 29, 2000 and May 5, 2001 and for the 53 weeks ended May 5, 2001 is derived from our unaudited financial statements and reflects only normal recurring adjustments and other items as disclosed in the footnotes to these selected consolidated financial and operating data which, in the opinion of our management, are necessary for the fair presentation of this information. You should not expect the consolidated results of operations data, other financial data or other operating data of interim periods to be an indication of results for a full year. You should read the following information together with our consolidated financial statements and related notes included elsewhere in this prospectus and "Management's Discussion and Analysis of Financial Condition and Results of Operations" in this prospectus.
FISCAL YEAR -------------------------------------------------------------- 1996(1) 1997 1998 1999(2) 2000(3) ---------- ---------- ---------- ---------- ---------- (IN THOUSANDS EXCEPT PER SHARE AND STORE DATA) RESULTS OF OPERATIONS DATA: Net sales(5)............ $1,378,277 $1,456,524 $1,573,965 $1,882,522 $2,249,440 Operating income (loss)................ (20,987) 68,942 89,112 122,672 148,417 Interest expense........ 21,038 23,448 22,678 22,654 18,026 Net income (loss)....... (31,233) 30,077 43,601 62,301 78,589 Diluted earnings (loss) per common share...... (1.35) 1.05 1.43 2.01 2.29 BALANCE SHEET DATA: Cash and equivalents.... $ 59,069 $ 162,283 $ 96,124 $ 77,398 $ 28,191 Merchandise inventories........... 351,208 385,580 501,239 615,065 663,700 Total current assets.... 437,543 573,183 621,928 722,987 729,816 Total assets............ 784,435 908,494 962,650 1,096,703 1,158,436 Working capital......... 239,812 358,691 391,227 452,011 440,808 Long-term debt(6)....... 238,608 234,889 230,896 224,635 125,145 Total debt.............. 242,823 239,551 236,869 230,988 125,876 Total liabilities....... 451,633 466,583 481,671 529,905 453,790 Stockholders' equity.... 332,802 441,911 480,979 566,798 704,646 OTHER FINANCIAL DATA: Ratio of earnings to fixed charges(7)...... -- (8) 1.8x 2.0x 2.2x 2.4x Cash flow from operating activities............ $ 29,749 $ 77,907 $ 6,038 $ 60,770 $ 146,758 Cash flow from investing activities............ (32,312) (38,988) (59,567) (90,759) (120,084) Cash flow from financing activities............ 58,762 64,295 (12,630) 11,263 (75,881) EBITDA(9)............... 21,694 117,589 143,255 184,251 218,042 EBITDA margin(10)....... 1.6% 8.1% 9.1% 9.8% 9.7% Adjusted EBITDA(11)..... $ 62,887 $ 117,589 $ 143,255 $ 185,751 $ 218,042 Adjusted EBITDA margin(12)............ 4.6% 8.1% 9.1% 9.9% 9.7% Total rental expense.... $ 92,293 $ 96,320 $ 109,251 $ 129,547 $ 157,824 OTHER OPERATING DATA: Average net sales per Michaels store(13).... $ 2,919 $ 3,122 $ 3,095 $ 3,310 $ 3,513 Comparable store sales increase (decrease)(14)........ (1)% 6% 1% 7% 5% Total selling square footage............... 7,821 8,082 8,981 10,411 12,063 13 WEEKS ENDED ----------------------- 53 WEEKS ENDED APRIL 29, MAY 5, MAY 5, 2000(3) 2001(4) 2001(4) ---------- ---------- -------------- (IN THOUSANDS EXCEPT PER SHARE AND STORE DATA) RESULTS OF OPERATIONS DATA: Net sales(5)............ $ 474,152 $ 524,720 $2,300,008 Operating income (loss)................ 21,338 16,084 143,163 Interest expense........ 5,520 3,778 16,284 Net income (loss)....... 8,230 7,289 77,648 Diluted earnings (loss) per common share...... 0.25 0.22 2.26 BALANCE SHEET DATA: Cash and equivalents.... $ 99,300 $ 21,365 $ 21,365 Merchandise inventories........... 641,857 744,701 744,701 Total current assets.... 772,898 801,155 801,155 Total assets............ 1,147,645 1,234,718 1,234,718 Working capital......... 495,786 453,380 453,380 Long-term debt(6)....... 223,545 125,068 125,068 Total debt.............. 229,510 154,829 154,829 Total liabilities....... 535,635 514,327 514,327 Stockholders' equity.... 612,010 720,391 720,391 OTHER FINANCIAL DATA: Ratio of earnings to fixed charges(7)...... 1.7x 1.5x 2.4x Cash flow from operating activities............ $ 9,091 $ (24,825) $ 112,842 Cash flow from investing activities............ (17,196) (19,027) (121,915) Cash flow from financing activities............ 30,007 37,026 (68,862) EBITDA(9)............... 38,810 32,630 211,862 EBITDA margin(10)....... 8.2% 6.2% 9.2% Adjusted EBITDA(11)..... $ 38,810 $ 36,702 $ 215,934 Adjusted EBITDA margin(12)............ 8.2% 7.0% 9.4% Total rental expense.... $ 36,008 $ 42,794 $ 164,610 OTHER OPERATING DATA: Average net sales per Michaels store(13).... N/A N/A $ 3,537 Comparable store sales increase (decrease)(14)........ 7% 3% 4% Total selling square footage............... 10,769 12,401 12,401
(CONTINUED ON FOLLOWING PAGE) 19
13 WEEKS ENDED FISCAL YEAR ----------------------- -------------------------------------------------------------- APRIL 29, MAY 5, 1996 1997 1998 1999 2000 2000 2001 ---------- ---------- ---------- ---------- ---------- ---------- ---------- STORES OPEN AT END OF PERIOD: Michaels................ 453 452 496 559 628 585 644 Aaron Brothers.......... 72 74 78 95 119 97 123 Star Wholesale.......... -- -- -- -- 1 -- 1 ---------- ---------- ---------- ---------- ---------- ---------- ---------- Total stores open at end of period............. 525 526 574 654 748 682 768 ========== ========== ========== ========== ========== ========== ========== 53 WEEKS ENDED MAY 5, 2001 -------------- STORES OPEN AT END OF PERIOD: Michaels................ 644 Aaron Brothers.......... 123 Star Wholesale.......... 1 ---------- Total stores open at end of period............. 768 ==========
- ------------------------------ (1) Operating loss in fiscal 1996 includes the effect of an unusual pre-tax charge of $41.2 million for costs associated with the sale to liquidate merchandise that was eliminated following store resets, markdowns on discontinued furniture and other home decor merchandise, and reserves for the closure of four stores and the write-down of leasehold improvements in three stores. (2) Operating income for fiscal 1999 includes a $1.5 million charge for the settlement of litigation. (3) Net income and diluted earnings per common share in fiscal 2000 include the cumulative effect of a change in accounting principle related to recognizing sales of custom frames, net of tax, in the amount of $1.9 million, or $0.06 per diluted share. (4) Operating income for the 13 weeks and for the 53 weeks ended May 5, 2001 includes a $3.2 million charge for the settlement of litigation and a $1.0 million charge relating to executive severance costs. (5) Net sales represents gross sales less returns. (6) Long-term debt includes the long-term portion of capital lease obligations, convertible subordinated notes which we redeemed in June 2000, and our 10 7/8% senior notes due 2006 in the amount of $125 million, which we have called for redemption. In connection with the redemption of the 10 7/8% senior notes due 2006, we will incur an estimated after-tax extraordinary loss of $5.3 million in the third quarter of fiscal 2001. (7) For purposes of calculating the ratio of earnings to fixed charges, earnings consist of income (loss) before income taxes for such period plus fixed charges deducted in calculating income (loss) before income taxes for such period. Fixed charges consist of interest incurred, amortization of deferred financing fees and an amount representing the interest factor included in rental expense. (8) Earnings were insufficient to cover fixed charges in fiscal 1996. The deficiency for fiscal 1996 was $41.1 million. (9) EBITDA is calculated as income (loss) before income taxes plus interest, depreciation, and amortization. EBITDA is presented because it is a widely accepted financial indicator of a company's ability to incur and service debt, but is not a financial measurement recognized by generally accepted accounting principles, and therefore, may not be comparable to similarly titled measures used by other entities. EBITDA should not be considered by an investor as an alternative to net income as an indicator of our operating performance, or as an alternative to cash flow as a measure of liquidity. (10) EBITDA margin is calculated as EBITDA, as defined above, divided by net sales. (11) Adjusted EBITDA is calculated as income (loss) before income taxes plus interest, depreciation, amortization, and unusual, non-recurring charges. Adjusted EBITDA for fiscal 1996 excludes the effect of an unusual pretax charge of $41.2 million for costs associated with the sale to liquidate merchandise that was eliminated following store resets, markdowns on discontinued furniture and other home decor merchandise and reserves for the closure of four stores and the write-down of leasehold improvements in three stores. Adjusted EBITDA for fiscal 1999 excludes the effect of an unusual $1.5 million pretax charge for the settlement of litigation between us and a competitor. Adjusted EBITDA for the 13 and 53 weeks ended May 5, 2001 excludes the effect of a $3.2 million pretax charge for the settlement of litigation and a $1.0 million pretax charge for executive severance. (12) Adjusted EBITDA margin is calculated as Adjusted EBITDA, as defined above, divided by net sales. (13) The calculation of average net sales per Michaels store only includes sales for stores open for the full 12 months. (14) Comparable store sales increase (decrease) represents the increase or decrease in net sales for stores open the same number of months in the indicated and comparable period of the previous year, including stores that were relocated or expanded during either period adjusted for unusual circumstances year over year such as inclement weather, natural disasters and other adjustments. A store is deemed to become comparable in its 14th full month of operation. The calculation of comparable store sales increases or decreases excludes the effect of deferring the recognition of custom frame sales for orders that have not been picked up by the customer at the end of the period. 20 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH OUR CONSOLIDATED FINANCIAL STATEMENTS AND THE NOTES TO THOSE STATEMENTS INCLUDED ELSEWHERE IN THIS PROSPECTUS. OUR FISCAL YEAR INCLUDES 52 OR 53 WEEKS AND ENDS ON THE SATURDAY CLOSEST TO JANUARY 31. REFERENCES TO FISCAL YEAR MEAN THE YEAR IN WHICH THAT FISCAL YEAR BEGAN. OUR FISCAL YEAR 1996 ENDED ON FEBRUARY 1, 1997 AND FISCAL YEAR 2000 ENDED ON FEBRUARY 3, 2001 AND EACH CONTAINED 53 WEEKS. OUR FISCAL YEAR 1997 ENDED ON JANUARY 31, 1998, FISCAL YEAR 1998 ENDED ON JANUARY 30, 1999 AND FISCAL YEAR 1999 ENDED ON JANUARY 29, 2000 AND EACH CONTAINED 52 WEEKS. THE FOLLOWING DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS THAT REFLECT OUR PLANS, ESTIMATES, AND BELIEFS. OUR ACTUAL RESULTS COULD MATERIALLY DIFFER FROM THOSE DISCUSSED IN THOSE FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED BELOW AND ELSEWHERE IN THIS PROSPECTUS, AND PARTICULARLY IN "RISK FACTORS" AND "FORWARD-LOOKING STATEMENTS." RESULTS OF OPERATIONS The following table sets forth the percentage relationship to net sales of each line item of our consolidated statements of income. This table should be read in conjunction with the following discussion and with our consolidated financial statements, including the related notes.
13 WEEKS ENDED FISCAL YEAR -------------------- ------------------------------ APRIL 29, MAY 5, 1998 1999 2000 2000 2001 -------- -------- -------- --------- -------- Net sales.............................................. 100.0% 100.0% 100.0% 100.0% 100.0% Cost of sales and occupancy expense.................... 66.8 66.1 66.4 66.1 66.2 ----- ----- ----- ----- ----- Gross margin........................................... 33.2 33.9 33.6 33.9 33.8 Selling, general, and administrative expense........... 27.0 26.7 26.5 28.8 29.8 Store pre-opening costs................................ 0.5 0.6 0.5 0.6 0.3 Litigation settlement.................................. -- 0.1 -- -- 0.6 ----- ----- ----- ----- ----- Operating income....................................... 5.7 6.5 6.6 4.5 3.1 Interest expense....................................... 1.4 1.2 0.8 1.2 0.7 Other (income) and expense, net........................ (0.2) (0.1) (0.2) (0.2) (0.0) ----- ----- ----- ----- ----- Income before income taxes and cumulative effect of accounting change.................................... 4.5 5.4 6.0 3.5 2.4 Provision for income taxes............................. 1.7 2.1 2.4 1.4 1.0 ----- ----- ----- ----- ----- Income before cumulative effect of accounting change... 2.8 3.3 3.6 2.1 1.4 Cumulative effect of accounting change for revenue recognition, net of tax.............................. -- -- 0.1 0.4 -- ----- ----- ----- ----- ----- Net income............................................. 2.8% 3.3% 3.5% 1.7% 1.4% ===== ===== ===== ===== =====
QUARTER ENDED MAY 5, 2001 COMPARED TO THE QUARTER ENDED APRIL 29, 2000 Net sales for the 13 weeks ended May 5, 2001 increased $50.6 million, or 11%, over the 13 weeks ended April 29, 2000. At the end of the first quarter of fiscal 2001, we operated 644 Michaels and 123 Aaron Brothers retail stores. The results for the first quarter of fiscal 2001 included sales from 62 Michaels and 27 Aaron Brothers retail stores that were opened and a wholesale operation that was acquired during the 12-month period ended May 5, 2001, more than offsetting lost sales from three Michaels and one Aaron Brothers store closures. Sales at the new stores (net of closures) and the acquired wholesale operation during the first quarter of fiscal 2001 accounted for $46.4 million of the increase in net sales. Comparable store sales increased 3% in the first quarter of fiscal 2001 compared 21 to the first quarter of fiscal 2000, which contributed $11.7 million to the net sales increase. The improvement in comparable store sales was due to a strong performance in our core categories of seasonal, ribbon, custom framing, general arts and crafts, and ready-made frames. Going forward, we expect to achieve comparable store sales increases for the remainder of fiscal 2001, taken as a whole. Our ability to continue to generate comparable store sales increases is dependent, in part, on our ability to continue to maintain store in-stock positions on the top-selling items, to properly allocate seasonal merchandise to the stores based upon anticipated sales trends utilizing POS rate of sale information, and the success of our sales promotion efforts. The above increases in net sales were partially offset by the net deferral of revenue related to the sale of custom frames, which resulted in a decrease in net sales of $7.5 million from the first quarter of fiscal 2000 to the first quarter of fiscal 2001. This decrease was due to the fluctuation in custom frame sales volume during the last two weeks of each fiscal quarter as a result of, but not limited to, seasonal trends and the timing of custom framing promotional activities. For purposes of calculating comparable store sales, a store is deemed to become comparable in its 14th full month of operation in order to eliminate grand opening sales distortions, and results are reported on a 52-week basis for the yearly period and a 13-week basis for the quarterly period. Cost of sales and occupancy expense, as a percentage of net sales, for the first quarter of fiscal 2001 was 66.2%, an increase of 0.1% compared to the first quarter of fiscal 2000. This increase was primarily attributable to higher occupancy costs associated with new and relocated stores and higher utilities costs compared to the first quarter of fiscal 2000, partially offset by improved merchandise margins. Selling, general, and administrative expense, as a percentage of net sales, increased by 1.0% from the first quarter of fiscal 2000 to the first quarter of fiscal 2001. This increase resulted principally from increased store payroll and related expenses, as a percentage of net sales, and higher advertising expenses. In addition, we incurred costs of approximately $1.0 million in the first quarter of fiscal 2001 related to severance agreements with former senior executives. Store pre-opening costs, as a percentage of net sales, decreased by 0.3% in the first quarter of fiscal 2001 compared to the first quarter of fiscal 2000. In the first quarter of fiscal 2001, we opened or relocated 20 Michaels and four Aaron Brothers stores compared to 30 Michaels and two Aaron Brothers stores opened or relocated in the first quarter of fiscal 2000. On June 6, 2001, we negotiated a tentative settlement of a purported class action with a former assistant manager of the company, Taiyeb Raniwala. Pursuant to the terms of the settlement, in exchange for a full release of claims, we are obligated to pay a maximum of $3.0 million covering all claims and attorneys' fees, plus estimated payroll taxes of approximately $153,000, which amount was accrued in the first quarter of fiscal 2001. The specific terms of the settlement are currently being finalized between the parties and must then be approved by the court. While we believe that it is likely that the settlement will be approved, we can provide no assurance to that effect. Operating income, as a percentage of net sales, decreased by 1.4% to $16.1 million in the first quarter of fiscal 2001 compared to $21.3 million for the first quarter of fiscal 2000. Operating income for the first quarter of fiscal 2001 was negatively impacted by $2.5 million resulting from the net deferral of custom framing revenue for reasons disclosed above, severance costs of approximately $1.0 million, and the litigation settlement charge of $3.2 million. Operating income for the first quarter of fiscal 2000 was positively impacted by $665,000 related to the net deferral of custom framing revenue. Excluding the effects of the net deferrals related to sales of custom frames, the one-time severance charge, and the litigation settlement charge, operating income increased 10% from $20.7 million in the first quarter of fiscal 2000 to $22.7 million in the first quarter of fiscal 2001, on a 12% increase in net sales during the same period. For more information, see Note 2 of Notes to 22 Consolidated Financial Statements for the three months ended May 5, 2001 included elsewhere in this prospectus. Interest expense (net of interest income), as a percentage of net sales, decreased by 0.3% in the first quarter of fiscal 2001 compared to the first quarter of fiscal 2000. This decrease resulted from interest savings related to the conversion and redemption of our convertible subordinated notes in June 2000, discussed under "Liquidity and Capital Resources" below, partially offset by lower investment income on lower average cash balances during the first quarter of fiscal 2001. The effective tax rate was 41% for the first quarter of fiscal 2001 and 40% for the first quarter of fiscal 2000. We changed our accounting policy with respect to revenue recognition related to the sale of custom frames effective retroactively as of the beginning of fiscal 2000. As a result, we recorded a non-cash charge of $1.9 million, net of tax, in the first quarter of fiscal 2000 for the cumulative effect of the change on fiscal years prior to fiscal 2000. Including this one-time charge, net income for the first quarter of fiscal 2000 was $8.2 million, or $0.25 per diluted share. Excluding this one-time charge, net income for the first quarter of fiscal 2000 was $10.1 million, or $0.31 per diluted share. FISCAL 2000 COMPARED TO FISCAL 1999 Net sales in fiscal 2000 increased $366.9 million, or 19.5%, over fiscal 1999. The results for fiscal 2000 included sales from 72 Michaels and 25 Aaron Brothers stores that were opened and a wholesale operation that was acquired during the year, more than offsetting lost sales from three Michaels and one Aaron Brothers store closures. Sales at the new stores (net of closures) and the acquired wholesale operation during fiscal 2000 accounted for $242.0 million of the increase in net sales. Comparable store sales increased 5% in fiscal 2000 compared to fiscal 1999, which contributed $93.0 million to the net sales increase. In addition, fiscal 2000 net sales includes sales from the 53rd week of $31.9 million. The improvement in comparable store sales was due to a strong performance in our core categories of general crafts, ribbon, art supplies, framing, and floral as well as substantial increases in the seasonal product categories. Cost of sales and occupancy expense, as a percentage of net sales, for fiscal 2000 was 66.4%, an increase of 0.3% compared to fiscal 1999. This increase was primarily attributable to higher fiscal 2000 seasonal inventory markdowns related to holiday clearance merchandise and higher occupancy costs associated with new and relocated stores. Selling, general, and administrative expense, as a percentage of net sales, decreased by 0.2% in fiscal 2000 compared to fiscal 1999. This decrease was primarily due to improved expense leverage in advertising and depreciation and amortization expenses, partially offset by increased payroll and related expenses, as a percentage of net sales, and costs associated with our supply chain initiative totaling $4.5 million. Store pre-opening costs, as a percentage of net sales, decreased by 0.1% in fiscal 2000 compared to fiscal 1999, as we opened or relocated 89 Michaels and 28 Aaron Brothers stores in fiscal 2000 compared to 95 Michaels and 23 Aaron Brothers stores in the prior fiscal year. Operating income, as a percentage of net sales, increased by 0.1% in fiscal 2000 compared to fiscal 1999. Operating income increased 21.0% from fiscal 1999 to fiscal 2000, on a 19.5% increase in net sales, to $148.4 million compared to $122.7 million in the prior fiscal year. Interest expense (net of interest income), as a percentage of net sales, in fiscal 2000 decreased by 0.5% compared to fiscal 1999. This decrease resulted from interest savings related to the conversion and redemption of the convertible subordinated notes in June 2000 and a leveraging of interest expense on expanded sales. 23 As more fully described in Note 2 of Notes to Consolidated Financial Statements for fiscal 2000 included elsewhere in this prospectus, we changed our accounting policy with respect to revenue recognition related to the sale of custom frames effective retroactively as of the beginning of fiscal 2000. As a result, we recorded a charge of $1.9 million, net of tax, or $0.06 per diluted share, in the first quarter of fiscal 2000 for the cumulative effect of the change on prior years. Including this one-time charge, net income for fiscal 2000 was $78.6 million, or $2.29 per diluted share. Excluding this one-time charge, net income for fiscal 2000 was $80.4 million, or $2.35 per diluted share. FISCAL 1999 COMPARED TO FISCAL 1998 Net sales in fiscal 1999 increased $308.5 million, or 20%, over fiscal 1998. The results for fiscal 1999 included sales from 69 Michaels and 17 Aaron Brothers stores that were opened during the year, more than offsetting lost sales from six Michaels and no Aaron Brothers store closures. Sales at the new stores (net of closures) during fiscal 1999 accounted for $198.9 million of the increase in net sales. Comparable store sales increased 7% in fiscal 1999 compared to fiscal 1998, which contributed $109.6 million to the net sales increase. The improvement in comparable store sales was due to a strong performance in our core categories of framing, general crafts, art supplies, floral, ribbon, home decor, and books as well as substantial increases in the seasonal product categories. Cost of sales and occupancy expense, as a percentage of net sales, for fiscal 1999 was 66.1%, a decrease of 0.7% compared to fiscal 1998. This decrease was primarily attributable to improved initial markup on inventories, improvements in the margins associated with fourth quarter promotional activities, and better margins on season-end clearance merchandise. This decrease was partially offset by larger investments in information systems infrastructure and higher occupancy costs associated with new and relocated stores. Selling, general, and administrative expense, as a percentage of net sales, decreased by 0.3% in fiscal 1999 compared to fiscal 1998. This decrease resulted from improved expense leverage in store payroll and related expenses, partially offset by higher bank fees associated with an increase in the percentage of sales via credit card. Store pre-opening costs, as a percentage of net sales, increased by 0.1% in fiscal 1999 compared to fiscal 1998, as we opened or relocated 95 Michaels and 23 Aaron Brothers stores in fiscal 1999 compared to 64 Michaels and 10 Aaron Brothers stores in the prior fiscal year. On January 15, 1999, MJDesigns, Inc., a competitor, filed a complaint alleging that some of our representatives disseminated negative information about the financial stability of MJDesigns, which, it was contended, contributed to MJDesigns' bankruptcy filing. On August 5, 1999, we reached an agreement to settle the litigation and, accordingly, we recorded a $1.5 million charge in the second quarter of fiscal 1999 to reflect the terms of the agreement. In addition to the settlement payment, we executed mutual releases with MJDesigns. The court approved the settlement on October 19, 1999. Including the litigation settlement charge, operating income in fiscal 1999 was $122.7 million. Excluding the litigation settlement charge, operating income in fiscal 1999 increased 39% from the prior fiscal year to $124.2 million compared to $89.1 million in fiscal 1998. Operating income, as a percentage of net sales, increased by 0.8% in fiscal 1999 compared to fiscal 1998. This improvement represented a 38% increase over the prior fiscal year, on a 20% increase in net sales, to $122.7 million compared to $89.1 million in the prior fiscal year. Interest expense (net of interest income), as a percentage of net sales, decreased by 0.1% for fiscal 1999 compared to fiscal 1998. This decrease resulted from a leveraging of interest expense on expanded sales, partially offset by lower invested cash balances in fiscal 1999 compared to fiscal 1998. Net income for fiscal 1999, including the litigation settlement charge, was $62.3 million, or $2.01 per diluted share. Excluding the litigation settlement charge, net income increased 45% from the prior 24 fiscal year to $63.2 million, or $2.03 per diluted share, compared to $43.6 million, or $1.43 per diluted share, in fiscal 1998. LIQUIDITY AND CAPITAL RESOURCES We require cash principally to finance capital investments, inventory for new, relocated, and expanded stores, and seasonal working capital. We opened 86 Michaels and Aaron Brothers stores in fiscal 1999 and 97 stores in fiscal 2000, relocated 32 Michaels and Aaron Brothers stores in fiscal 1999 and 20 stores in fiscal 2000, and expanded three Michaels stores in fiscal 1999 and one Michaels store in fiscal 2000. In recent years, we have financed our operations and new store openings primarily with cash from operations, borrowings under our bank credit facility, the issuance of our common stock, and proceeds from the exercise of outstanding stock options. We currently estimate that our capital expenditures will be approximately $145 million in fiscal 2001, which amount is net of proceeds of approximately $26.9 million from the completion in June 2001 of a sale/leaseback transaction for two distribution centers which we purchased in December 2000. We anticipate spending approximately $47 million to open approximately 75 new Michaels and 20 new Aaron Brothers stores; $30 million for improvements in existing stores; $29 million for new and existing distribution centers; $11 million on information systems projects; $4 million on corporate expansion; and $24 million for various other capital investment activities. We expect to spend on average approximately $1.25 million to open a new Michaels store, which includes $570,000 in net inventory and $110,000 of pre-opening costs and $436,000 to open a new Aaron Brothers store, which includes $133,000 in net inventory and $28,000 of pre-opening costs. We anticipate that our new Michaels and Aaron Brothers stores, as a group, will become profitable within the first 12 months of operation of each store. On June 9, 2000, we called for the redemption on June 29, 2000 of our convertible subordinated notes due January 15, 2003. The aggregate principal amount of the convertible subordinated notes outstanding was $96,935,000. The holders had the option to convert their convertible subordinated notes into shares of our common stock prior to 5:00 p.m., Eastern Time, on June 22, 2000, at a price of $38.00 per share. Alternatively, holders could have their convertible subordinated notes redeemed on June 29, 2000 at a total redemption price of $1,051.25 per $1,000 principal amount of convertible subordinated notes, which includes a premium for early redemption and accrued interest. As a result, a majority of the convertible subordinated notes was surrendered by the June 22, 2000 conversion date and were converted into 2,445,565 shares of our common stock. The remaining convertible subordinated notes were redeemed at a total redemption price of $4,206,051 on June 29, 2000. The loss from the redemption was not material. In fiscal 1998, we repurchased and placed in treasury 1,145,000 shares of our common stock for an aggregate purchase price of $20.4 million. On July 14, 1999, our Board of Directors authorized the repurchase of up to 5,000,000 shares of our common stock. Pursuant to this plan, in fiscal 1999 we repurchased and placed in treasury 364,000 shares of our common stock for an aggregate purchase price of $11.5 million. In the first quarter of fiscal 2000, we retired all of our common stock held in treasury. Subsequent to the first quarter of fiscal 2000, through December 14, 2000, we repurchased and retired 4,636,000 shares of our common stock for an aggregate purchase price of $139.4 million (average of $30.06 per share) and, as a result, we completed the July 1999 stock repurchase plan. On December 14, 2000, our Board of Directors authorized the repurchase of an additional 1,000,000 shares of our outstanding common stock. As of May 5, 2001, we have repurchased and retired 525,000 shares under this plan at an aggregate price of $17.2 million (average cost of $32.67 per share). We may continue our stock repurchases provided that market prices of our common stock make it advantageous. We are restricted by regulations of the SEC from making repurchases during specified 25 time periods. Finally, under the agreements governing our outstanding indebtedness, we can only repurchase shares if we maintain or comply with specified financial ratios and other covenants. Proceeds from the exercise of outstanding stock options have served as a source of cash for us, and we expect to receive proceeds from the exercise of outstanding stock options in the future. For the first quarter of fiscal 2001, proceeds from the exercise of stock options were $7.8 million. For fiscal 2000, proceeds from the exercise of stock options were $89.5 million. During fiscal 1999, proceeds from the exercise of stock options were $28.8 million. In October 1997, we began issuing our common stock through our dividend reinvestment and stock purchase plan. The plan provides owners of shares of our common stock with a convenient and economical means of purchasing our common stock. During fiscal 2000, 1999, and 1998, we issued 411,982, and 178,730 shares, respectively, through the plan, generating $14,000, $27,000, and approximately $6.2 million, respectively, in new equity. In October 1999, we began issuing our common stock through our employees stock purchase plan. The plan provides our employees with a convenient and economical means of purchasing our common stock. The plan also provides us with an additional way to raise equity capital. During fiscal 2000 and 1999, we issued 33,288 and 8,035 shares, respectively, through the plan, generating approximately $922,000 and $208,000, respectively, in proceeds. Prior to October 1999, shares for the employees stock purchase plan were acquired through open market purchases. CHANGES IN CASH AND EQUIVALENTS FIRST QUARTER OF FISCAL 2001 COMPARED TO FIRST QUARTER OF FISCAL 2000 Cash flow used in operating activities during the first quarter of fiscal 2001 was $24.8 million, compared with cash flow provided by operating activities of $9.1 million during the first quarter of fiscal 2000. Cash flow used in operating activities for the first quarter of fiscal 2001 was principally the result of higher investments in merchandise inventories, net of accounts payable, in the amount of $54.9 million compared with the first quarter of fiscal 2000 primarily as a result of new store openings and purchases made in the first quarter of fiscal 2001 to improve our in-stock position on core merchandise. Inventories per Michaels store of $1.106 million at May 5, 2001 increased 5% from $1.055 million at April 29, 2000. In connection with our continuing supply chain management initiatives, our plans are to continue to increase the basic inventory levels carried in our distribution centers in an effort to reduce the number of direct vendor shipments to our stores, thereby reducing the safety stock required at the store level. Cash flow used in investing activities in the first quarter of fiscal 2001 was $19.0 million compared to $17.2 million in the first quarter of fiscal 2000. Cash flow from investing activities in the first quarter of fiscal 2001 was primarily the result of capital expenditures related to the opening of 16 Michaels and four Aaron Brothers stores and the relocation of four Michaels stores in the first quarter of fiscal 2001. The following table sets forth capital expenditures for the first quarter of fiscal 2001 and the first quarter of fiscal 2000:
13 WEEKS ENDED -------------------- APRIL 29, MAY 5, 2000 2001 --------- -------- (IN THOUSANDS) New and relocated stores and stores not yet opened........ $10,453 $ 9,691 Existing stores........................................... 997 3,413 Distribution system expansion............................. 210 1,992 Information systems....................................... 4,635 1,984 Corporate and other....................................... 925 1,960 ------- ------- $17,220 $19,040 ======= =======
26 We anticipate additional capital expenditures during the remainder of fiscal 2001 to total approximately $126.0 million, which amount is net of proceeds of $26.9 million from the completion in June 2001 of a sale/leaseback transaction for the two distribution centers which we purchased in December 2000. Cash flow provided by financing activities in the first quarter of fiscal 2001 was $37.0 million compared to $30.0 million in the first quarter of fiscal 2000. The increase in cash provided by financing activities was primarily due to net borrowings outstanding under the credit agreement of $29.2 million as of May 5, 2001 partially offset by a decrease in the proceeds from the exercise of stock options. Proceeds from the exercise of stock options were $7.8 million for 325,667 shares of our common stock in the first quarter of fiscal 2001 and $31.3 million for 1,471,529 shares of our common stock in the first quarter of fiscal 2000. FISCAL 2000 COMPARED TO FISCAL 1999 Our net cash provided by operating activities in fiscal 2000 was $146.8 million compared to $60.8 million in fiscal 1999. This increase was due to increased profitability before depreciation and amortization and a smaller increase in merchandise inventories for fiscal 2000 compared to fiscal 1999. Our net cash used in investing activities in fiscal 2000 was $120.1 million compared to $90.8 million during fiscal 1999. Our cash used in investment activities resulted from opening 72 Michaels and 25 Aaron Brothers stores and relocating 17 Michaels and three Aaron Brothers stores during fiscal 2000. Capital expenditures were approximately $55.1 million for the newly opened stores, approximately $35.3 million related to existing stores and information systems enhancements, and approximately $27.6 million related to the exercise of our option to purchase two distribution facilities that were previously leased. In addition, we spent approximately $2.2 million related to the acquisition of the Star Wholesale operation. During fiscal 1999, we opened 69 Michaels and 17 Aaron Brothers stores and relocated 26 Michaels and six Aaron Brothers stores. Capital expenditures for the newly opened stores were approximately $58.5 million during fiscal 1999. Our net cash used in financing activities for fiscal 2000 was $75.9 million compared to net cash provided by financing activities of $11.3 million in fiscal 1999. This increase in net cash used in financing activities was primarily the result of repurchases of more shares of our common stock pursuant to the July 1999 stock repurchase program, partially offset by an increase in proceeds from the exercise of stock options. During fiscal 2000, we received $89.5 million from the exercise of stock options for 4,454,332 shares of our common stock, compared to $28.8 million for 1,857,336 shares during fiscal 1999. SENIOR UNSECURED BANK CREDIT FACILITY In May 2001, we completed a new senior unsecured revolving credit facility of $200 million with our bank lenders, which replaced our previous senior unsecured $100 million credit facility. Our new bank credit facility provides for a $200 million revolving line of credit with a $25 million competitive bid loan feature and a $70 million letter of credit sub-facility. Our new bank credit facility is further described in "Description of Other Indebtedness." We are in compliance with all terms and conditions of our credit agreement. Borrowings outstanding under our credit facility were $29.2 million as of May 5, 2001. Borrowings available under the credit agreement are reduced by the aggregate amount of letters of credit outstanding under the credit agreement ($8.7 million at May 5, 2001). Borrowings in the first quarter of fiscal 2001 were outstanding for 79 days, with an average outstanding borrowing of $13.0 million and a weighted average interest rate of 7.33%. Borrowings in fiscal 2000 and fiscal 1999 were outstanding under our previous $100 million credit facility for 47 days and 121 days, respectively, in connection with the inventory buildup for peak selling seasons (with average outstanding borrowings of $25 million and $40 million, respectively, and a weighted average interest rate of 7.80% and 6.29%, respectively). 27 GENERAL We believe that our available cash, funds generated by operating activities, funds available under our credit facility, the net proceeds from the outstanding notes, and proceeds from the exercise of stock options will be sufficient to redeem the 10 7/8% senior notes due 2006 and fund anticipated capital expenditures, working capital requirements, and any stock repurchases, for the foreseeable future. SEASONALITY Our business is highly seasonal, with higher sales in the third and fourth fiscal quarters. Historically, the fourth quarter, which includes the Christmas selling season, has accounted for approximately 36% of our sales and, excluding 1995 and 1996, approximately 60% of our operating income. For information with respect to our quarterly results for fiscal 2000, see the Unaudited Supplemental Quarterly Financial Data schedule in our Consolidated Financial Statements for fiscal 2000 included elsewhere in this prospectus. 28 INDUSTRY OVERVIEW As the leading specialty retailer providing materials, ideas, and education for creative activities in home decor, art, and craft projects, we believe that we are well positioned to benefit from several favorable consumer trends. Based on our historical sales trends, we believe demographic changes, particularly an aging baby boomer population, and a favorable economic environment have led to increases in investment in the home and purchases of new homes, an increasing focus on home-based, family activities, and the trend towards making, rather than buying, gift items. According to the industry study most recently published by the Hobby Industry Association, 65% of United States households surveyed had at least one member who engaged in a craft activity within the prior year. We compete across several additional industries, including home decor, party supplies, candles, photo frames, and custom framing. For example, approximately 46% of our sales are derived from three decorative categories--silk and dried flowers, picture framing, and seasonal products. When this broader focus is considered, a recently published research report estimates the market in which our products are sold at over $30 billion. The market in which we compete is highly fragmented, containing thousands of stores nationwide operated primarily by small, independent retailers. We are the largest and only national retailer dedicated to serving the arts and crafts market, and we believe that there are only four other major arts and crafts retailers in the United States with annual sales in excess of $200 million. Moreover, we believe that our fiscal 2000 sales were more than twice as large as those of our largest direct competitor. Customers tend to choose where to shop based upon store location, selection, price, quality of merchandise, availability of product, and customer service. We compete with many different types of retailers and classify our competition within the following categories: - MULTI-STORE CHAINS. This category includes several multi-store chains operating more than 35 stores in a region and comprises: Hobby Lobby, a chain which operates approximately 256 stores primarily in the Midwestern United States; A.C. Moore Arts & Crafts, Inc., a chain which operates approximately 53 stores in the mid-Atlantic and Northeast regions; Jo-Ann etc. (operated by Jo-Ann Stores, Inc.), which operates approximately 59 stores across the country; and Garden Ridge Corporation, which operates approximately 36 stores across the country. All of these chains are significantly smaller than Michaels with respect to number of stores and total net sales. While more sophisticated than the small, local specialty retailer, we believe none of these chains has buying power, distribution, and advertising capabilities comparable to ours. - SMALL, LOCAL SPECIALTY RETAILERS. This category includes thousands of local "Mom & Pop" art and craft retailers. Typically, these are single store operations managed by the owner. The stores generally offer a limited selection and have limited resources for advertising, purchasing, and distribution. Many of these stores have established a loyal customer base within a given community and compete on customer service. - MASS MERCHANDISERS. This category includes companies such as Wal-Mart Stores, Inc. and other mass merchandisers. These retailers typically dedicate only a small portion of their selling space to a limited selection of home decor, art and craft supplies, and seasonal merchandise. In addition, these mass merchandisers generally have limited customer service staffs with little or no experience in crafting projects. 29 BUSINESS GENERAL We are the largest national specialty retailer providing materials, ideas, and education for creative activities. As of May 5, 2001, we operate 644 Michaels retail stores in 48 states, as well as Canada and Puerto Rico, which offer products for the do-it-yourself home decorator and art and craft supplies. We also operate 123 Aaron Brothers stores as of May 5, 2001, primarily on the West Coast, which offer photo frames, a full line of ready-made frames, custom framing services, and a wide selection of art supplies. We also own and operate Star Wholesale, a single wholesale operation located in Dallas, Texas, offering merchandise primarily to interior decorators/designers, wedding/event planners, florists, hotels, restaurants, and commercial display companies. RECENT HISTORY During the early 1990s, we embarked on an aggressive national expansion program. By 1995, we had tripled our store base to over 500 stores through new store openings and acquisitions, accomplishing our goal of becoming the nation's largest specialty retailer in our industry. However, as a result of the lack of adequate information systems and infrastructure to support our rapid growth, our financial results began to weaken. In fiscal 1996, we hired Michael Rouleau, our current President and Chief Executive Officer, who has focused on increasing the profitability of our existing stores by implementing a variety of operating initiatives. These initiatives included installing POS systems chain-wide to record item-level sales, implementation of plan-o-grams, elimination of non-core merchandise, reduction of costs through centralized negotiated pricing and strengthening the quality and depth of our management team. During fiscal 1997, we continued to focus on key initiatives, including increasing the number of SKUs replenished and shipped from our distribution centers to our stores, testing a new store prototype and store opening process, and improving merchandising in our stores. With the success of these initiatives, we resumed an accelerated new store opening strategy by opening 50 new Michaels stores during fiscal 1998. We opened 69 Michaels stores and 17 Aaron Brothers stores in fiscal 1999 and 72 Michaels stores and 25 Aaron Brothers stores in fiscal 2000. Included in our fiscal 1999 and 2000 Michaels store openings are 15 and one stores, respectively, for which we acquired the leases from MJDesigns, Inc. During the first quarter of fiscal 2001, we opened 16 Michaels stores and four Aaron Brothers stores. MERCHANDISING AND MARKETING PRODUCT SELECTION Our Michaels store merchandising strategy is to provide a broad selection of products in an appealing store environment that emphasizes superior customer service. Each Michaels store offers more than 40,000 SKUs in a number of product categories. The following table shows a breakdown of sales for Michaels stores by department as a percentage of total sales for fiscal 1998, 1999, and 2000:
FISCAL YEAR ------------------------------ 1998 1999 2000 -------- -------- -------- General crafts............................................. 29% 28% 27% Picture framing............................................ 18 18 18 Silk and dried floral...................................... 18 17 17 Fine art materials......................................... 16 17 17 Hobby, party, and candles.................................. 11 11 10 Seasonal................................................... 8 9 11 --- --- --- 100% 100% 100% === === ===
30 The merchandise offered within each major category is as follows: - products for the do-it-yourself home decorator, including wall decor, candles, containers, baskets and potpourri; custom framing services, ready-made frames, mat boards, glass, backing materials and related supplies, framed art, and photo albums; and silk flowers, dried flowers and artificial plants sold separately or in ready-made and custom floral arrangements, all accessories needed for floral arranging and other floral items, such as wreaths; - art supplies, including memory book materials; surfaces and pads; adhesives and finishes; and pastels, watercolors, oil paints, acrylics, easels, brushes, paper, canvas, and stenciling materials; and - craft supplies, including beads, wood, doll making supplies, jewelry making supplies, rubber stamps, apparel crafts, books and magazines, and plaster; needlecraft items including stitchery supplies, hand-knitting yarns, needles, canvas, and related supplies for needlepoint, embroidery and cross stitching, knitting, crochet, rug making kits, and quilt and afghan kits; ribbon and wedding accessories; gifts; hobby items including plastic model kits and related supplies, kids' craft materials, plush toys, and paint-by-number kits; party needs including paper party goods, balloons, gift wrap, candy making supplies, and cake decorating supplies; and candle making supplies. Our Michaels stores regularly feature seasonal merchandise that complements our core merchandising strategy. Seasonal merchandise is offered for several holiday periods, including Valentine's Day, Easter, Mother's Day, Halloween, Thanksgiving, and Christmas. For example, seasonal merchandise for the Christmas season includes home decorating components such as artificial trees, wreaths, candles, lights, and ornaments. During the Christmas selling season, a significant portion of floor and shelf space in a typical Michaels store is devoted to Christmas crafts, Christmas decorations and gift making merchandise. Because of the project-oriented nature of these products, the Christmas selling season begins in August and extends through December. Accordingly, a fully developed seasonal merchandising program, including inventory, merchandise layout and instructional ideas, is implemented in each Michaels store beginning in July of each year. This program requires additional inventory accumulation so that each store is fully stocked during the peak season to meet higher demand from increased customer traffic. We routinely identify merchandise that requires some price reduction to accelerate sales of the product. The need for this reduction is generally attributable to either seasonal product remaining at the end of the season or product that is being displaced from its assigned location in the store to make room for new merchandise. Additional product candidates for repricing are identified using the POS sales data. In each case, the appropriate repricing is determined at our corporate office and sent to the stores with instructions on how to promote sales of the repriced product. Our Aaron Brothers stores offer on average 7,900 SKUs, including photo frames, a full line of ready-made frames, and a wide selection of art supplies and custom framing services. Our merchandising strategy for our Aaron Brothers stores is to provide guaranteed everyday low-priced custom framing services and selection, with a 10-day delivery guarantee. In addition, we strive to provide a fashion forward framing merchandise selection in an appealing environment with superior customer service. CUSTOMER SERVICE We believe that customer service is an important component of our merchandising strategy. Many of the craft supplies sold in Michaels stores can be assembled into unique end products with an appropriate amount of guidance and direction. Accordingly, we have displays in every store in an effort to stimulate new project ideas and we supply free project sheets with detailed instructions on how to 31 assemble the product. We also offer project sheets on our Internet site, www.michaels.com, and in our MICHAELS CREATE! magazine. In addition, many Michaels sales associates are craft enthusiasts who are able to help customers with ideas and instructions. We periodically offer inexpensive classes and demonstrations utilizing merchandise available in our stores as a means of promoting craft trends and expanding our customer base. ADVERTISING We focus on circular and newspaper advertising. We have found full-color circular advertising, primarily as an insert into newspapers, to be the most effective medium of advertising. The circulars advertise numerous products in order to emphasize the wide selection of products available at Michaels stores. We believe that our ability to advertise through circulars and newspapers throughout the year in each of our markets provides us with an advantage over our smaller competitors. In addition, our advertising reinforces and strengthens our brand name. In fiscal 2000, we spent approximately $108.8 million on advertising. STORE DESIGN AND OPERATIONS Our store design encourages purchases in a friendly, interactive environment. Our Michaels stores average 18,100 square feet of selling space, and our Aaron Brothers stores average 5,900 square feet of selling space. Many of the craft supplies sold in our Michaels stores can be assembled into unique end products with an appropriate amount of guidance and direction. Accordingly, we display completed projects in every Michaels store in an effort to stimulate new project ideas and we supply free project sheets with detailed instructions on how to assemble the product. Store design is developed centrally and implemented at the store level through the use of plan-o-grams which provide store associates with detailed descriptions and illustrations with respect to store layout and merchandise presentation. Plan-o-grams are also used to cluster various products that can be combined to create individual projects. We strive to complement our innovative store design with superior customer service to provide an enjoyable shopping experience. We believe that prompt, knowledgeable, and enthusiastic service fosters customer loyalty and can differentiate us from our competition. Many of our sales associates are craft enthusiasts who are able to help customers with ideas and instructions. A Michaels store is typically managed by a store manager, one assistant manager, and three department managers. The field organization for Michaels is headed by an executive vice president and is divided into four geographic zones. Each zone has its own vice president, loss prevention manager, human resources manager, and 12 to 13 district managers. There are a total of 50 districts. Typically, an Aaron Brothers store is managed by a store manager and one or two assistant managers. The field organization for Aaron Brothers is headed by a divisional vice president and is divided into 10 districts, each with a district manager. We believe this organizational structure enhances the communication among the individual stores and between the stores and corporate headquarters. PURCHASING We purchase merchandise from over 1,400 suppliers. We believe that our buying power and ability to make centralized purchases enable us to acquire products on favorable terms. Central merchandising management teams for Michaels and Aaron Brothers negotiate with vendors on behalf of all their stores in order to obtain the lowest net merchandise costs and improve control over product mix and inventory. In fiscal 2000, our top 10 vendors accounted for approximately 19% of total purchases with no single vendor accounting for more than 4% of total purchases. 32 In addition to purchasing from outside suppliers, our Michaels and Aaron Brothers stores purchase ready-made frames from our manufacturing division. This division, which also manufactures and sells custom framing materials and services to our stores, consists of a manufacturing facility and three regional processing centers to support our retail stores. Substantially all of the products sold in Michaels stores are manufactured in the United States, the Far East, Canada, and Mexico. Goods manufactured in the Far East generally require long lead times and are ordered four to six months in advance of delivery. Those products are either imported directly by us or acquired from distributors based in the United States. In all cases, purchases are denominated in United States dollars (or Canadian dollars for purchases of certain items delivered directly to stores in Canada). Our in-store merchandise assortments are selected by our centralized buying staff. More than 80% of our SKUs are carried year round and are considered basic items. These items are reordered by the stores on a weekly basis via a radio frequency handheld ordering device, or RF gun, and an in-store back-office computer. The in-store computer then generates an order to be faxed to a vendor for SKUs not carried in our distribution centers or transmits a replenishment order to the general office for items carried in our distribution centers. Late in fiscal 1998, we enhanced the RF gun software to provide the store order specialists with store specific sales history for any item. Early in fiscal 1999, store order specialists were given revised ordering procedures that encompassed the new expanded capability of the RF gun. Consequently, specialists reordering merchandise now have both the on-hand quantity and the sales history data at the time they determine order quantities. In fiscal 2000, additional functionality was added to the RF gun to provide a recommended order quantity for selected items. Further enhancements are anticipated during fiscal 2001. DISTRIBUTION We currently operate a distribution system that supplies our Michaels stores with merchandise, including substantially all seasonal and promotional items. Our distribution centers are located in Texas, California, Kentucky, and Florida. In fiscal 2000, we initiated an expansion of our California distribution center, and in fiscal 2001, we will begin building a new distribution facility in the Northeast. These projects, to be completed in the first half of fiscal 2002, will add approximately 1.1 million square feet to our current 1.8 million square feet of capacity. Michaels stores generally receive deliveries from the distribution centers each week through an internal distribution network using contract carriers. Aaron Brothers stores receive merchandise from their dedicated distribution center located in the Los Angeles, California area. Star Wholesale receives its merchandise from direct vendor shipments. We believe that our distribution system, with its planned expansion, will allow us to maintain sufficient inventory in each store to meet our customers' demands while controlling our overall investment in inventory. We currently have approximately 16,500 SKUs in our distribution centers. We intend to add approximately 9,000 SKUs that we will replenish through our distribution centers after our expansion is completed. We believe our distribution network provides us with an advantage over our competitors, and we intend to increase the amount of goods processed through our distribution system to reduce our supply chain costs and more effectively manage our investment in inventories. Approximately 57% of Michaels stores' merchandise is shipped through the Michaels distribution system, with the remainder being shipped directly from vendors. Approximately 63% of Aaron Brothers stores' merchandise is shipped through the Aaron Brothers distribution center, with the remainder being shipped directly from vendors. Each Aaron Brothers store is systematically restocked on a weekly or biweekly basis. 33 INVENTORY MANAGEMENT Our primary objectives for inventory management are maximizing the efficiency of the flow of product to the stores, improving store in-stock position, improving store labor efficiency, and optimizing overall investment in inventory. We manage our inventory in several ways, including: weekly tracking of inventory status; the use of plan-o-grams to control the merchandise assortment; the use of store level RF guns to order merchandise based on store specific rate of sale for each SKU; and the review of item-level sales information in order to track the sell-through of seasonal and promotional items and to plan our assortments. The data that we are obtaining from our POS system is an integral component in the inventory management process. In addition, inventories are verified through periodic physical counts conducted throughout the year on a rotating systematic schedule. We anticipate that the additional information on SKU-level inventories at each store, as provided by a perpetual inventory system, will dramatically improve our ability to balance our inventory and improve our replenishment process. We began testing such a perpetual inventory system in select stores in fiscal 2000, with plans to roll the process out to all Michaels stores beginning in fiscal 2002. BUSINESS STRATEGY We intend to increase our revenues and profits by strengthening our position as the leading national retailer within the arts and crafts and home decor sector through the following strategies: - INCREASE SALES AND PRODUCTIVITY OF MICHAELS STORES. Our Michaels stores that have been open for more than 12 months currently average $3.5 million in sales per store. We believe we can increase average sales per store to $5.0 million. We intend to achieve this objective by increasing the dollar amount per sale and by creating additional demand for our products. - INCREASING DOLLAR AMOUNT PER SALE. We believe if a customer consistently finds the desired product in-stock, the customer will view Michaels stores as a store-of-choice and purchase additional merchandise while in the store. We intend to enhance each store's in-stock position of key merchandise via the improvement of our supply chain. Our distribution centers allow us to leverage our price negotiations with our suppliers by ordering significant quantities, while also providing us the ability to break large orders into smaller quantities to allow for a timely and economical response to stores' in-stock demands. Through our distribution initiatives in fiscal 2001 and 2002, we will add distribution capacity of 1.1 million square feet to our existing 1.8 million square feet. We are also testing a perpetual inventory system, with an expected roll-out starting in fiscal 2002, to further enhance our capability to monitor and manage our in-store inventories. - CREATING ADDITIONAL DEMAND FOR OUR PRODUCTS. We are currently targeting increased demand for our products through traditional retail and advertising and multimedia channels. We are implementing this strategy by: u holding in-store classes, demonstrations, and other educational events utilizing merchandise available in our stores, u promoting craft ideas and projects in our recently launched bi-monthly MICHAELS CREATE! magazine, which has become the second most popular arts and crafts publication in its debut issue. The magazine will be carried by other major retailers, including K-mart and Target, u promoting craft ideas on our www.michaels.com website, and u participating in industry-wide promotion campaigns. - ENHANCE MERCHANDISE OPERATING MARGINS. We intend to enhance operating margins through additional leverage of our consolidated purchasing activities. We plan to leverage our technology 34 systems to improve margins on seasonal products through our implementation of allocation technologies that more efficiently allocate merchandise among stores, and to maximize margins on promotional sales by determining more accurately the most profitable promotional price for each product. We continue to seek value-added opportunities to complement our core businesses, such as our recent expansion into art prints and Michaels-manufactured framing products, which extends and enhances our custom framing business. In addition, we continue to evaluate opportunities to further reduce our merchandise costs and ensure adequate supplies through vertical integration. - GROW THROUGH NEW MICHAELS STORE OPENINGS. We believe the United States and Canadian markets can support up to 1,100 Michaels stores. We plan to open approximately 75 new Michaels stores each year beginning in fiscal 2001 and extending into the foreseeable future, funded primarily through operating earnings and seasonal borrowings. Since the beginning of fiscal 1998, we have opened or relocated 268 Michaels stores using our standard operating procedures, which contain more than 500 steps to ensure a smooth opening with a merchandise assortment and presentation consistent with our existing stores. We have developed and are refining our Michaels store prototype to constantly incorporate improved merchandising techniques and store layouts. - EXPAND AARON BROTHERS NATIONWIDE. We plan to open approximately 20 new Aaron Brothers stores in fiscal 2001, also funded primarily through operating earnings and seasonal borrowings. Assuming successful openings in new markets, we plan to roll out this concept nationwide and open 25 to 75 new Aaron Brothers stores per year in each of the subsequent three fiscal years. We believe the United States and Canadian markets can support up to 600 Aaron Brothers stores. In addition to the above core business strategies, we also intend to increase our revenues and profits through the following strategies: - TEST A WHOLESALE BUSINESS CONCEPT. In May 2000, in connection with our strategy of developing a wholesale business concept, we acquired Star Wholesale in Dallas, Texas. The target customers for this concept are interior decorators/designers, wedding/event planners, florists, hotels, restaurants, and commercial display companies. Star Wholesale features approximately 50,000 square feet of selling space and offers approximately 18,000 SKUs. This is a test concept that we see as an additional area in which we can expand our customer base, leverage our experience and vendor base, and add growth to our business. - ENHANCE THE MICHAELS WEBSITE. We have created a Michaels.com division that is focused on developing and maintaining an innovative online experience for our customers. The primary focus of our Internet strategy is to provide information, ideas, and education about crafting and to encourage consumers using our website to visit our retail stores to purchase merchandise they need for their projects. We look at our website as a permanent marketing tool for Michaels and we will use it to enhance our core retail business and the industry in general. The secondary focus for our Michaels.com division is to offer merchandise for sale online. STORE EXPANSION AND RELOCATION Having achieved our objective of becoming the largest and only national retailer of arts, crafts, and decorative items, we recognized in 1995 that we had the critical mass to achieve improved operating efficiencies that could result in higher returns on capital by focusing on key initiatives, such as strengthening our information systems and infrastructure to support future store growth. On August 23, 1995, we announced a shift in focus from sales growth to realizing higher returns on capital and as a result, moderated our internal growth rate in number of stores. In fiscal 1998, having successfully 35 completed these initiatives, we returned to an accelerated new store opening program and have maintained that growth through fiscal 2000. The following table shows our store growth:
FISCAL YEAR 13 WEEKS ---------------------------------------------------- ENDED 1996 1997 1998 1999 2000 MAY 5, 2001 -------- -------- -------- -------- -------- ----------- MICHAELS STORES: Retail stores open at end of period................ 453 452 496 559 628 644 Retail stores opened during the period............. 13 9 50 69 72 16 Retail stores closed during the period............. 2 10 6 6 3 -- Retail stores relocated during the period.......... 22 14 14 26 17 4 AARON BROTHERS STORES: Stores open at end of period....................... 72 74 78 95 119 123 Stores opened during the period.................... 4 3 5 17 25 4 Stores closed during the period.................... -- 1 1 -- 1 -- Stores relocated during the period................. 3 1 5 6 3 -- STAR WHOLESALE STORE: Wholesale store open at end of period.............. -- -- -- -- 1 1 Wholesale store acquired during the period......... -- -- -- -- 1 --
In keeping with our plans to continue to seek store growth while realizing higher returns on capital, in fiscal 2001, we plan to open approximately 75 new and relocate approximately 25 Michaels stores. We also plan to open approximately 20 new and relocate approximately five Aaron Brothers stores in fiscal 2001. Assuming successful openings in new markets, we plan to roll this concept out nationwide and open 25 to 75 new Aaron Brothers stores per year in each of the subsequent three fiscal years. Our expansion strategy is to give priority to adding stores in existing markets in order to enhance economies of scale associated with advertising, distribution, field supervision, and other regional expenses. We believe that few of our existing markets are saturated. The anticipated opening of Michaels and Aaron Brothers stores in fiscal 2001 and the rate at which stores are opened thereafter will depend upon a number of factors, including the success of existing Michaels and Aaron Brothers stores, the availability and the cost of capital for expansion, the availability of suitable store sites, and the ability to hire and train qualified managers. Michaels has developed a standardized procedure that allows for the efficient opening of new stores and their integration into our information and distribution systems. Michaels develops the floor plan and inventory layout and organizes the advertising and promotions in connection with the opening of each new store. In addition, Michaels maintains qualified store opening teams to provide new store personnel with in-store training. Accordingly, Michaels generally opens new stores during the period from February through October because new store personnel require significant in-store training prior to entering the Christmas selling season. Costs for opening stores at particular locations depend upon the type of building and general cost levels in the area. In fiscal 2000, the average net cost of opening a new Michaels store was approximately $1.2 million, which included approximately $641,000 of leasehold improvements, furniture, fixtures and equipment, and pre-opening costs, and an estimated initial inventory investment (net of accounts payable) of $570,000. The total cost of opening a new store depends on the store size, operating format, and the time of year in which the store is opened. The initial inventory investment in new Michaels stores is offset, in part, by vendor terms and allowances. In addition to new store openings, we continue to pursue a store relocation program to improve the quality and performance of our existing store base. During fiscal 1999 and 2000, we relocated 26 and 17 Michaels stores, respectively, and six and three Aaron Brothers stores, respectively. We plan to 36 relocate approximately 25 Michaels stores and five Aaron Brothers stores during fiscal 2001. During fiscal 1999 and 2000, we closed six and three Michaels stores, respectively, and in fiscal 2000, one Aaron Brothers store. We plan to close approximately five Michaels stores and no Aaron Brothers stores during fiscal 2001. INVESTMENT IN INFORMATION TECHNOLOGY We are committed to utilizing technology to increase operating efficiencies and to improve our ability to satisfy the needs of our customers. With the installation of the POS system, which includes bar code scanning, came the ability to better understand the demands of the customer, emerging merchandise trends, and inventory replenishment requirements. During fiscal 1998, we completed installation of new networked computer systems in every store to handle data communications, price management, enhanced radio frequency terminal applications for inventory management, faster credit authorization, and gift card processing. In addition, a new standardized warehouse management system utilizing radio frequency terminals with bar code scanning technology was installed in all distribution centers. We are continuing to install advanced merchandise information systems software that will be closely integrated with store systems and warehouse management systems to provide greatly enhanced inventory management capabilities, including the benefits attributable to our planned perpetual inventory and automated replenishment systems. We believe that information is a competitive tool and intend to be the craft industry leader in the effective and efficient utilization of this resource. FOREIGN SALES Our current international business is concentrated in Canada. Sales outside the United States accounted for approximately 2% of total sales in fiscal 1998, 3% in fiscal 1999, and 3% in fiscal 2000. During the last three years, less than 5% of our assets have been located outside of the United States. SERVICE AND TRADE MARKS The names "Michaels" and "Aaron Brothers" and the Michaels logo are each federally registered service marks. EMPLOYEES As of April 20, 2001, we employed approximately 33,000 associates, approximately 21,700 of whom were employed on a part-time basis. The number of part-time associates is substantially increased during the Christmas selling season. Of our full-time associates, approximately 2,300 are engaged in various executive, operating, training, distribution, and administrative functions in our corporate and division offices and distribution centers, and the remainder are engaged in store operations. None of our associates are members of labor unions. PROPERTIES We lease substantially all of the sites for our Michaels and Aaron Brothers stores, with lease terms generally ranging from five to 10 years. The base rental rates for Michaels stores generally range from $85,000 to $340,000 per year. Rental expense for our Michaels stores open for the full 12-month period of fiscal 2000 averaged $204,000, and rental expense for our Aaron Brothers stores open for the full 12-month period of fiscal 2000 averaged $116,000. The leases are generally renewable with increases in lease rental rates. Lessors have made leasehold improvements to prepare our stores for opening under a majority of our existing leases. In December 2000, we exercised our purchase option on properties we previously leased and acquired the 423,000 square foot building at the Alliance Airport in Tarrant County, Texas and the 506,000 square foot building in Jacksonville, Florida that we use as distribution centers. In June 2001, 37 we completed a sale/leaseback transaction of these two properties. As a result, we now lease these properties. In addition, we lease a 431,000 square foot building in Lancaster, California and 421,000 square feet of space in Lexington, Kentucky for use as distribution centers. Aaron Brothers leases 150,000 square feet of space in the Los Angeles, California area for use as a distribution center, a custom framing regional processing center, and other office space. Our manufacturing division leases 66,000 square feet of space in Kernersville, North Carolina for use as a manufacturing plant and a custom framing regional processing center. We lease 144,000 square feet of space in Coppell, Texas for Michaels.com and its related fulfillment operations, a custom framing regional processing center, and other office space. We also lease 162,000 square feet of space in Irving, Texas and 67,000 square feet in Coppell, Texas for our corporate headquarters along with a 35,000 square foot building in Grand Prairie, Texas as a processing center. The following table indicates the number of our retail stores and wholesale operations located in each state or province as of May 5, 2001:
NUMBER OF STATE/PROVINCE STORES - -------------- --------- Alabama........................... 10 Alaska............................ 2 Alberta........................... 5 Arizona(1)........................ 27 Arkansas.......................... 3 British Columbia.................. 3 California(1)..................... 176 Colorado(1)....................... 15 Connecticut....................... 7 Delaware.......................... 2 Florida........................... 35 Georgia........................... 24 Idaho............................. 3 Illinois.......................... 28 Indiana........................... 12 Iowa.............................. 6 Kansas............................ 5 Kentucky.......................... 5 Louisiana......................... 10 Maine............................. 2 Manitoba.......................... 1 Maryland.......................... 16 Massachusetts..................... 13 Michigan.......................... 21 Minnesota......................... 11 Mississippi....................... 3 Missouri.......................... 11 Montana........................... 3
NUMBER OF STATE/PROVINCE STORES - -------------- --------- Nebraska.......................... 2 Nevada(1)......................... 10 New Hampshire..................... 5 New Jersey........................ 13 New Mexico........................ 3 New York.......................... 22 North Carolina.................... 20 North Dakota...................... 1 Ohio.............................. 27 Oklahoma.......................... 7 Ontario........................... 17 Oregon(1)......................... 15 Pennsylvania...................... 21 Puerto Rico....................... 3 Rhode Island...................... 1 South Carolina.................... 6 South Dakota...................... 1 Tennessee......................... 10 Texas(1)(2)....................... 61 Utah.............................. 6 Vermont........................... 1 Virginia.......................... 23 Washington(1)..................... 24 West Virginia..................... 3 Wisconsin......................... 7 ------ Total............................. 768 ======
- ------------------------ (1) Of the store counts indicated in Arizona, California, Colorado, Nevada, Oregon, Texas, and Washington, Aaron Brothers accounts for 8, 85, 3, 5, 4, 11, and 7 stores, respectively. (2) The store count for Texas includes one Star Wholesale store. 38 LEGAL PROCEEDINGS On May 2, 2000, Taiyeb Raniwala, a former assistant manager of the company, filed a purported class action complaint (the "Raniwala Complaint") against us, on behalf of our former and current assistant store managers. The Raniwala Complaint was filed in the Alameda County Superior Court, California and alleges we violated various California laws by erroneously treating our assistant store managers as "exempt" employees who are not entitled to overtime compensation. Based on these allegations, the Raniwala Complaint asserts we: (1) violated various California Wage Orders, (2) violated Section 17200 of the California Business and Professions Code, and (3) engaged in conversion. The Raniwala Complaint seeks back wages, interest, penalties, and attorneys' fees. On July 20, 2000, Raniwala filed an amended complaint to correct various deficiencies in the original Complaint (the "Amended Raniwala Complaint"). On September 25, 2000, we filed our answer to the Amended Raniwala Complaint. On June 6, 2001, we negotiated a tentative settlement of the purported class action with Raniwala. Pursuant to the terms of the settlement, in exchange for a full release of claims, we are obligated to pay a maximum of $3.0 million covering all claims and attorneys' fees, plus estimated payroll taxes of approximately $153,000. The specific terms of the settlement are currently being finalized between the parties and must then be approved by the Alameda County Superior Court. While we believe that it is likely that the settlement will be approved, we can provide no assurance to that effect. On April 14, 1999, Suzanne Collins, a former assistant manager of our subsidiary, Aaron Brothers, Inc., filed a class action complaint (the "Collins Complaint") against Aaron Brothers on behalf of Aaron Brothers' former store managers, assistant store managers, and managers-in-training. The Collins Complaint was filed in Los Angeles County Superior Court, California and alleges that Aaron Brothers violated various California laws by erroneously treating its store managers, assistant store managers, and managers-in-training as "exempt" employees who are not entitled to overtime compensation. Based on these allegations, the Collins Complaint asserts that Aaron Brothers: (1) violated various California Labor Codes; (2) violated Section 17200 of the California Business and Professions Code; and (3) engaged in conversion. The Collins Complaint seeks back wages, interest, penalties, punitive damages and attorneys' fees. On June 25, 2001, Collins filed an amended Complaint which expanded the purported class to include all current salaried store managers, assistant store managers, and managers-in-training based in California; added a new plaintiff as a class representative; and added two additional causes of action for injunctive and declaratory relief. The Court has set a hearing date during the fourth quarter of fiscal 2001 to determine whether the case should proceed as a class action lawsuit. A trial date has not yet been scheduled. The case is currently in the discovery phase. There can be no assurance that Aaron Brothers will be successful in defending this litigation or that future operating results will not be materially adversely affected by the final resolution of the lawsuit. We are a defendant from time to time in lawsuits incidental to our business. Based on currently available information, we believe that resolution of all known contingencies, including the litigation described above, is uncertain, and there can be no assurance that future costs of such litigation would not be material to our financial position or results of operations. 39 MANAGEMENT The following table lists our directors and executive officers, their ages, and their positions as of July 31, 2001:
NAME AGE POSITION - ---- -------------------- ------------------------------------------------- Charles J. Wyly, Jr................... 67 Chairman of the Board of Directors Sam Wyly.............................. 66 Vice Chairman of the Board of Directors Richard E. Hanlon..................... 53 Director Richard C. Marcus..................... 62 Director Elizabeth A. VanStory................. 39 Director R. Michael Rouleau.................... 63 President and Chief Executive Officer Bryan M. DeCordova.................... 45 Executive Vice President-Chief Financial Officer Edward F. Sadler...................... 56 Executive Vice President-Store Operations Robert M. Spencer..................... 61 Executive Vice President-Merchandising Douglas B. Sullivan................... 50 Executive Vice President-Development James F. Tucker....................... 56 Executive Vice President-Chief Information Officer Thomas C. DeCaro...................... 46 Senior Vice President-Merchandise Planning and Control Sue Elliott........................... 50 Senior Vice President-Human Resources Stephen R. Gartner.................... 51 Senior Vice President-Supply Chain Management Duane E. Hiemenz...................... 47 Senior Vice President-New Business Development James C. Neustadt..................... 53 Senior Vice President-Advertising and Marketing
Mr. Charles J. Wyly, Jr. has served as Chairman of the Board since July 2001 and had served as Vice Chairman of the Board since 1985. He became a director in 1984. He co-founded Sterling Software, Inc. in 1981 and, until its acquisition in 2000 by another company, had served as a director and since 1984 as Vice Chairman of the Board. Mr. Wyly served as a director of Sterling Commerce, Inc. from December 1995 until its acquisition in 2000 by another company. Mr. Wyly was a director of Scottish Annuity & Life Holdings, Ltd. from October 1998 until November 2000. Mr. Wyly served from 1964 to 1975 as an officer and director, including serving as President from 1969 to 1973, of University Computing Company. Mr. Wyly and his brother, Sam Wyly, founded Earth Resources Company, an oil refining and silver mining company, and Charles J. Wyly, Jr. served as Chairman of the Board of that company from 1968 to 1980. He was also a founding partner of Maverick Capital, Ltd., a manager of equity hedge funds. Mr. Sam Wyly has served as Vice Chairman of the Board since July 2001 and had served as Chairman of the Board since 1984. Mr. Wyly is an entrepreneur who has created and managed several public and private companies. He founded University Computing Company, which became one of the first computer utility networks and one of the first software products companies. He was a founder and, until its acquisition in 2000 by another company, was Chairman and a director of Sterling Software, Inc., a worldwide supplier of software products. He also was Chairman of the Executive Committee and a director of Sterling Commerce, Inc., until its acquisition in 2000 by another company, and was Chairman and a director of Scottish Annuity & Life Holdings, Ltd., a variable life insurance and reinsurance company, from October 1998 until June 2000. He was a founding partner of Maverick Capital, Ltd., a manager of equity hedge funds. Mr. Hanlon became a director in April 1990. He has been Senior Vice President--Investor Relations of AOL Time Warner Inc., the world's first Internet-powered media and communications company, since its inception in January 2001. From February 1995 until its inception as AOL Time Warner, Inc. in January 2001, he held various executive positions at America Online, Inc., a leading provider of Internet online services. From March 1993 until February 1995, Mr. Hanlon was President 40 of Hanlon & Co., a consulting firm, and from 1988 until 1993 was Vice President--Corporate Communications and Secretary of LEGENT Corporation. Mr. Marcus became a director of Michaels in July 1999. Since January 1997, Mr. Marcus has served as Senior Advisor to Peter J. Solomon Company, an investment banking company. From December 1994 through December 1995, Mr. Marcus served as Chief Executive Officer of Plaid Clothing Group, a manufacturer of men's tailored clothing. He is currently on the boards of directors of Zale Corporation, Lands' End, Inc., Fashionmall.com, and GiftCertificates.com. Prior to these activities, Mr. Marcus was with Neiman Marcus for 27 years and served as Chairman and Chief Executive Officer from 1979 through 1988. Ms. VanStory became a director of Michaels in July 1999. Since October 2000, she has been President of Thinkout, a consulting firm. From June 1999 until October 2000, she served as President of iMotors.com. From 1997 to June 1999, Ms. VanStory was Vice President of OfficeDepot.com, a division of Office Depot, Inc. From 1995 to 1997, she served as Vice President and General Manager of New Media for The Weather Channel. Ms. VanStory began her career in interactive media as Director of Marketing for Bell Atlantic Video Services, where she served from 1992 to 1995. From 1988 to 1992, she held several marketing positions with MCI Telecommunications Corporation. Ms. VanStory was previously a director of shop.org, an online retailing association. Mr. Rouleau has served as Chief Executive Officer since April 1996, and has also served as President from April 1997 to June 1999 and again since March 2001. Prior to joining us, Mr. Rouleau had served as Executive Vice President of Store Operations for Lowe's Companies, Inc. from May 1992 until April 1996 and in addition as President of Lowe's Contractor Yard Division from February 1995 until April 1996. Prior to joining Lowe's, Mr. Rouleau was a co-founder and President and Chief Executive Officer of Office Warehouse, which subsequently merged into Office Max. Mr. Rouleau also served with the Target Stores division of Dayton Hudson Corporation for 20 years. Mr. DeCordova became Executive Vice President-Chief Financial Officer in March 1997. From 1990 until joining us, he served as Vice President of Finance and Chief Financial Officer, and from May 1991 also as Treasurer, for Duckwall-ALCO Stores, Inc. Mr. Sadler became Executive Vice President-Store Operations in October 1999. From June 1995 until joining us, he was Regional Vice President and subsequently Senior Vice President-Stores of Caldor. Prior to Caldor, Mr. Sadler served with Target for 19 years, most recently as Vice President- Store Operations. Mr. Spencer became Executive Vice President-Merchandising in January 2001. From January 1998 until January 2001, he served as Vice President-Northeast Zone. Prior to joining us, Mr. Spencer held senior management positions at A.C. Moore, where he was Executive Vice President and Chief Operating Officer from March 1996 until December 1997, and at McCrory Stores, Target, and W.T. Grant. Mr. Sullivan became Executive Vice President-Development in April 1997. He joined Michaels in 1987 and has served in a variety of capacities, overseeing the Company's store operations, distribution, store opening, real estate, legal, and personnel functions, including serving as President from August 1995 to April 1997. Prior to joining us, Mr. Sullivan had served with Family Dollar Stores, Inc. for 11 years, most recently as Vice President-Real Estate. Mr. Tucker became Executive Vice President-Chief Information Officer in June 1997. From 1994 until joining us, Mr. Tucker held the positions of Vice President of MIS and subsequently Senior Vice President and Chief Information Officer for Shopko Stores, Inc. Prior to 1994, Mr. Tucker held the position of Vice President-Management Information Services for Trans World Music Corp. 41 Mr. DeCaro became Senior Vice President-Merchandise Planning and Control in August 2000. From 1998 until joining us, he was Vice President-Merchandise for Disneyland Resort. Prior to this, he held the position of Senior Vice President-Merchandise Planning and Allocation for Kohl's Department Stores from February 1996 to April 1998. In addition, Mr. DeCaro has held various positions in Merchandise Planning and Allocation and Finance for The Disney Store, The Limited Stores, May Department Stores, and Sanger Harris Department Stores. Ms. Elliott became Senior Vice President-Human Resources in October 2000. From May 1998 until joining us, she was Senior Vice President-Human Resources for Luby's, Inc. Prior to this, she held the positions of Vice President-Human Resources and subsequently Senior Vice President-Italianni's Brand for Carlson Restaurants Worldwide from January 1993 to May 1998. In addition, Ms. Elliott has held various human resources and operations positions at PepsiCo (KFC Restaurants). Mr. Gartner joined us as Senior Vice President-Supply Chain Management in May 2001. From 1998 until joining us, Mr. Gartner held the position of Executive Vice President-Supply Chain Management for DSC Logistics. Prior to DSC Logistics, Mr. Gartner served with The Pilsbury Company for 20 years, most recently as Vice President-Distribution Operations. Mr. Hiemenz became Senior Vice President-New Business Development in October 1999, after joining us as a Zone Vice President in July 1996 and serving as Executive Vice President-Store Operations from August 1996 to October 1999. Prior to joining Michaels, Mr. Hiemenz had served with Lowe's for nine years, most recently as a Regional Vice President. Mr. Neustadt joined us as Senior Vice President-Advertising and Marketing in May 1998. From 1994 until joining us, Mr. Neustadt was Vice President-Advertising for Lowe's. Prior to Lowe's, he held a variety of advertising and marketing positions with Montgomery Ward, Handy Andy, and Payless Cashways, Inc. DESCRIPTION OF OTHER INDEBTEDNESS In May 2001, we completed a new senior unsecured bank credit facility with Fleet National Bank, as administrative agent and lender, and other lending institutions, which replaced our previous $100 million senior unsecured bank credit facility. Our new credit agreement has an initial term of three years, which may be extended for one additional year under specific conditions, and provides for a $200 million revolving line of credit with a $25 million competitive bid loan feature and a $70 million letter of credit sub-facility. In addition, we have an uncommitted documentary letter of credit facility for an additional $50.0 million and Aaron Brothers has a similar facility for $2.5 million. Our credit agreement contains various financial covenants, including: - balance sheet leverage ratio, not to exceed 0.75 to 1.00. The balance sheet leverage ratio is defined as (a) the sum of (i) the consolidated funded debt (as defined in the credit agreement) plus (ii) six times the consolidated rental expense (as defined in the credit agreement) for the four most recent consecutive fiscal quarters to (b) the sum of (i) the total capital (as defined in the credit agreement), plus (ii) six times the consolidated rental expense for the most recent four consecutive fiscal quarters, - cash flow coverage ratio, not to be less than 1.90 to 1.00. The cash flow coverage ratio is defined as the ratio of (a) the consolidated EBITDAR (as defined in the credit agreement) to (b) the sum of (i) the consolidated total interest expense (as defined in the credit agreement), plus (ii) any scheduled amortization of principal on indebtedness (as defined in the credit agreement) (including amortization relating to capital leases), plus (iii) the consolidated rental expense, 42 - cash flow leverage ratio, not to exceed 1.5 to 1.0. The cash flow leverage ratio is defined as the ratio of (a) the consolidated funded debt as of the last day of the period to (b) the consolidated EBITDA (as defined in the credit agreement) for the period, and - capital expenditure limitation (in the aggregate, subject to certain limitations, $200 million in 2001, $150 million in 2002, $190 million in 2003, $165 million in 2004, $200 million in 2005) with a permitted carryover to the next fiscal year of 25% of any unutilized amounts, and other covenants and events of default customary for bank facilities such as our credit agreement. Negative covenants include, without limitation, certain restrictions on indebtedness, liens, investments, distributions, mergers, consolidations and dispositions of assets, sales of accounts, and negative pledges. The credit agreement also contains a change of control provision. Interest on all borrowings varies based upon the type of borrowing, the fixed charge coverage ratio, and whether we elect to utilize the competitive bid loan feature available under our credit agreement. If the competitive bid loan feature is not utilized, the interest rate on borrowings under our credit agreement is generally (i) the higher of (1) an annual rate of interest announced from time to time by Fleet National Bank as its "base rate" or (2) 0.5% above the Federal Funds Effective Rate or (ii) the Eurodollar Rate, as defined by our credit agreement, plus an applicable margin from 0.55% to 1.15% based on our fixed charge coverage ratio. If the competitive bid feature is utilized, loans up to $25 million may be made under our credit agreement at competitively bid interest rates offered by lending institutions participating in the facility, which may have the effect of decreasing the amount of interest we would otherwise be obligated to pay on such borrowings. We are required to pay a facility fee from 0.20% to 0.35% per annum on the unused portion of the revolving line of credit as well as letter of credit fees from 0.25% to 1.15% that vary depending on the fixed charge coverage ratio and the type of letter of credit. Our wholly-owned subsidiary, Aaron Brothers, Inc., has guaranteed our obligations under the credit agreement; if we acquire or create any additional subsidiaries, the credit agreement may require those subsidiaries to likewise guarantee our credit agreement obligations if those subsidiaries are unrestricted subsidiaries as defined under the indenture for the notes. In addition, the repayment of certain intercompany indebtedness relating to our trademark and intellectual property licensing arrangements with affiliates, 5931, Inc. and 5931 Business Trust (which is not to exceed $1 billion pursuant to covenants in the new bank facility), has been subordinated to our obligations under the credit agreement. We are in compliance with all terms and conditions of our credit agreement. Borrowings outstanding under our credit agreement were $29.2 million as of May 5, 2001. Borrowings available under the credit agreement are reduced by the aggregate amount of letters of credit outstanding under the credit agreement ($8.7 million at May 5, 2001). Borrowings in the first quarter of fiscal 2001 were outstanding for 79 days, with an average outstanding borrowing of $13.0 million and a weighted average interest rate of 7.33%. Our wholly-owned subsidiary, Michaels of Canada, ULC, a Canadian unlimited liability company, has a line of credit, which may not exceed the US dollar equivalent of $2.0 million Canadian dollars. This facility has a $1.5 million revolving line of credit and a $0.5 million third party payment line. We guarantee this facility. Michaels of Canada pays a standby commitment fee of 1/8 of 1% on the unused portion of the revolving line of credit facility. Interest on the revolving line of credit for Canadian dollar loans is at the lender's prime rate for Canadian dollar loans made in Canada. As of May 5, 2001, there were no outstanding borrowings on this facility. 43 THE EXCHANGE OFFER PURPOSE AND EFFECT OF THE EXCHANGE OFFER On July 6, 2001, we sold $200.0 million in principal amount at maturity of the outstanding notes in a private placement through initial purchasers to a limited number of "Qualified Institutional Buyers," as defined under the Securities Act of 1933. In connection with the sale of the outstanding notes, Michaels Stores and the initial purchasers entered into a registration rights agreement, dated as of July 6, 2001. Under that agreement, Michaels Stores must, among other things, use its commercially reasonable efforts to file with the SEC a registration statement under the Securities Act covering the exchange offer and to cause that registration statement to become effective under the Securities Act. Upon the effectiveness of that registration statement, Michaels Stores must also offer each holder of the outstanding notes the opportunity to exchange its securities for an equal principal amount at maturity of exchange notes. You are a holder with respect to the exchange offer if you are a person in whose name any outstanding notes are registered on Michaels Stores' books or any other person who has obtained a properly completed assignment of outstanding notes from the registered holder. Michaels Stores is making the exchange offer to comply with its obligations under the registration rights agreement. A copy of the registration rights agreement has been filed as an exhibit to the registration statement of which this prospectus is a part. In order to participate in the exchange offer, you must represent to Michaels Stores, among other things, that: - the exchange notes being acquired pursuant to the exchange offer are being obtained in the ordinary course of business of the person receiving the exchange notes, - neither you nor any other person is engaging in or intends to engage in a distribution of those exchange notes, - neither you nor any other person has an arrangement or understanding with any third person to participate in the distribution of the exchange notes, and - neither you nor any other person is an affiliate of Michaels Stores. An affiliate is any person who "controls or is controlled by or is under common control with" Michaels Stores. RESALE OF THE EXCHANGE NOTES Based on a previous interpretation by the Staff of the SEC set forth in no-action letters issued to third parties, including Exxon Capital Holdings Corporation (available May 13, 1988), Morgan Stanley & Co. Incorporated (available June 5, 1991), Mary Kay Cosmetics, Inc. (available June 5, 1991), Warnaco, Inc. (available October 11, 1991), and K-III Communications Corp. (available May 14, 1993), Michaels Stores believes that the exchange notes issued in the exchange offer may be offered for resale, resold, and otherwise transferred by you, except if you are an affiliate of Michaels Stores, without compliance with the registration and prospectus delivery provisions of the Securities Act, provided that the representations set forth in "--Purpose and Effect of the Exchange Offer" apply to you. If you tender in the exchange offer with the intention of participating in a distribution of the exchange notes, you cannot rely on the interpretation by the Staff of the SEC as set forth in the Morgan Stanley & Co. Incorporated no-action letter and other similar letters and you must comply with the registration and prospectus delivery requirements of the Securities Act in connection with a secondary resale transaction. In the event that Michaels Stores' belief regarding resale is inaccurate, those who transfer exchange notes in violation of the prospectus delivery provisions of the Securities Act and without an exemption from registration under the federal securities laws may incur liability under these laws. Michaels Stores does not assume or indemnify you against this liability. 44 The exchange offer is not being made to, nor will Michaels Stores accept surrenders for exchange from, holders of outstanding notes in any jurisdiction in which the exchange offer or the acceptance thereof would not be in compliance with the securities or blue sky laws of the particular jurisdiction. Each broker-dealer that receives exchange notes for its own account in exchange for outstanding notes, where the outstanding notes were acquired by that broker-dealer as a result of market-making activities or other trading activities, must acknowledge that it will deliver a prospectus in connection with any resale of the exchange notes. In order to facilitate the disposition of exchange notes by broker-dealers participating in the exchange offer, Michaels Stores has agreed, subject to specific conditions, to make this prospectus, as it may be amended or supplemented from time to time, available for delivery by those broker-dealers to satisfy their prospectus delivery obligations under the Securities Act. Any holder that is a broker-dealer participating in the exchange offer must notify the exchange agent at the telephone number set forth in the enclosed Letter of Transmittal and must comply with the procedures for brokers-dealers participating in the exchange offer. Michaels Stores has not entered into any arrangement or understanding with any person to distribute the exchange notes to be received in the exchange offer. See "Plan of Distribution." TERMS OF THE EXCHANGE OFFER Upon the terms and subject to the conditions set forth in this prospectus and in the Letter of Transmittal, Michaels Stores will accept any and all outstanding notes validly tendered and not withdrawn prior to 5:00 p.m., New York City time, on the day the exchange offer expires. As of the date of this prospectus, $200.0 million in principal amount at maturity of the notes are outstanding. This prospectus, together with the Letter of Transmittal, is being sent to all registered holders of the outstanding notes on this date. There will be no fixed record date for determining registered holders of the outstanding notes entitled to participate in the exchange offer; however, holders of the outstanding notes must tender their certificates therefor or cause their outstanding notes to be tendered by book-entry transfer prior to the expiration date of the exchange offer to participate. The form and terms of the exchange notes will be the same as the form and terms of the outstanding notes except that the exchange notes will be registered under the Securities Act and therefore will not bear legends restricting their transfer. Following consummation of the exchange offer, all rights under the registration rights agreement accorded to holders of outstanding notes, including the right to receive additional incremental interest on the outstanding notes, to the extent and in the circumstances specified in the registration rights agreement, will terminate. Michaels Stores intends to conduct the exchange offer in accordance with the provisions of the registration rights agreement and applicable federal securities laws. Outstanding notes that are not tendered for exchange under the exchange offer will remain outstanding and will be entitled to the rights under the related indenture. Any outstanding notes not tendered for exchange will not retain any rights under the registration rights agreement and will remain subject to transfer restrictions. See "--Consequences of Failure to Exchange." Michaels Stores will be deemed to have accepted validly tendered outstanding notes when, as and if Michaels Stores will have given oral or written notice of its acceptance to the exchange agent. The exchange agent will act as agent for the tendering holders for the purposes of receiving the exchange notes from Michaels Stores. If any tendered outstanding notes are not accepted for exchange because of an invalid tender, the occurrence of other events set forth in this prospectus, or otherwise, certificates for any unaccepted outstanding notes will be returned, or, in the case of outstanding notes tendered by book-entry transfer, those unaccepted outstanding notes will be credited to an account maintained with The Depository Trust Company, without expense to the tendering holder of those outstanding notes as promptly as practicable after the expiration date of the exchange offer. See "--Procedures for Tendering." 45 Those who tender outstanding notes in the exchange offer will not be required to pay brokerage commissions or fees or, subject to the instructions in the Letter of Transmittal, transfer taxes with respect to the exchange pursuant to the exchange offer. Michaels Stores will pay all charges and expenses, other than applicable taxes described below, in connection with the exchange offer. See "--Fees and Expenses." EXPIRATION DATE; EXTENSIONS; AMENDMENTS The expiration date is 5:00 p.m., New York City time on , 2001, unless Michaels Stores, in its sole discretion, extends the exchange offer, in which case, the expiration date will be the latest date and time to which the exchange offer is extended. Michaels Stores may, in its sole discretion, extend the expiration date of, or terminate, the exchange offer. To extend the exchange offer, Michaels Stores must notify the exchange agent by oral or written notice prior to 9:00 a.m., New York City time, on the next business day after the previously scheduled expiration date and make a public announcement of the extension. Michaels Stores reserves the right: - to delay accepting any outstanding notes, to extend the exchange offer or to terminate the exchange offer if any of the conditions set forth below under "--Conditions" are not satisfied by giving oral or written notice of the delay, extension, or termination to the exchange agent; or - to amend the terms of the exchange offer in any manner consistent with the registration rights agreement. Any delay in acceptances, extension, termination, or amendment will be followed as promptly as practicable by oral or written notice of the delay to the registered holders of the outstanding notes. If Michaels Stores amends the exchange offer in a manner that constitutes a material change, Michaels Stores will promptly disclose the amendment by means of a prospectus supplement that will be distributed to the registered holders of the outstanding notes, and Michaels Stores will extend the exchange offer for a period of five to ten business days, depending upon the significance of the amendment and the manner of disclosure to the registered holders of the outstanding notes, if the exchange offer would otherwise expire during the five to ten business day period. Without limiting the manner in which Michaels Stores may choose to make a public announcement of any delay, extension, amendment, or termination of the exchange offer, Michaels Stores will have no obligation to publish, advertise, or otherwise communicate that public announcement, other than by making a timely release to an appropriate news agency. Upon satisfaction or waiver of all the conditions to the exchange offer, Michaels Stores will accept, promptly after the expiration date of the exchange offer, all outstanding notes properly tendered and will issue the exchange notes promptly after acceptance of the outstanding notes. See "--Conditions" below. For purposes of the exchange offer, Michaels Stores will be deemed to have accepted properly tendered outstanding notes for exchange when, as and if Michaels Stores will have given oral or written notice of its acceptance to the exchange agent. In all cases, issuance of the exchange notes for outstanding notes that are accepted for exchange pursuant to the exchange offer will be made only after timely receipt by the exchange agent of certificates for those outstanding notes or a timely confirmation of book-entry transfer of the outstanding notes into the exchange agent's account at The Depository Trust Company, a properly completed and duly executed Letter of Transmittal, and all other required documents; provided, however, that Michaels Stores reserves the absolute right to waive any defects or irregularities in the tender of outstanding notes or in the satisfaction of conditions of the exchange offer by holders of the outstanding notes. If any tendered outstanding notes are not accepted for any reason set forth in the 46 terms and conditions of the exchange offer, if the holder withdraws such previously tendered outstanding notes, or if outstanding notes are submitted for a greater principal amount of outstanding notes than the holder desires to exchange, then the unaccepted, withdrawn or portion of non-exchanged outstanding notes, as appropriate, will be returned as promptly as practicable after the expiration or termination of the exchange offer, or, in the case of outstanding notes tendered by book-entry transfer, those unaccepted, withdrawn or portion of non-exchanged outstanding notes, as appropriate, will be credited to an account maintained with The Depository Trust Company, without expense to the tendering holder thereof. CONDITIONS Without regard to other terms of the exchange offer, Michaels Stores will not be required to exchange any exchange notes for any outstanding notes and may terminate the exchange offer before the acceptance of any outstanding notes for exchange, if: - any action or proceeding is instituted or threatened in any court or by or before any governmental agency with respect to the exchange offer which, in Michaels Stores' reasonable judgment, might materially impair the ability of Michaels Stores to proceed with the exchange offer; - the Staff of the SEC proposes, adopts or enacts any law, statute, rule or regulation or issues any interpretation of any existing law, statute, rule or regulation, which, in Michaels Stores' reasonable judgment, might materially impair the ability of Michaels Stores to proceed with the exchange offer; or - any governmental approval or approval by holders of the outstanding notes has not been obtained, which approval Michaels Stores will, in its reasonable judgment, deem necessary for the consummation of the exchange offer. If Michaels Stores determines that any of these conditions are not satisfied, Michaels Stores may - refuse to accept any outstanding notes and return all tendered outstanding notes to the tendering holders, or, in the case of outstanding notes tendered by book-entry transfer, credit those outstanding notes to an account maintained with The Depository Trust Company, - extend the exchange offer and retain all outstanding notes tendered prior to the expiration of the exchange offer, subject, however, to the rights of holders who tendered the outstanding notes to withdraw their tendered outstanding notes, or - waive unsatisfied conditions with respect to the exchange offer and accept all properly tendered outstanding notes that have not been withdrawn. If the waiver constitutes a material change to the exchange offer, Michaels Stores will promptly disclose the waiver by means of a prospectus supplement that will be distributed to the registered holders of the outstanding notes, and Michaels Stores will extend the exchange offer for a period of five to ten business days, depending upon the significance of the waiver and the manner of disclosure to the registered holders of the outstanding notes, if the exchange offer would otherwise expire during this period. PROCEDURES FOR TENDERING To tender in the exchange offer, you must complete, sign and date an original or facsimile Letter of Transmittal, have the signatures thereon guaranteed if required by the Letter of Transmittal, and mail or otherwise deliver the Letter of Transmittal to the exchange agent prior to the expiration date of the exchange offer. In addition, either: - certificates for the outstanding notes must be received by the exchange agent, along with the Letter of Transmittal, or 47 - a timely confirmation of transfer by book-entry of those outstanding notes, if the book-entry procedure is available, into the exchange agent's account at The Depository Trust Company, as set forth in the procedure for book-entry transfer described below, which the exchange agent must receive prior to the expiration date of the exchange offer, or you must comply with the guaranteed delivery procedures described below. To be tendered effectively, the exchange agent must receive the Letter of Transmittal and other required documents at the address set forth below under "--Exchange Agent" prior to the expiration of the exchange offer. If you tender your outstanding notes and do not withdraw them prior to the expiration date of the exchange offer, you will be deemed to have an agreement with Michaels Stores in accordance with the terms and subject to the conditions set forth in this prospectus and in the Letter of Transmittal. THE METHOD OF DELIVERY OF OUTSTANDING NOTES AND THE LETTER OF TRANSMITTAL AND ALL OTHER REQUIRED DOCUMENTS TO THE EXCHANGE AGENT IS AT YOUR RISK. INSTEAD OF DELIVERY BY MAIL, IT IS RECOMMENDED THAT YOU USE AN OVERNIGHT OR HAND DELIVERY SERVICE, PROPERLY INSURED. IN ALL CASES, SUFFICIENT TIME SHOULD BE ALLOWED TO ASSURE DELIVERY TO THE EXCHANGE AGENT BEFORE THE EXPIRATION DATE OF THE EXCHANGE OFFER. NO LETTER OF TRANSMITTAL OR OUTSTANDING NOTES SHOULD BE SENT TO MICHAELS STORES. YOU MAY REQUEST YOUR RESPECTIVE BROKERS, DEALERS, COMMERCIAL BANKS, TRUST COMPANIES, OR NOMINEES TO EFFECT THE ABOVE TRANSACTIONS FOR YOU. Any beneficial owner whose outstanding notes are registered in the name of a broker, dealer, commercial bank, trust company, or other nominee and who wishes to tender its outstanding notes should contact the registered holder promptly and instruct that registered holder to tender the outstanding notes on the beneficial owner's behalf. If the beneficial owner wishes to tender its outstanding notes on the owner's own behalf, that owner must, prior to completing and executing the Letter of Transmittal and delivering its outstanding notes, either make appropriate arrangements to register ownership of the outstanding notes in that owner's name or obtain a properly completed assignment from the registered holder. The transfer of registered ownership of outstanding notes may take considerable time. Signatures on a Letter of Transmittal or a notice of withdrawal, as the case may be, must be guaranteed by an eligible institution unless the outstanding notes tendered pursuant thereto are tendered: - by a registered holder who has not completed the box entitled "Special Payment Instructions" or "Special Delivery Instructions" on the Letter of Transmittal, or - for the account of an eligible institution. In the event that signatures on a Letter of Transmittal or a notice of withdrawal, as the case may be, are required to be guaranteed, each of the following is deemed an eligible institution: - a member firm of a registered national securities exchange or of the National Association of Securities Dealers, Inc., - commercial bank, - trust company having an office or correspondent in the United States, or - eligible guarantor institution as provided by Rule 17Ad-15 of the Securities Exchange Act of 1934. 48 If the Letter of Transmittal is signed by a person other than the registered holder of any outstanding notes, the outstanding notes must be endorsed or accompanied by a properly completed bond power, signed by the registered holder as his, her or its name appears on the outstanding notes. If trustees, executors, administrators, guardians, attorneys-in-fact, officers of corporations or others acting in a fiduciary or representative capacity sign the Letter of Transmittal or any outstanding notes or bond power, those persons should so indicate when signing, and unless Michaels Stores waives evidence satisfactory to Michaels Stores of their authority to so act must be submitted with the Letter of Transmittal. Michaels Stores will determine all questions as to the validity, form, eligibility, including time of receipt, acceptance of tendered outstanding notes, and withdrawal of tendered outstanding notes, in its sole discretion. All of these determinations by Michaels Stores will be final and binding. Michaels Stores reserves the absolute right to reject any and all outstanding notes not properly tendered or any outstanding notes Michaels Stores' acceptance of which would, in the opinion of counsel for Michaels Stores, be unlawful. Michaels Stores also reserves the right to waive any defects, irregularities or conditions of tender as to particular outstanding notes. Michaels Stores' interpretation of the terms and conditions of the exchange offer, including the instructions in the Letter of Transmittal will be final and binding on all parties. Unless waived, any defects or irregularities in connection with tenders of outstanding notes must be cured within the time Michaels Stores determines. Although Michaels Stores intends to notify holders of outstanding notes of defects or irregularities with respect to tenders of outstanding notes, neither Michaels Stores, nor the exchange agent, or any other person will incur any liability for failure to give this notification. Tenders of outstanding notes will not be deemed to have been made until defects or irregularities have been cured or waived. Any outstanding notes received by the exchange agent that are not properly tendered and as to which the defects or irregularities have not been cured or waived will be returned by the exchange agent to the tendering holders of outstanding notes, unless otherwise provided in the Letter of Transmittal, as soon as practicable following the expiration date of the exchange offer. In addition, Michaels Stores reserves the right, in its sole discretion, to purchase or make offers for any outstanding notes that remain outstanding subsequent to the expiration date of the exchange offer or, as set forth above under "--Conditions," to terminate the exchange offer and, to the extent permitted by applicable law and the terms of its agreements relating to its outstanding indebtedness, purchase outstanding notes in the open market, in privately negotiated transactions or otherwise. The terms of any purchases or offers could differ from the terms of the exchange offer. If the holder of outstanding notes is a broker-dealer participating in the exchange offer that will receive exchange notes for its own account in exchange for outstanding notes that were acquired as a result of market-making activities or other trading activities, that broker-dealer will be required to acknowledge in the Letter of Transmittal that it will deliver a prospectus in connection with any resale of the exchange notes and otherwise agree to comply with the procedures described above under "--Resale of the Exchange Notes"; however, by so acknowledging and delivering a prospectus, that broker-dealer will not be deemed to admit that it is an "underwriter" within the meaning of the Securities Act. In all cases, issuance of exchange notes pursuant to the exchange offer will be made only after timely receipt by the exchange agent of certificates for the outstanding notes or a timely confirmation of book-entry transfer of outstanding notes into the exchange agent's account at The Depository Trust Company, a properly completed and duly executed Letter of Transmittal, and all other required documents. If any tendered outstanding notes are not accepted for any reason set forth in the terms and conditions of the exchange offer or if outstanding notes are submitted for a greater principal amount of outstanding notes than the holder of outstanding notes desires to exchange, the unaccepted or portion of non-exchanged outstanding notes will be returned as promptly as practicable after the 49 expiration or termination of the exchange offer, or, in the case of outstanding notes tendered by book-entry transfer into the exchange agent's account at The Depository Trust Company pursuant to the book-entry transfer procedures described below, the unaccepted or portion of non-exchanged outstanding notes will be credited to an account maintained with The Depository Trust Company, without expense to the tendering holder of outstanding notes. BOOK-ENTRY TRANSFER The exchange agent will make a request to establish an account with respect to the outstanding notes at The Depository Trust Company for the purposes of the exchange offer within two business days after the date of this prospectus, and any financial institution that is a participant in The Depository Trust Company's systems may make book-entry delivery of outstanding notes by causing The Depository Trust Company to transfer the outstanding notes into the exchange agent's account at The Depository Trust Company in accordance with The Depository Trust Company's procedures for transfer. However, although delivery of outstanding notes may be effected through book-entry transfer at The Depository Trust Company, the Letter of Transmittal or facsimile thereof, with any required signature guarantees and any other required documents, must, in any case, be transmitted to and received by the exchange agent at the address set forth below under "--Exchange Agent" on or prior to the expiration date of the exchange offer, unless the holder complies with the guaranteed delivery procedures described below. GUARANTEED DELIVERY PROCEDURES Holders who wish to tender their outstanding notes and (1) whose outstanding notes are not immediately available or (2) who cannot deliver their outstanding notes, the Letter of Transmittal, or any other required documents to the exchange agent prior to the expiration date, may effect a tender if: - The tender is made through an eligible institution; - Prior to the expiration date of the exchange offer, the exchange agent receives from such eligible institution a properly completed and duly executed Notice of Guaranteed Delivery, by facsimile transmission, mail or hand delivery, setting forth the name and address of the holder, the certificate number(s) of the outstanding notes and the principal amount of outstanding notes tendered and stating that the tender is being made thereby and guaranteeing that, within three Nasdaq National Market trading days after the expiration date of the exchange offer, the Letter of Transmittal, together with the certificate(s) representing the outstanding notes in proper form for transfer or a confirmation of book-entry transfer, as the case may be, and any other documents required by the Letter of Transmittal will be deposited by the eligible institution with the exchange agent; and - The exchange agent receives the properly completed and executed Letter of Transmittal, as well as the certificate(s) representing all tendered outstanding notes in proper form for transfer and other documents required by the Letter of Transmittal within three Nasdaq National Market trading days after the expiration date of the exchange offer. Upon request to the exchange agent, a Notice of Guaranteed Delivery will be sent to holders who wish to tender their outstanding notes according to the guaranteed delivery procedures set forth above. WITHDRAWAL OF TENDERS Except as otherwise provided, tenders of outstanding notes may be withdrawn at any time prior to 5:00 p.m., New York City time, on the expiration date of the exchange offer. 50 To withdraw a tender of outstanding notes in the exchange offer, a written or facsimile transmission notice of withdrawal must be received by the exchange agent at its address set forth herein prior to 5:00 p.m., New York City time, on the expiration date of the exchange offer. Any such notice of withdrawal must - specify the name of the person having deposited the outstanding notes to be withdrawn, - identify the outstanding notes to be withdrawn, - be signed by the holder in the same manner as the original signature on the Letter of Transmittal by which the outstanding notes were tendered or be accompanied by documents of transfer sufficient to have the exchange agent register the transfer of the outstanding notes in the name of the person withdrawing the tender, and - specify the name in which any outstanding notes are to be registered, if different from that of the person who deposited the outstanding notes to be withdrawn. Michaels Stores will determine all questions as to the validity, form, and eligibility of the notices, whose determination will be final and binding on all parties. Any outstanding notes so withdrawn will be deemed not to have been validly tendered for purposes of the exchange offer, and no exchange notes will be issued with respect to those outstanding notes unless the outstanding notes so withdrawn are validly retendered. Any outstanding notes that have been tendered but that are not accepted for payment will be returned to the holder of those outstanding notes, or in the case of outstanding notes tendered by book-entry transfer, will be credited to an account maintained with The Depository Trust Company, without cost to the holder as soon as practicable after withdrawal, rejection of tender or termination of the exchange offer. Properly withdrawn outstanding notes may be retendered by following one of the procedures described above under "--Procedures for Tendering" at any time prior to the expiration date of the exchange offer. TERMINATION OF CERTAIN RIGHTS All rights given to holders of outstanding notes under the registration rights agreement will terminate upon the consummation of the exchange offer except with respect to Michaels Stores' duty: - to keep the registration statement effective until the closing of the exchange offer, and - to provide copies of the latest version of this prospectus to any broker-dealer that requests copies of this prospectus for use in connection with any resale by that broker-dealer of exchange notes received for its own account pursuant to the exchange offer in exchange for outstanding notes acquired for its own account as a result of market-making or other trading activities, subject to the conditions described above under "--Resale of the Exchange Notes." EXCHANGE AGENT The Bank of New York has been appointed exchange agent for the exchange offer. Questions and requests for assistance, requests for additional copies of this prospectus or the Letter of Transmittal, 51 and requests for copies of the Notice of Guaranteed Delivery with respect to the outstanding notes should be addressed to the exchange agent as follows: By Hand or Overnight Courier: By Registered or Certified Mail: 101 Barclay Street 101 Barclay Street, 7E New York, New York 10286 New York, New York 10286 Corporate Trust Services Window Attention: Diane Amorroso Ground Level Reorganization Section Attention: Diane Amorroso Reorganization Section
By Telephone (to confirm receipt of facsimile): (202) 815-3738 By Facsimile (for Eligible Institutions only): (212) 815-6339 FEES AND EXPENSES Michaels Stores will pay the expenses of soliciting tenders in connection with the exchange offer. The principal solicitation is being made by mail; however, additional solicitation may be made by telecopier, telephone, or in person by officers and regular employees of Michaels Stores and its affiliates. Michaels Stores has not retained any dealer-manager in connection with the exchange offer and will not make any payments to broker-dealers or others soliciting acceptances of the exchange offer. Michaels Stores, however, will pay the exchange agent reasonable and customary fees for its services and will reimburse the exchange agent for its reasonable out-of-pocket expenses in connection with the exchange offer. Michaels Stores estimates that its cash expenses in connection with the exchange offer will be approximately $75,000. These expenses include registration fees, fees and expenses of the exchange agent, accounting and legal fees, and printing costs, among others. Michaels Stores will pay all transfer taxes, if any, applicable to the exchange of the outstanding notes for exchange notes. The tendering holder of outstanding notes, however, will pay applicable taxes if certificates representing outstanding notes not tendered or accepted for exchange are to be delivered to, or are to be issued in the name of, any person other than the registered holder of outstanding notes tendered, or - if tendered, the certificates representing outstanding notes are registered in the name of any person other than the person signing the Letter of Transmittal, or - if a transfer tax is imposed for any reason other than the exchange of the outstanding notes in the exchange offer. If satisfactory evidence of payment of the transfer taxes or exemption from payment of transfer taxes is not submitted with the Letter of Transmittal, the amount of the transfer taxes will be billed directly to the tendering holder and the exchange notes need not be delivered until the transfer taxes are paid. CONSEQUENCES OF FAILURE TO EXCHANGE Participation in the exchange offer is voluntary. Holders of the outstanding notes are urged to consult their financial and tax advisors in making their own decisions on what action to take. 52 Outstanding notes that are not exchanged for the exchange notes in the exchange offer will not retain any rights under the registration rights agreement and will remain restricted securities for purposes of the federal securities laws. Accordingly, the outstanding notes may not be offered, sold, pledged, or otherwise transferred except: - to Michaels Stores or any subsidiary thereof; - to a "Qualified Institutional Buyer" within the meaning of Rule 144A under the Securities Act purchasing for its own account or for the account of a qualified institutional buyer in a transaction meeting the requirements of Rule 144A; - pursuant to an exemption from registration under the Securities Act provided by Rule 144 thereunder, if available; or - pursuant to an effective registration statement under the Securities Act, and, in each case, in accordance with all other applicable securities laws. ACCOUNTING TREATMENT For accounting purposes, Michaels Stores will recognize no gain or loss as a result of the exchange offer. The exchange notes will be recorded at the same carrying value as the outstanding notes, as reflected in Michaels Stores' accounting records on the date of the exchange. The expenses of the exchange offer will be amortized over the remaining term of the exchange notes. 53 DESCRIPTION OF THE NOTES GENERAL The outstanding notes were and the exchange notes will be issued under an Indenture, dated as of July 6, 2001 (the "Indenture"), between Michaels Stores, Inc. (the "Company") and The Bank of New York, as Trustee (the "Trustee"). All references in this section to "the Company" do not include our subsidiaries unless the context otherwise requires and all references to "the Notes" include the outstanding notes and the exchange notes. The following summary of certain provisions of the Indenture and the Notes does not purport to be complete and is subject to, and is qualified in its entirety by reference to, all the provisions of the Indenture, including the definitions of certain terms therein and those terms made a part thereof by the TIA. The summary provides an accurate description of all material terms of the Notes. Capitalized terms used herein and not otherwise defined have the meanings set forth under "--Certain Definitions." Principal of, premium, if any, and interest on the Notes will be payable, and the Notes may be exchanged or transferred, at the office or agency of the Company in the Borough of Manhattan, The City of New York (which initially shall be the corporate trust office of the Trustee, at 101 Barclay Street, New York, New York 10286), except that, at the option of the Company, payment of interest may be made by check mailed to the registered holders of the Notes at their registered addresses. The Notes will be issued only in fully registered form, without coupons, in denominations of $1,000 and any integral multiple of $1,000. No service charge will be made for any registration of transfer or exchange of Notes, but the Company may require payment of a sum sufficient to cover any transfer tax or other similar governmental charge payable in connection therewith. The definition of "Restricted Subsidiary" in the Indenture will exclude any "Unrestricted Subsidiary" and, as a result, Unrestricted Subsidiaries generally will not be bound by the restrictive provisions of the Indenture. The Board of Directors will have the ability, subject to the provisions of the Indenture, to designate certain other Restricted Subsidiaries as Unrestricted Subsidiaries after the Issue Date. Subject to the provisions of the Indenture, the Board of Directors may also designate Unrestricted Subsidiaries to be Restricted Subsidiaries. See the definitions of "Restricted Subsidiary" and "Unrestricted Subsidiary" and "--Certain Covenants--Limitation on Restricted Payments" herein. TERMS OF THE NOTES The Notes are unsecured, senior obligations of the Company, are initially in the aggregate principal amount of $200.0 million, subject to our ability to issue additional notes which may be of the same series as these Notes and, together with these Notes, will not exceed $250.0 million in the aggregate, as described under "--Further Issues." The Notes mature on July 1, 2009. Each Note bears interest at a rate per annum of 9 1/4% from July 6, 2001, or from the most recent date to which interest has been paid or provided for, payable semiannually to Holders of record at the close of business on the June 15 or December 15 immediately preceding the interest payment date on January 1 and July 1 of each year, commencing January 1, 2002. Interest on the Notes will be computed on the basis of a 360-day year of twelve 30-day months. OPTIONAL REDEMPTION The Notes will be redeemable, at the Company's option, in whole or in part, at any time on or after July 1, 2005, and prior to maturity, upon not less than 30 nor more than 60 days' prior notice mailed by first-class mail to each Holder's registered address, at the following redemption prices (expressed as a percentage of principal amount), plus accrued interest, if any, to the redemption date 54 (subject to the right of Holders of record on the relevant record date to receive interest due on the relevant interest payment date), if redeemed during the 12-month period commencing on July 1 of the years set forth below:
REDEMPTION PERIOD PRICE - ------ ----------- 2005........................................................ 104.625% 2006........................................................ 102.313% 2007 and thereafter......................................... 100%
In addition, at any time and from time to time prior to July 1, 2004, the Company may redeem in the aggregate up to 35% of the aggregate principal amount of the Notes with the proceeds of one or more Equity Offerings so long as there is a Public Market at the time of such redemption at a redemption price (expressed as a percentage of principal amount thereof) of 109.25% plus accrued interest, if any, to the redemption date (subject to the right of Holders of record on the relevant record date to receive interest due on the relevant interest payment date); PROVIDED, HOWEVER, that at least 65% of the initial aggregate principal amount of the Notes must remain outstanding after each such redemption. In the case of any partial redemption, selection of the Notes for redemption will be made by the Trustee on a pro rata basis, by lot or by such other method as the Trustee in its sole discretion shall deem to be fair and appropriate, although no Note of $1,000 in original principal amount or less will be redeemed in part. If any Note is to be redeemed in part only, the notice of redemption relating to such Note shall state the portion of the principal amount thereof to be redeemed. A new Note in principal amount equal to the unredeemed portion thereof will be issued in the name of the Holder thereof upon cancellation of the original Note. RANKING The indebtedness evidenced by the Notes is unsecured Senior Indebtedness of the Company, will rank PARI PASSU in right of payment with all existing and future Senior Indebtedness of the Company and will be senior in right of payment to all existing and future Subordinated Obligations of the Company. The Notes are effectively subordinated to all existing and future Secured Indebtedness of the Company to the extent of the value of the assets securing such Indebtedness and to all existing and future Indebtedness of any Subsidiary of the Company. As of May 5, 2001, after giving effect to the offering of the notes and the use of proceeds from the outstanding notes to redeem our 10 7/8% senior notes due 2006, the Company would have had $200.6 million of senior indebtedness outstanding and, except for the guarantee by Aaron Brothers, Inc. of the Credit Agreement, the non-guarantor Subsidiaries would have had no indebtedness outstanding. The Company has no Subordinated Obligations other than intercompany Indebtedness. Although the Indenture contains limitations on the amount of additional Indebtedness which the Company or any Restricted Subsidiary may Incur, under certain circumstances the amount of such Indebtedness could be substantial and such debt may be secured Indebtedness or Indebtedness of Subsidiaries. See "Risk Factors--Secured Indebtedness and Borrowings by Subsidiaries That Do Not Become Guarantors Will Be Effectively Senior to the Notes" and "--Certain Covenants--Limitation on Indebtedness" and "--Limitation on Liens." CHANGE OF CONTROL Upon the occurrence of any of the following events (each a "Change of Control") with respect to the Company, each Holder will have the right to require the Company to repurchase all or any part of such Holder's Notes at a purchase price in cash equal to 101% of the principal amount thereof, plus 55 accrued and unpaid interest, if any, to the date of repurchase (subject to the right of Holders of record on the relevant record date to receive interest due on the related interest payment date): (i) (A) any "person" (as such term is used in Sections 13(d) and 14(d) of the Exchange Act), other than one or more Permitted Holders, is or becomes the beneficial owner (as defined in Rules 13d-3 and 13d-5 under the Exchange Act), directly or indirectly, of more than 35% of the total voting power of the Voting Stock of the Company and (B) the Permitted Holders "beneficially own" (as defined in Rules 13d-3 and 13d-5 under the Exchange Act), directly or indirectly, in the aggregate a lesser percentage of the total voting power of the Voting Stock of the Company than such other person and do not have the right or ability by voting power, contract or otherwise to elect or designate for election a majority of the Board of Directors of the Company (for the purposes of this clause, such other person shall be deemed to beneficially own any Voting Stock of a specified corporation held by a parent corporation, if such other person "beneficially owns" (as defined in Rules 13d-3 and 13d-5 under the Exchange Act), directly or indirectly, more than 35% of the voting power of the Voting Stock of such parent corporation and the Permitted Holders "beneficially own" (as defined in Rules 13d-3 and 13d-5 under the Exchange Act), directly or indirectly, in the aggregate a lesser percentage of the voting power of the Voting Stock of such parent corporation and do not have the right or ability by voting power, contract or otherwise to elect or designate for election a majority of the board of directors of such parent corporation); (ii) during any period of two consecutive years, individuals who at the beginning of such period constituted the Board of Directors of the Company (together with any new directors whose election by such Board of Directors or whose nomination for election by the shareholders of the Company was approved by a vote of 66 2/3% of the directors of the Company then still in office who were either directors at the beginning of such period or whose election or nomination for election was previously so approved) cease for any reason to constitute a majority of the Board of Directors of the Company then in office; (iii) any sale, lease, exchange or other transfer (in one transaction or a series of related transactions) of all, or substantially all, the assets of the Company to any Person or group of Persons (other than to any Wholly Owned Subsidiary of the Company); or (iv) the merger or consolidation of the Company with or into another corporation with the effect that either (A) immediately after such transaction any person (as defined in clause (i) above) (other than a Permitted Holder) shall have become the "beneficial owner" (as defined in clause (i) above) of securities of the surviving corporation of such merger or consolidation representing a majority of the voting power of the Voting Stock of the surviving corporation or (B) the securities of the Company that are outstanding immediately prior to such transaction and which represent 100% of the voting power of the Voting Stock of the Company are changed into or exchanged for cash, securities or property, unless pursuant to such transaction such securities are changed into or exchanged for, in addition to any other consideration, (1) securities of the surviving corporation that represent immediately after such transaction, at least a majority of the voting power of the Voting Stock of the surviving corporation or (2) securities that represent immediately after such transaction at least a majority of the voting power of the Voting Stock of the corporation that owns, directly or indirectly, 100% of the voting power of the Voting Stock of the surviving corporation of that transaction. Within 30 days following any Change of Control, or at the Company's option, prior to any Change of Control but after the public announcement thereof, the Company shall mail a notice to each Holder with a copy to the Trustee stating: (1) that a Change of Control has or may have occurred and that such Holder has the right to require the Company to purchase such Holder's Notes at a purchase price in cash equal to 101% of the principal amount thereof, plus accrued and unpaid interest, if any, to the date of repurchase (subject to the right of Holders of record on a record date to receive interest on the 56 relevant interest payment date); (2) the circumstances and relevant facts and pro forma financial information regarding such Change of Control; (3) the repurchase date (which shall be no earlier than the consummation of the Change of Control and no earlier than 30 days nor later than 60 days from the date such notice is mailed); (4) that the Change of Control offer is conditioned on the Change of Control occurring if the notice is mailed prior to the Change of Control; and (5) the instructions determined by the Company, consistent with this covenant, that a Holder must follow in order to have its Notes purchased. Notwithstanding the occurrence of a Change of Control, the Company shall not be obligated to repurchase the Notes upon a Change of Control if the Company has irrevocably elected to redeem all of the Notes under the provisions described under "--Optional Redemption" above, provided that the Company does not default in its redemption obligations pursuant to such election. Neither the Trustee nor the Board of Directors of the Company may waive the covenant relating to the Holder's right to have its Notes repurchased upon a Change of Control. The phrase "all or substantially all," as used with respect to a sale of assets in the definition in the Indenture of "Change of Control," varies according to the facts and circumstances of the subject transaction, has no clearly established meaning under New York law (the law governing the Indenture) and is subject to judicial interpretation. Accordingly, in certain circumstances, there may be a degree of uncertainty in ascertaining whether a particular transaction would involve a disposition of "all or substantially all" of the assets of a Person and therefore it may be unclear whether a Change of Control has occurred. The existence of a Holder's right to require the Company to repurchase such Holder's Notes upon a Change of Control may deter a third party from acquiring the Company in a transaction which constitutes a Change of Control. The Company will comply, to the extent applicable, with the requirements of Section 14(e) of the Exchange Act and any other securities laws or regulations in connection with the repurchase of Notes pursuant to this covenant. To the extent that the provisions of any securities laws or regulations conflict with provisions of this covenant, the Company will comply with the applicable securities laws and regulations and will not be deemed to have breached its obligations under this paragraph by virtue thereof. The Change of Control purchase feature is a result of negotiations between the Company and the initial purchasers of the Notes. The Company has no present intention to engage in a transaction involving a Change of Control, although it is possible that the Company would decide to do so in the future. Subject to the limitations discussed below, the Company could, in the future, enter into certain transactions, including acquisitions, refinancings or other recapitalizations, that would not constitute a Change of Control under the Indenture, but that could increase the amount of indebtedness outstanding at such time or otherwise affect the Company's capital structure or credit rating. The Company will not be required to make a Change of Control offer upon a Change of Control if a third party makes the Change of Control offer in the manner, at the times and otherwise in compliance with the requirements described in the Indenture applicable to a Change of Control offer made by the Company and purchases all notes validly tendered and not withdrawn under such Change of Control offer. The occurrence of certain of the events that would constitute a Change of Control would constitute a default under the Credit Agreement. Future Indebtedness of the Company may contain prohibitions of certain events which would constitute a Change of Control and may require such Indebtedness to be repaid or repurchased upon a Change of Control. Moreover, the exercise by the Holders of their right to require the Company to repurchase the Notes could cause a default under such Indebtedness, even if the Change of Control itself does not, due to the financial effect of such repurchase on the Company. Finally, the Company's ability to pay cash to the Holders upon a 57 repurchase may be limited by the Company's then existing financial resources. There can be no assurance that sufficient funds will be available when necessary to make any required repurchases. CERTAIN COVENANTS The Indenture contains covenants including, among others, the following: LIMITATION ON INDEBTEDNESS. (a) The Company will not Incur, and will not permit any Restricted Subsidiary to Incur, any Indebtedness; PROVIDED, HOWEVER, that the Company, any Guarantor and any Foreign Restricted Subsidiary may Incur Indebtedness (including Acquired Indebtedness) if on the date thereof the Consolidated Coverage Ratio would be equal to or greater than 2.5 to 1.0. (b) Notwithstanding the foregoing paragraph (a), the Company and any Restricted Subsidiaries (to the extent set forth below) may Incur the following Indebtedness ("Permitted Indebtedness"): (i) Indebtedness and letters of credit (with letters of credit being deemed to have a principal amount equal to the maximum face amount thereunder) of the Company, Aaron Brothers, Inc. (in the form of a guarantee of the Company's obligations) as long as it is a Restricted Subsidiary that is not a Significant Subsidiary or any Restricted Subsidiary which is a Guarantor of the Notes under the Credit Agreement, Letter of Credit Facility and any Refinancing Indebtedness in respect thereof in an aggregate principal amount outstanding at any time not to exceed the greater of (x) an amount equal to 50% of the book value of the inventory of the Company and its Restricted Subsidiaries as of any date of Incurrence calculated on a consolidated basis in accordance with GAAP and (y) $325 million; provided that if Aaron Brothers, Inc. is at any time a Restricted Subsidiary that is a Significant Subsidiary and an obligor (including as a guarantor) under the Credit Agreement, Letter of Credit Facility or Refinancing Indebtedness in respect thereof, such event will be deemed to constitute the incurrence of Indebtedness guaranteed by Aaron Brothers, Inc. under the Credit Agreement, Letter of Credit Facility or Refinancing Indebtedness in respect thereof, as the case may be; (ii) Indebtedness of the Company owing to and held by any Wholly Owned Subsidiary or Indebtedness of a Restricted Subsidiary owing to and held by the Company or any Wholly Owned Subsidiary; PROVIDED, HOWEVER, that any subsequent issuance or transfer of any Capital Stock or any other event which results in any such Wholly Owned Subsidiary ceasing to be a Wholly Owned Subsidiary or any subsequent transfer of any such Indebtedness (except to the Company or a Wholly Owned Subsidiary) will be deemed, in each case, to constitute the Incurrence of such Indebtedness by the issuer thereof; (iii) (x) Indebtedness represented by the Notes and any Guarantees of the Notes by any of the Company's Subsidiaries in an amount not to exceed the amount outstanding on the initial Issue Date, (y) any Indebtedness of the Company or any Restricted Subsidiary (other than the Indebtedness described in clauses (i)-(ii) above) outstanding on the Issue Date, provided that the 10 7/8% Senior Notes shall only be deemed Permitted Indebtedness until 60 days after the Issue Date and (z) any Refinancing Indebtedness Incurred in respect of any Indebtedness described in this clause (iii) other than the 10 7/8% Senior Notes or paragraph (a); (iv) (A) Acquired Indebtedness of the Company or a Restricted Subsidiary; PROVIDED, HOWEVER, that at the time such Restricted Subsidiary or assets is acquired by the Company or a Restricted Subsidiary, the Company would have been able to Incur $1.00 of additional Indebtedness pursuant to paragraph (a) of this covenant after giving effect to the Incurrence of such Indebtedness pursuant to this clause (iv) and such transaction or series of related transactions and (B) Refinancing Indebtedness Incurred by a Restricted Subsidiary in respect of Indebtedness Incurred by such Restricted Subsidiary pursuant to this clause (iv); 58 (v) Indebtedness (A) in respect of performance bonds, bankers' acceptances, letters of credit and surety or appeal bonds provided by the Company or any Restricted Subsidiary in the ordinary course of its business and which do not secure other Indebtedness and (B) under Currency Agreements, Interest Rate Agreements and Commodity Price Protection Agreements Incurred which, at the time of Incurrence, is in the ordinary course of business; PROVIDED, HOWEVER, that, in the case of Currency Agreements, Interest Rate Agreements and Commodity Price Protection Agreements, such Currency Agreements, Interest Rate Agreements and Commodity Price Protection Agreements do not increase the Indebtedness of the Company outstanding at any time other than as a result of fluctuations in foreign currency exchange rates, interest rates or commodity prices or by reason of fees, indemnities and compensation payable thereunder; (vi) Indebtedness (A) represented by Guarantees by the Company of Indebtedness otherwise permitted to be Incurred pursuant to this covenant and (B) represented by Guarantees by a Restricted Subsidiary of Indebtedness of the Company or another Restricted Subsidiary otherwise permitted to be Incurred pursuant to this covenant; PROVIDED that, in the case of clause (B), if a Restricted Subsidiary Guarantees any such Indebtedness other than any Guarantee by Aaron Brothers, Inc. of Indebtedness under the Credit Agreement, Letter of Credit Facility and any Refinancing Indebtedness in respect thereof, such Restricted Subsidiary executes and delivers to the Trustee a supplemental indenture in form satisfactory to the Trustee providing for the Guarantee on an equal basis of the Notes; provided, however, if Aaron Brothers, Inc. is at any time a Restricted Subsidiary that is a Significant Subsidiary while it has Guaranteed the Credit Agreement, Letter of Credit Facility, or Refinancing Indebtedness in respect thereof, Aaron Brothers, Inc. shall Guarantee the Notes on an equal basis as set forth in this clause (vi); (vii) Indebtedness of the Company or any Restricted Subsidiary represented by Capitalized Lease Obligations, mortgage financings or purchase money obligations, in each case Incurred for the purpose of financing or refinancing all or any part of the purchase price or cost of construction, repairs, renovation, remodeling, expansion or other improvement of property, plant and equipment, including services and equipment supporting such items, used in the Company's or any Restricted Subsidiary's business or a Related Business (collectively, "Purchase Money Debt") in an aggregate principal amount not to exceed 10% of Total Assets at the time of any Incurrence thereof; (viii) Indebtedness of the Company or any Restricted Subsidiary represented by Capitalized Lease Obligations Incurred from time to time for point-of-sale equipment and store systems, including services and equipment supporting such equipment and systems, with the aggregate capitalized amount of such obligation determined in accordance with GAAP outstanding at any one time not to exceed $50 million; (ix) Indebtedness of the Company or any Restricted Subsidiary Incurred with respect to acquisitions of assets or a Person or consisting of Guarantees of such Indebtedness, so long as such Indebtedness was not created in anticipation of such acquisition and does not exceed, in the aggregate, $10 million; and (x) other Indebtedness of the Company or any Restricted Subsidiary in an aggregate principal amount outstanding at any time not to exceed $50 million, of which no more than $10 million may be borrowed by non-Guarantor Restricted Subsidiaries. (c) Notwithstanding the foregoing, the Company shall not Incur any Indebtedness pursuant to the foregoing paragraph (b) if the proceeds thereof are used, directly or indirectly, to Refinance any Subordinated Obligations unless such new Indebtedness shall be subordinated to the Notes to at least the same extent as such Subordinated Obligations being Refinanced. The Indenture further provides that, notwithstanding any other provision of this "--Limitation on Indebtedness" covenant, the 59 Company will not, and will not permit any Restricted Subsidiary to, Incur any Guarantee of Indebtedness of any Unrestricted Subsidiary. (d) Notwithstanding the foregoing, any Guarantee by a Restricted Subsidiary of the Notes may be released (i) upon the sale, transfer or other disposition of all of the Capital Stock of such Restricted Subsidiary held by the Company or any Subsidiary to a Person other than the Company or a Subsidiary, (ii) if such Restricted Subsidiary no longer guarantees any Indebtedness of the Company or has outstanding any Indebtedness which it would not be able to incur without guaranteeing the Notes pursuant to paragraph (b) of this "--Limitation on Indebtedness" covenant if such Indebtedness was incurred on the date of such release, or (iii) if such Subsidiary is designated an Unrestricted Subsidiary in compliance with "--Limitation on Restricted Payments." (e) For purposes of determining compliance with the foregoing covenant, (i) in the event that an item of Indebtedness meets the criteria of more than one of the types of Indebtedness described above, the Company may classify or later reclassify such item of Indebtedness or any portion thereof and only be required to include the amount and type of such Indebtedness in one of the above clauses and (ii) an item of Indebtedness may be divided and classified in more than one of the types of Indebtedness described above. LIMITATION ON RESTRICTED PAYMENTS. (a) The Company will not, and will not permit any Restricted Subsidiary to, directly or indirectly, (i) declare or pay any dividend or make any distribution on or in respect of its Capital Stock (including any payment in connection with any merger or consolidation involving the Company), except (1) dividends or distributions payable solely in its Capital Stock (other than Disqualified Stock) or in options, warrants or other rights to purchase such Capital Stock, and (2) dividends or distributions payable to the Company or another Restricted Subsidiary (and, if such Restricted Subsidiary making such dividend or distribution is not wholly owned, to its other shareholders on a pro rata basis), (ii) purchase, redeem, retire or otherwise acquire for value any Capital Stock of the Company held by Persons other than the Company or another Restricted Subsidiary, (iii) purchase, repurchase, redeem, defease or otherwise acquire or retire for value, prior to scheduled maturity, scheduled repayment or scheduled sinking fund payment any Subordinated Obligations (other than (A) the purchase, repurchase or other acquisition of Subordinated Obligations in anticipation of satisfying a sinking fund obligation, principal installment or final maturity, in each case due within one year of the date of such purchase, repurchase or acquisition or (B) the repayment, redemption or retirement for value of the Company's obligations owed to 5931, Inc. or 5931 Business Trust or successors thereto so long as it remains a Wholly Owned Subsidiary) or (iv) make any Investment (other than a Permitted Investment) in any Person (any such dividend, distribution, purchase, redemption, repurchase, defeasance, other acquisition, retirement, Investment or payment being herein referred to as a "Restricted Payment") if at the time the Company or such Restricted Subsidiary makes such Restricted Payment: (1) a Default or Event of Default will have occurred and be continuing (or would result therefrom); (2) the Company could not Incur at least $1.00 of additional Indebtedness under paragraph (a) of the covenant described under "--Limitation on Indebtedness;" or (3) the aggregate amount of such Restricted Payment and all other Restricted Payments (the amount so expended, if other than in cash, to be determined in good faith by the Board of Directors of the Company, whose determination will be evidenced by a resolution of such 60 Board of Directors certified in an Officers' Certificate to the Trustee) declared or made subsequent to the Issue Date would exceed the sum of: (A) 50% of the Consolidated Net Income with respect to the period (treated as one accounting period) from the end of the most recent fiscal quarter ending prior to the Issue Date to the end of the most recent fiscal quarter for which financial statements are available to the Trustee (or, in case such Consolidated Net Income will be a deficit, minus 100% of such deficit) plus $100 million; (B) the aggregate Net Cash Proceeds received by the Company from the issue or sale of Capital Stock (other than Disqualified Stock) subsequent to the Issue Date (other than an issuance or sale to a Subsidiary); (C) the amount by which Indebtedness of the Company is reduced on the Company's balance sheet upon the conversion or exchange (other than by a Restricted Subsidiary) subsequent to the Issue Date of any Indebtedness of the Company convertible or exchangeable for Capital Stock (other than Disqualified Stock) of the Company (less the amount of any cash or other property distributed by the Company upon such conversion or exchange); (D) in the case of designation of an Unrestricted Subsidiary as a Restricted Subsidiary (as long as the designation of such Subsidiary as an Unrestricted Subsidiary was deemed a Restricted Payment) the value (as provided in the definition of "Investment") of the Company's interest in such Subsidiary provided that such amount shall not in any case exceed the aggregate amount of the Restricted Payments deemed made at the time or after the Subsidiary was designated as an Unrestricted Subsidiary; and (E) in the case of the disposition, return, dividend or repayment of any Investment constituting a Restricted Payment made after the date of the Indenture an amount (to the extent not included in Consolidated Net Income) equal to the lesser of payments made to the Company or a Restricted Subsidiary with respect to such Investment and the initial amount of such Investment, in either case, less the cost of disposition of such Investment and net of taxes (to the extent not reflected in Consolidated Net Income). (b) The provisions of the foregoing paragraph (a) will not prohibit: (i) any purchase, redemption, defeasance or other acquisition of Capital Stock of the Company or Subordinated Obligations made by exchange for, or out of the Net Cash Proceeds of the substantially concurrent sale of, Capital Stock of the Company (other than Disqualified Stock and other than Capital Stock issued or sold to a Subsidiary); PROVIDED, HOWEVER, that (A) such purchase, redemption, defeasance or other acquisition will be excluded in the calculation of the amount of Restricted Payments and (B) the Net Cash Proceeds from such sale will be excluded from clause (3) (B) of paragraph (a) above; (ii) any purchase, redemption, defeasance or other acquisition of Subordinated Obligations made by exchange for, or out of the net proceeds of the substantially concurrent sale of, Subordinated Obligations of the Company; PROVIDED, HOWEVER, that (A) the principal amount of such new Indebtedness does not exceed the principal amount of the Subordinated Obligations being so redeemed, purchased, defeased, acquired or retired for value (plus the amount of any premium required to be paid under the terms of the instrument governing the Subordinated Obligations being so redeemed, purchased, defeased, acquired or retired), (B) such new Indebtedness is subordinated to the Notes at least to the same extent as such Subordinated Obligations so redeemed, purchased, defeased, acquired or retired for value, (C) such new Indebtedness has a final scheduled maturity date later than the final scheduled maturity date of 61 the Notes and (D) such new Indebtedness has an Average Life equal to or greater than the Average Life of the Notes; PROVIDED FURTHER, HOWEVER, that such purchase, redemption, defeasance or other acquisition will be excluded in the calculation of the amount of Restricted Payments; (iii) any purchase, redemption, defeasance or other acquisition of Subordinated Obligations (1) from Net Available Cash to the extent permitted by the covenant described under "--Limitation on Sales of Assets and Subsidiary Stock"; PROVIDED, HOWEVER, that such purchase or redemption will be excluded in the calculation of the amount of Restricted Payments or (2) pursuant to an offer to purchase which is then required to be made upon a change of control of the Company pursuant to the terms of the instrument governing such Subordinated Obligation; PROVIDED, HOWEVER, that such purchase will be included in the calculation of the amount of Restricted Payments; (iv) dividends paid within 60 days after the date of declaration thereof if at such date of declaration such dividend would have complied with this covenant; PROVIDED, HOWEVER, that the amount of such dividend will be included in the calculation of the amount of Restricted Payments; or (v) repurchase, acquisitions or retirements of shares of Capital Stock of the Company deemed to occur upon the exercise of stock options or similar rights issued under employee benefit plans of the Company if such shares represent all or a portion of the exercise price or are surrendered in connection with satisfying any federal or state income tax obligation or are repurchased or acquired to fulfill obligations of the Company or any Restricted Subsidiary under employee compensation or other benefit arrangements entered into or provided for in the ordinary course of business; provided that cash payments pursuant to this clause (v) shall not exceed $2 million in any fiscal year. LIMITATION ON RESTRICTIONS ON DISTRIBUTIONS FROM RESTRICTED SUBSIDIARIES. The Company will not, and will not permit any Restricted Subsidiary to, create or otherwise cause or permit to exist or become effective any consensual encumbrance or restriction on the ability of any Restricted Subsidiary to (i) pay dividends or make any other distributions on its Capital Stock or pay any Indebtedness or other obligation owed to the Company, (ii) make any Investments in the Company or (iii) transfer any of its property or assets to the Company or any Restricted Subsidiary, except: (1) any encumbrance or restriction pursuant to an agreement in effect at or entered into on the Issue Date; (2) any encumbrance or restriction with respect to a Restricted Subsidiary pursuant to an agreement in effect on or prior to the date on which such Restricted Subsidiary was acquired by the Company or a Restricted Subsidiary (other than encumbrances or restrictions Incurred in connection with, or in contemplation of, the transaction or series of related transactions pursuant to which such Restricted Subsidiary became a Subsidiary or was acquired by the Company or a Restricted Subsidiary) and outstanding on such date; (3) any encumbrance or restriction pursuant to an agreement effecting a refinancing of Indebtedness Incurred pursuant to an agreement referred to in clause (1) or (2) of this covenant or contained in any amendment, waiver, modification or renewal of an agreement referred to in clause (1) or (2) of this covenant; PROVIDED, HOWEVER, that the encumbrances and restrictions contained in any such refinancing agreement or amendment, waiver, modification or renewal are no less favorable to the Noteholders than the encumbrances and restrictions contained in such agreements as determined in good faith by the Company; 62 (4) in the case of clause (iii), any encumbrance or restriction (A) that restricts in a customary manner the subletting, assignment or transfer of any property or asset that is subject to a lease, license or similar contract, (B) by virtue of any transfer of, agreement to transfer, option or right with respect to, or Lien on, any property or assets of the Company or any Restricted Subsidiary not otherwise prohibited by the Indenture, (C) arising or agreed to in the ordinary course of business and that does not individually or in the aggregate, detract from the value of property or assets of the Company or any Restricted Subsidiary in any manner material to the Company or such Restricted Subsidiary or (D) contained in security agreements securing Indebtedness of a Restricted Subsidiary to the extent such encumbrance or restrictions restrict the transfer of the property subject to such security agreements; (5) any restriction with respect to a Restricted Subsidiary imposed pursuant to an agreement entered into for the sale or disposition of all or substantially all the Capital Stock or assets of such Restricted Subsidiary pending the closing of such sale or disposition; and (6) encumbrances or restrictions contained in any financing agreement of a Foreign Restricted Subsidiary or arising or existing by reason of applicable law, including any legal limitations restricting the ability of Foreign Restricted Subsidiaries to pay as dividends or distribute or otherwise pay or repatriate funds to the Company or its Subsidiaries. LIMITATION ON SALES OF ASSETS AND SUBSIDIARY STOCK. (a) The Company will not, and will not permit any Restricted Subsidiary to, make any Asset Disposition unless (i) the Company or such Restricted Subsidiary receives consideration at the time of such Asset Disposition at least equal to the fair market value, as determined in good faith by the Board of Directors of the Company (including as to the value of all non-cash consideration), of the shares and assets subject to such Asset Disposition, (ii) at least 75% of the consideration thereof received by the Company or such Restricted Subsidiary (other than Asset Swaps) is in the form of cash or Temporary Cash Investments and (iii) an amount equal to 100% of the Net Available Cash from such Asset Disposition is applied by the Company or such Restricted Subsidiary, as the case may be (A) FIRST, to the extent the Company or any Restricted Subsidiary, as the case may be, elects (or is required by the terms of any Senior Indebtedness), to prepay, repay or purchase Senior Indebtedness or Indebtedness (other than Disqualified Stock) of a Wholly Owned Subsidiary (in each case other than Indebtedness owed to the Company or an Affiliate of the Company) within 180 days from the later of the date of such Asset Disposition or the receipt of such Net Available Cash; (B) SECOND, to the extent of the balance of Net Available Cash after application in accordance with clause (A), to the extent the Company or such Restricted Subsidiary, as the case may be, elects, to the investment by the Company or any Restricted Subsidiary in Additional Assets within one year from the later of the date of such Asset Disposition or the receipt of such Net Available Cash; (C) THIRD, to the extent of the balance of such Net Available Cash after application in accordance with clauses (A) and (B), to make an Offer (as defined below) to purchase Notes pursuant to and subject to the conditions set forth in paragraph (b) of this covenant within 45 days after the date that is one year from the receipt of such Net Available Cash; and (D) FOURTH, to the extent of the balance of such Net Available Cash after application in accordance with clauses (A), (B) and (C), to (x) the acquisition by the Company or any Wholly Owned Subsidiary of Additional Assets, (y) the prepayment, repayment, purchase or other acquisition of Indebtedness of the Company (other than Indebtedness owed to an 63 Affiliate of the Company and other than Disqualified Stock of the Company) or Indebtedness of any Restricted Subsidiary (other than Indebtedness owed to the Company or an Affiliate of the Company) or (z) to general corporate purposes (other than to the payment of dividends or distributions in respect of, or repurchases of, Capital Stock), in each case within 45 days after the later of one year from the receipt of such Net Available Cash and the date the Offer described in paragraph (b) below is consummated; PROVIDED, HOWEVER that in connection with any prepayment, repayment, purchase or other acquisition of Indebtedness pursuant to clause (A), (C) or (D) above, the Company or such Restricted Subsidiary will, to the extent such Indebtedness is not revolving Indebtedness, retire such Indebtedness and, except as to Indebtedness described in clause (i) of paragraph (b) under "--Limitation on Indebtedness," will cause any related loan commitment or availability (if any) to be permanently reduced in an amount equal to the principal amount so prepaid, repaid or purchased. Notwithstanding the foregoing provisions, the Company and its Restricted Subsidiaries shall not be required to apply any Net Available Cash in accordance herewith except to the extent that the aggregate Net Available Cash from all Asset Dispositions which are not applied in accordance with this covenant exceeds $10,000,000. The Company shall not be required to make an Offer for Notes pursuant to this covenant if the Net Available Cash available therefor (after application of the proceeds as provided in clauses (A) and (B)) are less than $15,000,000 for any particular Asset Disposition (which lesser amounts shall be carried forward for purposes of determining whether an Offer is required with respect to the Net Available Cash from any subsequent Asset Disposition). For the purposes of this covenant, the following are deemed to be cash: (x) the assumption by the transferee of Indebtedness of the Company (other than Disqualified Stock of the Company) or any Restricted Subsidiary and the release of the Company or such Restricted Subsidiary from all liability on such Indebtedness in connection with such Asset Disposition, (y) any Designated Noncash Consideration received by the Company or any of its Restricted Subsidiaries in the Asset Sale and (z) securities received by the Company or any Restricted Subsidiary from the transferee that are promptly converted by the Company or such Restricted Subsidiary into cash. With respect to an Asset Swap constituting an Asset Disposition, the Company or any Restricted Subsidiary shall be required to receive in cash (as such term is deemed to be defined for purposes of this paragraph (a)) or Temporary Cash Investments in an amount equal to 75% of the proceeds of the Asset Disposition which do not consist of in-kind assets acquired with the Asset Swap. (b) In the event of an Asset Disposition that requires the purchase of Notes pursuant to clause (a)(iii)(C) of this covenant, the Company will be required to purchase Notes tendered pursuant to an offer by the Company for the Notes (the "Offer") at a purchase price of 100% of their principal amount plus accrued interest to the date of purchase in accordance with the procedures (including prorating in the event of oversubscription) set forth in the Indenture. If the aggregate purchase price of Notes tendered pursuant to the Offer is less than the Net Available Cash allotted to the purchase of the Notes, the Company will apply the remaining Net Available Cash in accordance with clause (a)(iii)(D) above. (c) The Company will comply, to the extent applicable, with the requirements of Section 14(e) of the Exchange Act and any other securities laws or regulations in connection with the repurchase of Notes pursuant to this covenant. To the extent that the provisions of any securities laws or regulations conflict with provisions of this covenant, the Company will comply with the applicable securities laws and regulations and will not be deemed to have breached its obligations under this covenant by virtue thereof. LIMITATION ON TRANSACTIONS WITH AFFILIATES. (a) The Company will not, and will not permit any Restricted Subsidiary to, directly or indirectly, enter into any agreement or conduct any transaction or series of related transactions (including the purchase, sale, lease or exchange of any property, or 64 rendering of any service) with any Affiliate of the Company (an "Affiliate Transaction") unless (i) the terms of such transaction or agreement are no less favorable to the Company or such Restricted Subsidiary, as the case may be, than those that could be obtained at the time of such transaction in arm's-length dealings with a Person who is not such an Affiliate; and (ii) in the event such Affiliate Transaction involves an aggregate amount in excess of $5,000,000, the terms of such transaction or agreement shall have been approved by a majority of the members of the Board of Directors having no personal stake in such Affiliate Transaction (and such majority determines that such Affiliate Transaction satisfies the criteria in clause (i) above). (b) The foregoing shall not apply to (i) any Restricted Payment permitted to be made pursuant to "--Limitation on Restricted Payments," (ii) any issuance of securities, or other payments, awards or grants in cash, securities or otherwise pursuant to, or the funding of, employment arrangements, stock options and stock ownership plans approved by the Board of Directors or the payment of fees and indemnities to directors of the Company and its Restricted Subsidiaries in the ordinary course of business, (iii) loans or advances to employees in the ordinary course of business, (iv) any transaction between the Company and a Wholly Owned Subsidiary or between Wholly Owned Subsidiaries, (v) transactions pursuant to written agreements in existence on the Issue Date, (vi) repurchases, acquisitions or retirements of shares of Capital Stock of the Company deemed to occur upon the exercise of stock options or similar rights issued under employee benefit plans of the Company if such shares represent all or a portion of the exercise price or are surrendered in connection with satisfying any federal or state income tax obligation or are repurchased or acquired to fulfill obligations of the Company or any Restricted Subsidiary under employee compensation or other benefit arrangements entered into or provided for in the ordinary course of business; provided that cash payments pursuant to this clause (vi) shall not exceed $2 million in any fiscal year, or (vii) any transaction between the Company or any Wholly Owned Subsidiary, on the one hand, and a Restricted Subsidiary, on the other hand, in the ordinary course of business on terms that are customary in the industry or consistent with past practice. LIMITATION ON LIENS. The Company will not, and will not permit any Restricted Subsidiary to, directly or indirectly, create or permit to exist any Lien on any of its property or assets (including Capital Stock), whether owned on the Issue Date or thereafter acquired, securing any obligation, other than Permitted Liens, unless contemporaneously therewith effective provision is made to secure the Notes equally and ratably with (or on a senior basis to, in the case of Subordinated Obligations) such obligation for so long as such obligation is so secured. LIMITATION ON SALE/LEASEBACK TRANSACTIONS. The Company will not, and will not permit any Restricted Subsidiary to, enter into any Sale/Leaseback Transaction with respect to any property unless (i) the Company or such Restricted Subsidiary would be entitled to (A) Incur Indebtedness in an amount equal to the Attributable Indebtedness with respect to such Sale/Leaseback Transaction pursuant to the covenant described under "--Limitation on Indebtedness" and (B) create a Lien, if any, on such property securing such Attributable Indebtedness without equally and ratably securing the Notes pursuant to the covenant described under "--Limitation on Liens," (ii) the Net Cash Proceeds received by the Company or any Restricted Subsidiary in connection with such Sale/Leaseback Transaction are at least equal to the fair value (as determined in good faith and certified in an Officers' Certificate to the Trustee) of such property and (iii) the transfer of such property is permitted by, and the Company or such Restricted Subsidiary applies the proceeds of such transaction in compliance with, the covenant described under "--Limitation on Sales of Assets and Subsidiary Stock." LIMITATION ON SALE OF SUBSIDIARY PREFERRED STOCK. The Company (i) will not, and will not permit any Restricted Subsidiary of the Company to, transfer, convey, sell, lease or otherwise dispose of any Preferred Stock of any Restricted Subsidiary to any Person (other than to the Company or a Wholly Owned Subsidiary), unless (a) such transfer, conveyance, sale, lease or other disposition is of all the 65 Capital Stock of such Restricted Subsidiary (or, in the case of a non-wholly owned Restricted Subsidiary, all of the Capital Stock held by the Company or its Restricted Subsidiaries) and (b) the net cash proceeds from such transfer, conveyance, sale, lease or other disposition are applied in accordance with the covenant described above under "--Limitation on Sales of Assets and Subsidiary Stock" and (ii) will not permit any Restricted Subsidiary to issue any of its Preferred Stock to any Person other than to the Company or a Wholly Owned Subsidiary SEC REPORTS. Notwithstanding that the Company may not be required to remain subject to the reporting requirements of Section 13 or 15(d) of the Exchange Act, the Company will file with the SEC and provide the Trustee and Noteholders with the annual reports and such information, documents and other reports which are specified in Sections 13 and 15(d) of the Exchange Act. The Company also will comply with the other provisions of TIA Section 314(a). MERGER AND CONSOLIDATION The Company will not consolidate with or merge with or into, or convey, transfer or lease all or substantially all its assets to, any Person, unless: (i) the resulting, surviving or transferee Person (the "Successor Company") will be a corporation organized and existing under the laws of the United States of America, any State thereof or the District of Columbia and the Successor Company (if not the Company) will expressly assume, by supplemental indenture, executed and delivered to the Trustee, in form satisfactory to the Trustee, all the obligations of the Company under the Notes and the Indenture; (ii) immediately after giving effect to such transaction (and treating any Indebtedness which becomes an obligation of the Successor Company or any Restricted Subsidiary as a result of such transaction as having been Incurred by the Successor Company or such Restricted Subsidiary at the time of such transaction), no Default or Event of Default will have occurred and be continuing; (iii) immediately after giving effect to such transaction, the Successor Company would be able to Incur an additional $1.00 of Indebtedness under paragraph (a) of the covenant described under "--Limitation on Indebtedness"; and (iv) the Company will have delivered to the Trustee an Officers' Certificate and an Opinion of Counsel, each stating that such consolidation, merger or transfer and such supplemental indenture, if any, comply with the Indenture, as set forth in the Indenture. The Successor Company will succeed to, and be substituted for, and may exercise every right and power of, the Company under the Indenture, but the predecessor Company in the case of a lease of all its assets or a conveyance, transfer or lease of substantially all its assets will not be released from the obligation to pay the principal of and interest on the Notes. Notwithstanding the foregoing clauses (ii) and (iii), any Wholly Owned Subsidiary may consolidate with, merge into or transfer all or part of its properties and assets to the Company and the Company will not be required to take any action under clause (iv) in connection therewith. DEFAULTS An Event of Default is defined in the Indenture as (i) a default in any payment of interest on any Note when due, continued for 30 days, (ii) a default in the payment of principal of any Note when due at its Stated Maturity, upon optional redemption, upon required repurchase, upon declaration or otherwise, (iii) the failure by the Company to comply with its obligations described under "--Merger and Consolidation," "--Limitation on Sales of Assets and Subsidiary Stock" or "--Change of Control," (iv) the failure by the Company to comply for 60 days after notice with its other agreements contained in the Indenture, (v) the failure by the Company or any Significant Subsidiary of the Company to pay any Indebtedness within any applicable grace period after final maturity or the acceleration of any such Indebtedness by the holders thereof because of a default if the total amount of such Indebtedness unpaid or accelerated exceeds $10 million or its foreign currency equivalent (the "cross acceleration provision"), (vi) certain events of bankruptcy, insolvency or reorganization of the Company or any 66 Significant Subsidiary of the Company (the "bankruptcy provisions") or (vii) any final, non-appealable judgment or decree for the payment of money in excess of $10 million is rendered against the Company or any Significant Subsidiary of the Company and either (A) an enforcement proceeding has been commenced by any creditor upon such judgment or decree or (B) such judgment or decree remains unpaid and outstanding for a period of 60 days following such judgment and is not discharged, waived or stayed (the "judgment default provision"). The foregoing will constitute Events of Default whatever the reason for any such Event of Default and whether it is voluntary or involuntary or is effected by operation of law or pursuant to any judgment, decree or order of any court or any order, rule or regulation of any administrative or governmental body. However, a default under clauses (iv) or (v) will not constitute an Event of Default until the Trustee or the Holders of 25% in aggregate principal amount of the outstanding Notes notify the Company as provided in the Indenture of the default and the Company does not cure such default within the time specified in clauses (iv) and (v) hereof after receipt of such notice. If an Event of Default occurs and is continuing, the Trustee or the Holders of at least 25% in aggregate principal amount of the then outstanding Notes by notice to the Company may declare the principal of and accrued but unpaid interest on all the Notes to be due and payable. Upon such a declaration, such principal and interest will be due and payable immediately. If an Event of Default relating to certain events of bankruptcy, insolvency or reorganization of the Company occurs and is continuing, the principal of and accrued interest on all the Notes will become immediately due and payable without any declaration or other act on the part of the Trustee or any Holders. Under certain circumstances, the Holders of a majority in aggregate principal amount of the outstanding Notes may rescind any such acceleration with respect to the Notes and its consequences. Subject to the provisions of the Indenture relating to the duties of the Trustee, in case an Event of Default occurs and is continuing, the Trustee will be under no obligation to exercise any of the rights or powers under the Indenture at the request or direction of any of the Holders unless such Holders shall have offered to the Trustee reasonable indemnity or security against any loss, liability or expense. Except to enforce the right to receive payment of principal, premium, if any, or interest when due, no Holder may pursue any remedy with respect to the Indenture or the Notes unless (i) such Holder shall have previously given the Trustee notice that an Event of Default is continuing, (ii) Holders of at least 25% in aggregate principal amount of the outstanding Notes shall have requested the Trustee to pursue the remedy, (iii) such Holders shall have offered the Trustee reasonable security or indemnity against any loss, liability or expense, (iv) the Trustee shall not have complied with such request within 60 days after the receipt of the request and the offer of security or indemnity and (v) the Holders of a majority in principal amount of the outstanding Notes shall not have given the Trustee a direction inconsistent with such request within such 60-day period. Subject to certain restrictions, the Holders of a majority in principal amount of the outstanding Notes are given the right to direct the time, method and place of conducting any proceeding for any remedy available to the Trustee or of exercising any trust or power conferred on the Trustee. The Trustee, however, may refuse to follow any direction that conflicts with law or the Indenture or that the Trustee determines is unduly prejudicial to the rights of any other Holder or that would involve the Trustee in personal liability. Prior to taking any action under the Indenture, the Trustee will be entitled to indemnification from the Noteholders satisfactory to it in its sole discretion against all losses and expenses caused by taking or not taking such action. The Indenture provides that if a Default occurs and is continuing and is known to the Trustee, the Trustee must mail to each Holder notice of the Default within the earlier of 90 days after it occurs or 30 days after it is known by a Trust Officer or written notice of it is received by the Trustee. Except in the case of a Default in the payment of principal of, premium, if any, or interest on any Note, the Trustee may withhold notice if and so long as a committee of its Trust Officers in good faith determines 67 that withholding notice is in the interests of the Noteholders. In addition, the Company is required to deliver to the Trustee, within 120 days after the end of each fiscal year, a certificate indicating whether the signers thereof know of any Default that occurred during the previous year. The Company also is required to deliver to the Trustee, within 30 days after the occurrence thereof, written notice of any event which would constitute certain Defaults, their status and what action the Company is taking or proposes to take in respect thereof. SATISFACTION AND DISCHARGE The Indenture will be discharged and will cease to be of further effect (except as to surviving rights of registration of transfer or exchange of the Notes as expressly provided for in the Indenture) as to all outstanding Notes under the Indenture when (a) either (1) all such Notes theretofore authenticated and delivered (except lost, stolen or destroyed Notes which have been replaced or paid or Notes whose payment has been deposited in trust or segregated and held in trust by the Company and thereafter repaid to the Company or discharged from such trust as provided for in the Indenture) have been delivered to the Trustee for cancellation or (2) all Notes not theretofore delivered to the Trustee for cancellation (a) have become due and payable, (b) will become due and payable at their Stated Maturity within 91 days or (c) are to be called for redemption within 91 days under arrangements satisfactory to the Trustee for the giving of notice of redemption by the Trustee in the name, and at the expense, of the Company; (b) the Company or any other Person has irrevocably deposited or caused to be deposited with the Trustee as trust funds in trust an amount in United States dollars sufficient to pay and discharge the entire indebtedness on the Notes not theretofore delivered to the Trustee for cancellation, including principal of, premium, if any, and accrued interest at such maturity, Stated Maturity or redemption date; and (c) the Company or any other Person has paid or caused to be paid all other sums payable under the Indenture by the Company. The Company may request the Trustee to acknowledge the discharge upon delivery to the Trustee of an officers' certificate and an opinion of independent counsel each stating that all conditions precedent under the Indenture relating to the satisfaction and discharge of such Indenture have been complied with. AMENDMENTS AND WAIVERS Subject to certain exceptions, the Indenture may be amended with the consent of the Holders of a majority in principal amount of the Notes then outstanding and any past default or compliance with any provisions may be waived with the consent of the Holders of a majority in principal amount of the Notes then outstanding. However, without the consent of each Holder of an outstanding Note affected, no amendment may, among other things, (i) reduce the amount of Notes whose Holders must consent to an amendment, (ii) reduce the rate of or extend the time for payment of interest on any Note, (iii) reduce the principal of or extend the Stated Maturity of any Note, (iv) reduce the premium payable upon the redemption of any Note or change the time at which any Note may be redeemed as described under "--Optional Redemption," (v) make any Note payable in money other than that stated in the Note, (vi) impair the right of any Holder to receive payment of principal of and interest on such Holder's Notes on or after the due dates therefor or to institute suit for the enforcement of any payment on or with respect to such Holder's Notes or (vii) make any change in the amendment provisions which require each Holder's consent or in the waiver provisions. Without the consent of any Holder, the Company and the Trustee may amend the Indenture to cure any ambiguity, omission, defect or inconsistency, to provide for the assumption by a successor corporation of the obligations the Company under the Indenture, to provide for uncertificated Notes in addition to or in place of certificated Notes (provided that the uncertificated Notes are issued in registered form for purposes of Section 163(f) of the Code, or in a manner such that the uncertificated Notes are as described in Section 163(f) (2) (B) of the Code), to add Guarantees with respect to the Notes, to secure the Notes, to add to the covenants of the Company for the benefit of the Noteholders 68 or to surrender any right or power conferred upon the Company, to make any change that does not adversely affect the rights of any Holder and to comply with any requirement of the SEC in connection with the qualification of the Indenture under the TIA. The consent of the Noteholders is not necessary under the Indenture to approve the particular form of any proposed amendment. It is sufficient if such consent approves the substance of the proposed amendment. After an amendment under the Indenture becomes effective, the Company is required to mail to Noteholders a notice briefly describing such amendment. However, the failure to give such notice to all Noteholders, or any defect therein, will not impair or affect the validity of the amendment. TRANSFER AND EXCHANGE A Noteholder may transfer or exchange Notes in accordance with the Indenture. Upon any transfer or exchange, the registrar and the Trustee may require a Noteholder, among other things, to furnish appropriate endorsements and transfer documents and the Company may require a Noteholder to pay any taxes required by law or permitted by the Indenture, including any transfer tax or other similar governmental charge payable in connection therewith. The Company is not required to transfer or exchange any Note selected for redemption or to transfer or exchange any Note for a period of 15 days prior to a selection of Notes to be redeemed or an interest payment date. The Notes will be issued in registered form and the registered holder of a Note will be treated as the owner of such Note for all purposes. DEFEASANCE The Company at any time may terminate all of its obligations under the Notes and the Indenture ("legal defeasance"), except for certain obligations, including those respecting the defeasance trust (as defined herein) and obligations to register the transfer or exchange of the Notes, to replace mutilated, destroyed, lost or stolen Notes and to maintain a registrar and paying agent in respect of the Notes. The Company at any time may terminate its obligations under the covenants described under "--Certain Covenants," the operation of the cross acceleration provision, the bankruptcy provisions with respect to Significant Subsidiaries and the judgment default provision described under "--Defaults" and the limitations contained in clauses (iii) and (iv) under "--Merger and Consolidation" ("covenant defeasance"). The Company may exercise its legal defeasance option notwithstanding its prior exercise of its covenant defeasance option. If the Company exercises its legal defeasance option, payment of the Notes may not be accelerated because of an Event of Default with respect thereto. If the Company exercises its covenant defeasance option, payment of the Notes may not be accelerated because of an Event of Default specified in clause (iv), (v), (vi) (with respect only to Significant Subsidiaries), or (vii) under "--Defaults" above or because of the failure of the Company to comply with clauses (ii), (iii) or (iv) under "--Merger and Consolidation." In order to exercise either defeasance option, the Company must irrevocably deposit or cause to be deposited in trust (the "defeasance trust") with the Trustee money or U.S. Government Obligations which through the scheduled payment of principal and interest in respect thereof in accordance with their terms will provide cash at such times and in such amounts as will be sufficient to pay principal and interest when due on all the Notes (except lost, stolen or destroyed Notes which have been replaced or repaid) to maturity or redemption, as the case may be, and must comply with certain other conditions, including delivery to the Trustee of an Opinion of Counsel to the effect that Holders of the Notes will not recognize income, gain or loss for federal income tax purposes as a result of such deposit and defeasance and will be subject to federal income tax on the same amount and in the same manner and at the same times as would have been the case if such deposit and defeasance had not 69 occurred (and, in the case of legal defeasance only, such Opinion of Counsel must be based on a ruling of the Internal Revenue Service or other change in applicable federal income tax law). CONCERNING THE TRUSTEE The Bank of New York is the Trustee under the Indenture and has been appointed by the Company as Registrar and Paying Agent with regard to the Notes. FALL AWAY EVENT In the event of the occurrence of a Fall Away Event, the covenants and provisions described above under "--Change of Control," "--Certain Covenants--Limitation on Indebtedness," "--Limitation on Restricted Payments," "--Limitation on Restrictions on Distributions from Restricted Subsidiaries," "--Limitation on Sales of Assets and Subsidiary Stock," "--Limitation on Transactions with Affiliates," and "--Limitation on Sale of Subsidiary Preferred Stock" shall each no longer be in effect for the remaining term of the Notes, subject to the next paragraph; provided that after a Fall Away Event, so long as the Notes retain an Investment Grade status the Company will become subject to a new covenant that will provide that from and after the occurrence of a Fall Away Event the non-Guarantor Subsidiaries of the Company (other than Foreign Restricted Subsidiaries, and except that Aaron Brothers, Inc. may guarantee the Credit Agreement, Letter of Credit Facility or Refinancing Indebtedness, so long as it is not a Significant Subsidiary), may not Guarantee Indebtedness of the Company or otherwise incur Indebtedness other than Indebtedness of the types described under "--Certain Covenants--Limitation on Indebtedness" in clauses (ii), (iii)(x), (iii)(y) of such covenant as in effect on the date of the occurrence of the Fall Away Event with respect to Indebtedness outstanding on the date of the occurrence of the Fall Away Event, in clause (iii)(z) of such covenant as in effect on the date of the occurrence of the Fall Away Event with respect to Indebtedness outstanding on the date of the occurrence of the Fall Away Event, in clause (iv) of such covenant (except that the proviso contained therein shall not be applicable); in clauses (v), (vii) and (viii) of such covenant and Indebtedness in an aggregate principal amount not to exceed 5% of the Company's Consolidated Tangible Net Worth at any one time outstanding. The covenant will also contain a release provision that any guarantee by a Subsidiary may be released (a) upon the sale, transfer or other disposition of all of the Capital Stock of such Subsidiary held by the Company or any Subsidiary to a Person other than the Company or a Subsidiary or (b) if such Subsidiary no longer guarantees any Indebtedness of the Company or has any Indebtedness outstanding which it would not be able to incur without guaranteeing the Notes pursuant to this covenant if such Indebtedness was incurred on the date of the release. If, at any time, after the occurrence of a Fall Away Event, the Company fails to maintain Investment Grade status or a Default or Event of Default has occurred and is continuing, then the covenants which are no longer in effect pursuant to the preceding paragraph will be immediately reinstated and be applicable to the Company and its Restricted Subsidiaries and the new covenant in the preceding paragraph shall be terminated although any actions taken during the pendency of the Fall Away Event shall not be deemed a Default or Event of Default under the Indenture whether or not they would have been permitted if the covenants did not fall away. FURTHER ISSUES We may from time to time, without notice to or the consent of the Holders of the Notes, create and issue further notes ranking equally with the Notes in all respects (or in all respects other than the payment of interest accruing prior to the issue date of such further notes or except for the first payment of interest following the issue date of such further notes). Such further notes, together with these Notes, will not exceed $250.0 million in the aggregate, may be consolidated and form a single series with the Notes and have the same terms as to status, redemption, voting or otherwise as to the 70 Notes. All references herein to the Notes will include any further notes once issued, unless the context otherwise requires. GOVERNING LAW The Indenture provides that it and the Notes are governed by, and construed in accordance with, the laws of the State of New York without giving effect to applicable principles of conflicts of law to the extent that the application of the law of another jurisdiction would be required thereby. CERTAIN DEFINITIONS "Acquired Indebtedness" means Indebtedness of a Person (i) existing at the time such Person becomes a Restricted Subsidiary or (ii) assumed in connection with the acquisition of assets from such Person, in each case, other than Indebtedness incurred in connection with, or in contemplation of, such Person becoming a Restricted Subsidiary or such acquisition, as the case may be. Acquired Indebtedness shall be deemed to be incurred on the date of the related acquisition of assets from any Person or the date the acquired Person becomes a Restricted Subsidiary, as the case may be. "Additional Assets" means (i) any property or assets (other than inventory in the ordinary course of business and other than Indebtedness and Capital Stock) in a Related Business; (ii) the Capital Stock of a Person that becomes a Restricted Subsidiary as a result of the acquisition of such Capital Stock by the Company or another Restricted Subsidiary; or (iii) Capital Stock constituting a minority interest in any Person that at such time is a Restricted Subsidiary; PROVIDED, HOWEVER, that, in the case of clauses (ii) and (iii), such Restricted Subsidiary is primarily engaged in a Related Business. "Affiliate" of any specified Person means any other Person, directly or indirectly, controlling or controlled by or under direct or indirect common control with such specified Person. For the purposes of this definition, "control" when used with respect to any Person means the power to direct the management and policies of such Person, directly or indirectly, whether through the ownership of voting securities, by contract or otherwise; and the terms "controlling" and "controlled" have meanings correlative to the foregoing. For purposes of the covenants in the Indenture, "Affiliate" shall also mean any beneficial owner of shares representing 10% or more of the total voting power of the Voting Stock (on a fully diluted basis) of the Company or of rights or warrants to purchase such Voting Stock (whether or not currently exercisable) and any Person who would be an Affiliate of any such beneficial owner pursuant to the first sentence hereof. "Asset Disposition" means any sale, lease, transfer or other disposition (or series of related sales, leases, transfers or dispositions) of shares of Capital Stock of a Restricted Subsidiary (other than directors' qualifying shares), property or other assets (each referred to for the purposes of this definition as a "disposition") by the Company or any of its Restricted Subsidiaries (including any disposition by means of a merger, consolidation or similar transaction) other than (i) a disposition by a Restricted Subsidiary to the Company or by the Company or a Restricted Subsidiary to a Wholly Owned Subsidiary, (ii) a disposition of property, assets, inventory or Temporary Cash Investments in the ordinary course of business, (iii) for purposes of the "Limitation on Sales of Assets and Subsidiary Stock" covenant only, a disposition that constitutes a Restricted Payment permitted by the "Limitation on Restricted Payments" covenant, (iv) a disposition of duplicative or excessive real property where less than 75% of the consideration received is in the form of cash or Temporary Cash Investments, which disposition occurs within one year of the acquisition thereof and (v) any disposition of assets or series of related dispositions with an aggregate fair market value (as determined in good faith) of less than $5 million. "Asset Swap" means the exchange by the Company or a Restricted Subsidiary of a portion of its property, business or assets, for property, businesses or assets or Capital Stock of a Person, which all or substantially all of whose assets are a type used in the business of the Company on the date of the 71 Indenture or in a Related Business, or a combination of any property, business or assets or Capital Stock of such a Person and cash or Temporary Cash Investments. "Attributable Indebtedness" in respect of a Sale/Leaseback Transaction means, as at the time of determination, the present value (discounted at the interest rate borne by the Notes, compounded annually) of the total obligations of the lessee for rental payments during the remaining term of the lease included in such Sale/Leaseback Transaction (including any period for which such lease has been extended); PROVIDED, HOWEVER, that "Attributable Indebtedness" shall not include any such obligations to the extent they relate to the lease of stores, warehouses, offices or distribution facilities, including without limitation, the fixtures appertaining thereto, unless such obligations are required to be recorded on the Company's balance sheet in accordance with GAAP. "Average Life" means, as of the date of determination, with respect to any Indebtedness or Preferred Stock, the quotient obtained by dividing (i) the sum of the product of the numbers of years from the date of determination to the dates of each successive scheduled principal payment of such Indebtedness or redemption or similar payment with respect to such Preferred Stock multiplied by the amount of such payment by (ii) the sum of all such payments. "Board of Directors" means the Board of Directors or equivalent governing body of a Person (or the general partner of such Person, as the case may be) or any committee thereof duly authorized to act on behalf of such Board or equivalent governing body. "Business Day" means a day other than a Saturday, Sunday or other day on which banking institutions in New York State are authorized or required by law to close. "Capitalized Lease Obligation" means an obligation that is required to be classified and accounted for as a capitalized lease for financial reporting purposes in accordance with GAAP, and the amount of Indebtedness represented by such obligation shall be the capitalized amount of such obligation determined in accordance with GAAP; and the Stated Maturity thereof shall be the date of the last payment of rent or any other amount due under such lease. "Capital Stock" of any Person means any and all shares, interests, rights to purchase, warrants, options, participation or other equivalents of or interests in (however designated) equity of such Person, including any Preferred Stock, but excluding any debt securities convertible into such equity. "Code" means the Internal Revenue Code of 1986, as amended. "Commodity Price Protection Agreement" means any forward contract, commodity swap, commodity option or other similar financial agreement or arrangement relating to, or the value which is dependent upon, fluctuations in commodity prices. "Consolidated Coverage Ratio" as of any date of determination means the ratio of (i) the aggregate amount of EBITDA for the period of the most recent four consecutive fiscal quarters for which financial statements are available to (ii) Consolidated Interest Expense for such period; PROVIDED, HOWEVER, that (1) if the Company or any Restricted Subsidiary has Incurred any Indebtedness since the beginning of such period that remains outstanding or if the transaction giving rise to the need to calculate the Consolidated Coverage Ratio is an Incurrence of Indebtedness, or both, EBITDA and Consolidated Interest Expense for such period shall be calculated after giving effect on a pro forma basis to such Indebtedness as if such Indebtedness had been Incurred on the first day of such period and the discharge of any other Indebtedness repaid, repurchased, defeased or otherwise discharged with the proceeds of such new Indebtedness as if such discharge had occurred on the first day of such period, (2) if since the beginning of such period the Company or any Restricted Subsidiary shall have made any Asset Disposition or if the transaction giving rise to the need to calculate the Consolidated Coverage Ratio is an Asset Disposition, the EBITDA for such period shall be reduced by an amount equal to the EBITDA (if positive) directly attributable to the assets which are the subject of such Asset 72 Disposition for such period, or increased by an amount equal to the EBITDA (if negative) directly attributable thereto for such period and Consolidated Interest Expense for such period shall be reduced by an amount equal to the Consolidated Interest Expense directly attributable to any Indebtedness of the Company or any Restricted Subsidiary repaid, repurchased, defeased or otherwise discharged with respect to the Company and its continuing Restricted Subsidiaries in connection with such Asset Disposition for such period (or, if the Capital Stock of any Restricted Subsidiary is sold, the Consolidated Interest Expense for such period directly attributable to the Indebtedness of such Restricted Subsidiary to the extent the Company and its continuing Restricted Subsidiaries are no longer liable for such Indebtedness after such sale), (3) if since the beginning of such period the Company or any Restricted Subsidiary (by merger or otherwise) shall have made an Investment in any Restricted Subsidiary (or any Person which becomes a Restricted Subsidiary) or an acquisition of assets, including any acquisition of assets occurring in connection with a transaction causing a calculation to be made hereunder, which constitutes all or substantially all of an operating unit of a business, EBITDA and Consolidated Interest Expense for such period shall be calculated after giving pro forma effect thereto (including the Incurrence of any Indebtedness) as if such Investment or acquisition occurred on the first day of such period and (4) if since the beginning of such period any Person (that subsequently became a Restricted Subsidiary or was merged with or into the Company or any Restricted Subsidiary since the beginning of such period) shall have made any Asset Disposition or any Investment that would have required an adjustment pursuant to clause (2) or (3) above if made by the Company or a Restricted Subsidiary during such period, EBITDA and Consolidated Interest Expense for such period shall be calculated after giving pro forma effect thereto as if such Asset Disposition or Investment occurred on the first day of such period. For purposes of this definition, whenever pro forma effect is to be given to an acquisition of assets, the amount of income or earnings relating thereto and the amount of Consolidated Interest Expense associated with any Indebtedness Incurred in connection therewith, the pro forma calculations shall be determined in good faith by a responsible financial or accounting officer of the Company. If any Indebtedness bears a floating rate of interest and is being given pro forma effect, the interest expense on such Indebtedness shall be calculated as if the rate in effect on the date of determination had been the applicable rate for the entire period (taking into account any Interest Rate Agreement applicable to such Indebtedness if such Interest Rate Agreement has a remaining term in excess of 12 months). "Consolidated Interest Expense" means, for any period, the total interest expense of the Company and its consolidated Restricted Subsidiaries, plus, to the extent not included in such interest expense, (i) interest expense attributable to capital leases, (ii) amortization of debt discount and debt issuance costs, (iii) non-cash interest expense, (iv) commissions, discounts and other fees and charges owed with respect to letters of credit and bankers' acceptance financing, (v) interest actually paid by the Company or any such Restricted Subsidiary under any Guarantee of Indebtedness or other obligation of any other Person, (vi) net costs associated with Hedging Obligations (including amortization of fees), (vii) Preferred Stock dividends in respect of all Preferred Stock of the Company and its Subsidiaries held by Persons other than the Company or a Wholly Owned Subsidiary and (viii) the cash contributions to any employee stock ownership plan or similar trust to the extent such contributions are used by such plan or trust to pay interest or fees to any Person (other than the Company) in connection with Indebtedness Incurred by such plan or trust; PROVIDED, HOWEVER, that there shall be excluded therefrom any such interest expense of any Unrestricted Subsidiary to the extent the related Indebtedness is not Guaranteed or paid by the Company or any Restricted Subsidiary. "Consolidated Net Income" means, for any period, the net income (loss) of the Company and its consolidated Subsidiaries in accordance with GAAP; PROVIDED, HOWEVER, that there shall not be included in such Consolidated Net Income: (i) any net income (loss) of any Person if such Person is not a Restricted Subsidiary, except that (A) subject to the limitations contained in (iv) below the Company's equity in the net income 73 of any such Person for such period shall be included in such Consolidated Net Income up to the aggregate amount of cash actually distributed by such Person during such period to the Company or a Restricted Subsidiary as a dividend or other distribution (subject, in the case of a dividend or other distribution to a Restricted Subsidiary, to the limitations contained in clause (iii) below) and (B) the Company's equity in a net loss of any such Person (other than an Unrestricted Subsidiary) for such period shall be included in determining such Consolidated Net Income, (ii) any net income (loss) of any Person acquired by the Company or a Restricted Subsidiary in a pooling of interests transaction for any period prior to the date of such acquisition, (iii) any net income of any Restricted Subsidiary if such Restricted Subsidiary is subject to restrictions, directly or indirectly, on the payment of dividends or the making of distributions by such Restricted Subsidiary, directly or indirectly, to the Company, except that (A) subject to the limitations contained in (iv) below the Company's equity in the net income of any such Restricted Subsidiary for such period shall only be included in such Consolidated Net Income up to the aggregate amount of cash that could have been distributed by such Restricted Subsidiary during such period to the Company or another Restricted Subsidiary as a dividend (subject, in the case of a dividend to another Restricted Subsidiary, to the limitation contained in this clause) and (B) the Company's equity in a net loss of any such Restricted Subsidiary for such period shall be included in determining such Consolidated Net Income, (iv) any gain (but not loss) realized upon the sale or other disposition of any property, plant or equipment of the Company or its consolidated Subsidiaries (including pursuant to any Sale/ Leaseback Transaction) which is not sold or otherwise disposed of in the ordinary course of business and any gain (but not loss) realized upon the acquisition or disposition of any securities, of any Person, (v) any extraordinary gain or loss net of taxes (less all fees and expenses relating thereto), (vi) the cumulative effect of a change in accounting principles, (vii) any gain or loss, net of taxes, realized upon the termination of any employee pension benefit plan, and (viii) any net gain arising from the extinguishment, under GAAP, of any Indebtedness of any Person. "Consolidated Tangible Net Worth" of any Person means, at any time, for such Person and its Restricted Subsidiaries on a consolidated basis, an amount computed equal to (a) the consolidated stockholders' equity of the Person and its Restricted Subsidiaries, minus, (b) all Intangible Assets of the Person and its Restricted Subsidiaries, in each case as of such time. "Credit Agreement" means the Revolving Credit Agreement, dated as of May 1, 2001, among the Company, Fleet National Bank and the lenders parties thereto, as it may be amended, extended, renewed, refinanced, substituted or replaced from time to time (including increases in principal amount thereof to the extent permitted under the Notes, the addition of one or more lenders to an existing facility or the replacement or inclusion of one or more lenders in a new facility) in one or more agreements. "Currency Agreement" means in respect of a Person any foreign exchange contract, currency swap agreement or other similar agreement as to which such Person is a party or a beneficiary. "Default" means any event which is, or after notice or passage of time or both would be, an Event of Default. "Designated Noncash Consideration" means the fair market value of non-cash consideration received by the Company or any of its Restricted Subsidiaries in connection with an Asset Disposition 74 that is so designated pursuant to an officer's certificate, setting forth the basis of the valuation. The aggregate fair market value of the Designated Noncash Consideration, taken together with the fair market value at the time of receipt of all other Designated Noncash Consideration then held by the Company or any Restricted Subsidiary, may not exceed 5% of the Company's Consolidated Tangible Net Worth, at the time of the receipt of the Designated Noncash Consideration (with the fair market value being measured at the time received and without giving effect to subsequent changes in value). "Disqualified Stock" means, with respect to any Person, any Capital Stock which by its terms (or by the terms of any security into which it is convertible or for which it is exchangeable) or upon the happening of any event (i) matures or is mandatorily redeemable pursuant to a sinking fund obligation or otherwise, (ii) is convertible or exchangeable for Indebtedness or Disqualified Stock or (iii) is redeemable at the option of the holder thereof, in whole or in part, in each case on or prior to the first anniversary of the Stated Maturity of the Notes (other than upon a change of control or sale of assets by the Company in circumstances where the holders of the Notes would have similar rights). "EBITDA" for any period means the sum of Consolidated Net Income for such period, plus the following to the extent deducted in calculating such Consolidated Net Income: (i) income tax expense, (ii) Consolidated Interest Expense, (iii) depreciation expense, (iv) amortization expense, and (v) all other non-cash items reducing Consolidated Net Income (excluding any non-cash items to the extent they represent an accrual of, or reserve for, cash disbursements for any subsequent period), less all non-cash items increasing such Consolidated Net Income, in each case for such period. Notwithstanding the foregoing, the income tax expense, depreciation expense and amortization expense of a Restricted Subsidiary of the Company shall be included in EBITDA only to the extent (and in the same proportion) that the net income of such Subsidiary was included in calculating Consolidated Net Income and only if a corresponding amount would be permitted at the date of determination to be distributable to the Company by such Subsidiary as a dividend. "Equity Offering" means an offering for cash of common stock of the Company. "Exchange Act" means the Securities Exchange Act of 1934, as amended. "Fall Away Event" means the Notes shall have achieved Investment Grade status and the Company delivers to the Trustee an officer's certificate certifying that the foregoing condition has been satisfied. "Foreign Restricted Subsidiary" means a Restricted Subsidiary that is organized and existing under the laws of any country or other jurisdiction other than the United States of America, any State thereof or the District of Columbia and substantially all of the assets of which are located outside the United States of America. "GAAP" means generally accepted accounting principles in the United States of America as in effect as of the date of the Indenture, including those set forth in the opinions and pronouncements of the Accounting Principles Board of the American Institute of Certified Public Accountants and statements and pronouncements of the Financial Accounting Standards Board or in such other statements by such other entity as approved by a significant segment of the accounting profession. All ratios and computations based on GAAP contained in the Indenture shall be computed in conformity with GAAP. "Guarantee" means any obligation, contingent or otherwise, of any Person directly or indirectly guaranteeing any Indebtedness or other obligation of any other Person and any obligation, direct or indirect, contingent or otherwise, of such Person (i) to purchase or pay (or advance or supply funds for the purchase or payment of) such Indebtedness or other obligation of such other Person (whether arising by virtue of partnership arrangements, or by agreement to keep-well, to purchase assets, goods, securities or services, to take-or-pay, or to maintain financial statement conditions or otherwise) or (ii) entered into for purposes of assuring in any other manner the obligee of such Indebtedness or 75 other obligation of the payment thereof or to protect such obligee against loss in respect thereof (in whole or in part); PROVIDED, HOWEVER, that the term "Guarantee" shall not include endorsements for collection or deposit in the ordinary course of business. The term "Guarantee" used as a verb has a corresponding meaning. "Guarantor" means any guarantor of the Notes. "Hedging Obligations" of any Person means the obligations of such Person pursuant to any Interest Rate Agreement, Currency Agreement, or Commodity Price Protection Agreement. "Holder" or "Noteholder" means the Person in whose name a Note is registered on the Registrar's books. "Incur" means issue, assume, Guarantee, incur or otherwise become liable for; PROVIDED, HOWEVER, that any Indebtedness or Capital Stock of a Person existing at the time such Person becomes a Subsidiary (whether by merger, consolidation, acquisition or otherwise) shall be deemed to be incurred by such Subsidiary at the time it becomes a Subsidiary. "Indebtedness" means, with respect to any Person on any date of determination (without duplication), (i) the principal of and premium, if any, in respect of indebtedness of such Person for borrowed money, (ii) the principal of and premium, if any, in respect of obligations of such Person evidenced by bonds, debentures, notes or other similar instruments, (iii) all obligations of such Person in respect of letters of credit or other similar instruments (including reimbursement obligations with respect thereto), (iv) all obligations of such Person to pay the deferred and unpaid purchase price of property or services (except Trade Payables), which purchase price is due more than six months after the date of placing such property in service or taking delivery and title thereto or the completion of such services, (v) all Capitalized Lease Obligations and all Attributable Indebtedness of such Person, (vi) the amount of all obligations of such Person with respect to the redemption, repayment or other repurchase of any Disqualified Stock or, with respect to any Restricted Subsidiary, any Preferred Stock (but excluding, in each case, any accrued dividends), (vii) all Indebtedness of other Persons secured by a Lien on any asset of such Person, whether or not such Indebtedness is assumed by such Person; PROVIDED, HOWEVER, that the amount of such Indebtedness shall be the lesser of (A) the fair market value of such asset at such date of determination and (B) the amount of such Indebtedness of such other Person, (viii) all Indebtedness of other Persons to the extent Guaranteed by such Person, and (ix) to the extent not otherwise included in this definition, Hedging Obligations. The amount of Indebtedness of any Person at any date shall be the outstanding balance at such date of all unconditional obligations as described above and the maximum liability, upon the occurrence of the contingency giving rise to the obligation, of any contingent obligations at such date. "Intangible Assets" means intellectual property, goodwill and other intangible assets, in each case determined in accordance with GAAP. "Interest Rate Agreement" means with respect to any Person any interest rate protection agreement, interest rate future agreement, interest rate option agreement, interest rate swap 76 agreement, interest rate cap agreement, interest rate collar agreement, interest rate hedge agreement or other similar agreement or arrangement as to which such Person is party or a beneficiary. "Investment" in any Person means any direct or indirect advance, loan (other than advances to customers in the ordinary course of business that are recorded as accounts receivable on the balance sheet of such Person) or other extension of credit (including by way of Guarantee or similar arrangement) or capital contribution to (by means of any transfer of cash or other property to others or any payment for property or services for the account or use of others), or any purchase or acquisition of Capital Stock, Indebtedness or other similar instruments issued or owned by such Person and all other items that would be classified as investments on a balance sheet prepared in accordance with GAAP. For purposes of the definition of "Unrestricted Subsidiary" and the "Limitation on Restricted Payments" covenant, (i)"Investment" shall include the portion (proportionate to the Company's equity interest in such Subsidiary) of the fair market value of the net assets of any Subsidiary of the Company at the time that such Subsidiary is designated an Unrestricted Subsidiary; PROVIDED, HOWEVER, that upon a redesignation of such Subsidiary as a Restricted Subsidiary, the Company shall be deemed to continue to have a permanent "Investment" in an Unrestricted Subsidiary in an amount (if positive) equal to (x) the Company's "Investment" in such Subsidiary at the time of such redesignation less (y) the portion (proportionate to the Company's equity interest in such Subsidiary) of the fair market value of the net assets of such Subsidiary at the time that such Subsidiary is so redesignated a Restricted Subsidiary; and (ii) any property transferred to or from an Unrestricted Subsidiary shall be valued at its fair market value at the time of such transfer, in each case as determined in good faith by the Board of Directors and evidenced by a resolution of such Board of Directors certified in an Officers' Certificate to the Trustee. "Investment Grade" means BBB- or higher by Standard & Poor's Ratings Group and its successors and Baa3 or higher by Moody's Investors Service, Inc. and its successors. "Issue Date" means the date on which the Notes are originally issued. "Letter of Credit Facility" means the Master Commercial Letter of Credit Reimbursement Agreement, dated as of May 1, 2001, among the Company and Fleet National Bank, as it may be amended, extended, renewed, refinanced, substituted, or replaced from time to time (including increases in principal or notional amount thereof to the extent permitted under the Notes, or the addition of one or more lenders to an existing facility or the replacement or inclusion of one or more lenders in a new facility) in one or more agreements. "Lien" means any mortgage, pledge, security interest, encumbrance, lien or charge of any kind (including any conditional sale or other title retention agreement or lease in the nature thereof). "Net Available Cash" from an Asset Disposition means cash payments received (including any cash payments received by way of deferred payment of principal pursuant to a note or installment receivable or otherwise, but only as and when received, but excluding any other consideration received in the form of assumption by the acquiring Person of Indebtedness or other obligations relating to such properties or assets or received in any other non-cash form and excluding Designated Non Cash Consideration and Asset Swaps except to the extent they are converted into cash) therefrom, in each case net of (i) all legal, title and recording tax expenses, commissions and other fees and expenses incurred, and all Federal, state, provincial, foreign and local taxes required to be paid or accrued as a liability under GAAP, as a consequence of such Asset Disposition, (ii) all payments made on any Indebtedness which is secured by any assets subject to such Asset Disposition, in accordance with the terms of any Lien upon such assets, or which must by its terms, or in order to obtain a necessary consent to such Asset Disposition, or by applicable law be repaid out of the proceeds from such Asset Disposition, (iii) all distributions and other payments required to be made to minority interest holders in Subsidiaries or joint ventures as a result of such Asset Disposition, (iv) the deduction of appropriate amounts to be provided by the seller as a reserve, in accordance with GAAP, against any liabilities associated with the 77 assets disposed of in such Asset Disposition and retained by the Company or any Restricted Subsidiary after such Asset Disposition and (v) in the case of an Asset Disposition by a Foreign Restricted Subsidiary, any amount which, as a result of applicable law, may not be legally paid as a dividend, or distributed or otherwise paid or repatriated to the Company or its Subsidiaries. "Net Cash Proceeds," with respect to any issuance or sale of Capital Stock, means the cash proceeds of such issuance or sale net of attorneys' fees, accountants' fees, underwriters' or placement agents' fees, discounts or commissions and brokerage, consultant and other fees and expenses actually incurred in connection with such issuance or sale and net of taxes paid or payable as a result thereof. "Permitted Holders" means Sam Wyly, Charles J. Wyly, Jr., Evan A. Wyly, trusts established by or for the benefit of any such Persons or any of their lineal descendants, entities controlled by any such trusts, and their respective Affiliates. "Permitted Investment" means an Investment by the Company or any Restricted Subsidiary in (i) the Company, a Restricted Subsidiary or a Person which will, upon the making of such Investment, become a Restricted Subsidiary; PROVIDED, HOWEVER, that the primary business of such Restricted Subsidiary is a Related Business; (ii) another Person if as a result of such Investment such other Person is merged or consolidated with or into, or transfers or conveys all or substantially all its assets to, the Company or a Restricted Subsidiary; PROVIDED, HOWEVER, that such Person's primary business is a Related Business; (iii) Temporary Cash Investments; (iv) receivables owing to the Company or any Restricted Subsidiary, if created or acquired in the ordinary course of business and payable or dischargeable in accordance with customary trade terms; PROVIDED, HOWEVER, that such trade terms may include such concessionary trade terms as the Company or any such Restricted Subsidiary deems reasonable under the circumstances; (v) payroll, travel and similar advances to cover matters that are expected at the time of such advances ultimately to be treated as expenses for accounting purposes and that are made in the ordinary course of business; (vi) loans or advances to employees made in the ordinary course of business consistent with past practice of the Company or such Restricted Subsidiary; (vii) stock, obligations or securities received in settlement of debts created in the ordinary course of business and owing to the Company or any Restricted Subsidiary or in satisfaction of judgments; (viii) any Investment to the extent the consideration therefore consists of Qualified Capital Stock of the Company; (ix) advances to vendors in the ordinary course of business in an aggregate principal amount at any one time outstanding not to exceed $5 million; (x) in the form of payment pursuant to deferred compensation plans for former and current directors, officers, consultants and employees; and (xi) in addition to items (i)-(x) above, an amount not to exceed 2.5% of the Company's Consolidated Tangible Net Worth in the aggregate at any one time outstanding. "Permitted Liens" means, with respect to any Person, (a) pledges or deposits by such Person under workmen's compensation laws, unemployment insurance laws or similar legislation, or good faith deposits in connection with bids, tenders, 78 contracts (other than for the payment of Indebtedness) or leases to which such Person is a party, or deposits to secure public or statutory obligations of such Person or deposits of cash or United States government bonds to secure surety or appeal bonds to which such Person is a party, or deposits as security for contested taxes or import duties or for the payment of rent, in each case incurred in the ordinary course of business; (b) Liens imposed by law, such as carriers', warehousemen's and mechanics' Liens, in each case for sums not yet due or being contested in good faith by appropriate proceedings or other Liens arising out of judgments or awards against such Person with respect to which such Person shall then be proceeding with an appeal or other proceedings for review and landlords' Liens; (c) Liens for property taxes not yet due or payable or subject to penalties for non-payment or which are being contested in good faith by appropriate proceedings; (d) Liens in favor of issuers of surety bonds or letters of credit issued pursuant to the request of and for the account of such Person in the ordinary course of its business; (e) minor survey exceptions, minor encumbrances, easements or reservations of, or rights of others for, licenses, rights-of-way, sewers, electric lines, telegraph and telephone lines and other similar purposes, or zoning or other restrictions as to the use of real properties or Liens incidental to the conduct of the business of such Person or to the ownership of its properties which were not incurred in connection with Indebtedness and which do not in the aggregate materially adversely affect the value of said properties or materially impair their use in the operation of the business of such Person; (f) Liens securing Hedging Obligations so long as the related Indebtedness is, and is permitted to be under the Indenture, secured by a Lien on the same property securing such Hedging Obligations; (g) leases and subleases of real property which do not interfere with the ordinary conduct of the business of the Company or any of its Restricted Subsidiaries, and which are made on customary and usual terms applicable to similar properties; (h) Liens existing as of the date of the Indenture and Liens created by the Indenture; (i) Liens created solely for the purpose of securing Purchase Money Debt Incurred after the date on which the Notes are originally issued; PROVIDED, HOWEVER, that (A) the aggregate principal amount of Indebtedness secured by such Liens shall not exceed the lesser of cost or fair market value of the assets or property so acquired or constructed, (B) the Indebtedness secured by such Liens shall have otherwise been permitted to be issued under the Indenture and (C) such Liens shall not encumber any other assets or property of the Company or any of its Restricted Subsidiaries and shall attach to such assets or property within 90 days of the construction, acquisition or improvement of such assets or property; (j) Liens on the assets or property of a Restricted Subsidiary of the Company existing at the time such Restricted Subsidiary became a Subsidiary of the Company and not incurred as a result of (or in connection with or in anticipation of) such Restricted Subsidiary becoming a Subsidiary of the Company; PROVIDED, HOWEVER, that (A) any such Lien does not by its terms cover any property or assets after the time such Restricted Subsidiary becomes a Subsidiary which were not covered immediately prior to such time, (B) the incurrence of the Indebtedness secured by such Lien shall have otherwise been permitted to be Incurred under the Indenture, and (C) such Liens do not extend to or cover any other property or assets of the Company or any of its Restricted Subsidiaries; (k) Liens to secure Capitalized Lease Obligations permitted to be Incurred under the Indenture; 79 (l) Liens to secure Indebtedness permitted to be Incurred under the Indenture which is recourse solely to the assets securing such Indebtedness; PROVIDED that (i) the fair market value, as determined in good faith, of the assets subject to such Liens (determined at the time such Liens are granted) does not exceed an amount equal to 125% of the amount of such Indebtedness and (ii) the aggregate principal amount outstanding of all Indebtedness secured by such Liens at the time when such additional Indebtedness is Incurred shall not exceed 5% of the Company's Consolidated Tangible Net Worth; and (m) Liens extending, renewing or replacing in whole or in part a Lien permitted by the Indenture; PROVIDED, HOWEVER, that (A) such Liens do not extend beyond the property subject to the existing Lien and improvements and construction on such property and (B) the Indebtedness secured by the Lien may not exceed the Indebtedness secured at the time by the existing Lien. "Person" means any individual, corporation, limited liability company, partnership, joint venture, association, joint-stock company, trust, unincorporated organization, government or any agency or political subdivision thereof or any other entity. "Preferred Stock," as applied to any Person, means Capital Stock of any class or classes (however designated) which is preferred as to the payment of dividends or distribution, or as to the distribution of assets upon any voluntary or involuntary liquidation or dissolution of such Person, over shares of Capital Stock of any other class of such Person. "Public Market" means any time after (x) the common stock of the Company is then registered with the SEC pursuant to Section 12(b) or 12(g) of the Exchange Act and traded either on a national securities exchange or in the National Association of Securities Dealers Automated Quotation System and (y) at least 20% of the total issued and outstanding Voting Stock of the Company has been distributed by means of an effective registration statement under the Securities Act. "Qualified Capital Stock" of any Person means any and all Capital Stock of such Person other than Disqualified Stock. "Refinancing Indebtedness" means Indebtedness that refunds, refinances, replaces, renews, repays or extends (including pursuant to any defeasance or discharge mechanism) (collectively, "refinances," and "refinanced" shall have a correlative meaning) any Indebtedness existing on the Issue Date or Incurred in compliance with the Indenture (including Indebtedness of the Company that refinances Indebtedness of any Restricted Subsidiary and Indebtedness of any Restricted Subsidiary that refinances Indebtedness of another Restricted Subsidiary) including Indebtedness that refinances Refinancing Indebtedness; PROVIDED, HOWEVER, that (i) the Refinancing Indebtedness has a Stated Maturity no earlier than the Stated Maturity of the Indebtedness being refinanced, (ii) the Refinancing Indebtedness has an Average Life at the time such Refinancing Indebtedness is Incurred that is equal to or greater than the Average Life of the Indebtedness being refinanced and (iii) such Refinancing Indebtedness is Incurred in an aggregate principal amount (or if issued with original issue discount, an aggregate issue price) that is equal to (or, to the extent of any applicable premium in connection with a refinancing, greater than) or less than the sum of the aggregate principal amount (or if issued with original issue discount, the aggregate accreted value) then outstanding of the Indebtedness being refinanced; PROVIDED FURTHER, HOWEVER, that Refinancing Indebtedness shall not include (x) Indebtedness of a Restricted Subsidiary that refinances Indebtedness of the Company other than Indebtedness owed to such Restricted Subsidiary by the Company, (y) Indebtedness of a non-Guarantor Restricted Subsidiary that refinances Indebtedness of a Guarantor or (z) Indebtedness of the Company or a Restricted Subsidiary that refinances Indebtedness of an Unrestricted Subsidiary. "Related Business" means any business related, ancillary or complementary to the businesses of the Company and the Restricted Subsidiaries on the applicable date. 80 "Restricted Subsidiary" means any Subsidiary of the Company other than an Unrestricted Subsidiary. "Sale/Leaseback Transaction" means an arrangement relating to property now owned or hereafter acquired whereby the Company or a Restricted Subsidiary transfers such property to a Person and the Company or a Restricted Subsidiary leases it from such Person. "SEC" means the Securities and Exchange Commission, as from time to time constituted, created under the Exchange Act, or if at any time after the execution of the Indenture the SEC is not existing and performing the duties now assigned to it under the TIA, then the body performing such duties at such time. "Secured Indebtedness" means any Indebtedness of the Company secured by a Lien. "Senior Indebtedness" means all Indebtedness of the Company (including, without limitation, Indebtedness under the Credit Agreement, and fees, costs and expenses incurred thereunder), including interest thereon, whether outstanding on the Issue Date or thereafter Incurred, unless in the instrument creating or evidencing the same or pursuant to which the same is outstanding it is provided that such obligations are subordinated in right of payment to the Notes; PROVIDED, HOWEVER, that Senior Indebtedness shall not include (1) any obligation of the Company to any Subsidiary, (2) any liability for federal, state, local or other taxes owed or owing by the Company, (3) any accounts payable or other liability to trade creditors arising in the ordinary course of business (including Guarantees thereof or instruments evidencing such liabilities), (4) any Indebtedness, Guarantee or obligation of the Company which is subordinate or junior expressly by its written terms in any respect to any other Indebtedness, Guarantee or obligation of the Company, including any Subordinated Obligations, (5) any obligations with respect to any Capital Stock, (6) Indebtedness which, when Incurred and without respect to any election under Section 1111(b) of Title II, United States Code, is without recourse to the Company, or (7) any Indebtedness Incurred in violation of the Indenture. "Significant Subsidiary" means any Restricted Subsidiary that would be a "Significant Subsidiary" of the Company within the meaning of Rule 1-02 under Regulation S-X promulgated by the SEC as of the Issue Date. "Stated Maturity" means, with respect to any security, the date specified in such security as the fixed date on which the payment of principal of such security is due and payable, including pursuant to any mandatory redemption provision (but excluding any provision providing for the repurchase of such security at the option of the holder thereof upon the happening of any contingency beyond the control of the issuer unless such contingency has occurred). "Subordinated Obligation" means any Indebtedness of the Company (whether outstanding on the Issue Date or thereafter Incurred) which is subordinate or junior in right of payment to the Notes pursuant to a written agreement. "Subsidiary" of any Person means any corporation, association, partnership or other business entity of which more than 50% of the total voting power of shares of Capital Stock or other interests (including partnership interests) entitled (without regard to the occurrence of any contingency) to vote in the election of directors, managers or trustees thereof is at the time owned or controlled, directly or indirectly, by (i) such Person, (ii) such Person and one or more Subsidiaries of such Person or (iii) one or more Subsidiaries of such Person. "Temporary Cash Investments" means any of the following: (i) any investment in direct obligations of the United States of America or any agency thereof or obligations Guaranteed by the United States of America or any agency thereof, (ii) investments in time deposit accounts, certificates of deposit and money market deposits maturing within 180 days of the date of acquisition thereof issued by a bank or trust company which is organized under the laws of the United States of America, any state thereof or 81 any foreign country recognized by the United States of America having capital, surplus and undivided profits aggregating in excess of $250,000,000 (or the foreign currency equivalent thereof) and whose long-term debt is rated "A" (or such similar equivalent rating) or higher by at least one nationally recognized statistical rating organization (as defined in Rule 436 under the Securities Act), (iii) repurchase obligations with a term of not more than 30 days for underlying securities of the types described in clause (i) above entered into with a bank or trust company meeting the qualifications described in clause (ii) above, (iv) investments in commercial paper, maturing not more than 365 days after the date of acquisition, issued by a Person (other than an Affiliate of the Company) organized and in existence under the laws of the United States of America, any State thereof or any foreign country recognized by the United States of America with a rating at the time as of which any investment therein is made of "P-1" (or higher) according to Moody's Investors Service, Inc. or "A-1" (or higher) according to Standard & Poor's Ratings Group, (v) investments in securities with maturities of six months or less from the date of acquisition issued or fully guaranteed by any state, commonwealth or territory of the United States of America, or by any political subdivision or taxing authority thereof, and rated at least "A" by Standard & Poor's Ratings Group or "A" by Moody's Investors Service, Inc., and (vi) investments in mutual funds whose investment guidelines restrict such funds' investments to investments which are substantially similar to those described in clauses (i)-(v) above. "10 7/8% Senior Notes" means the Company's 10 7/8% Senior Notes due 2006. "TIA" means the Trust Indenture Act of 1939, as amended, or any successor statute. "Total Assets" means, as of any date, the Company's total consolidated assets as of such date, as determined in accordance with GAAP. "Trade Payables" means, with respect to any Person, any accounts payable or any indebtedness or monetary obligation to trade creditors created, assumed or Guaranteed by such Person arising in the ordinary course of business in connection with the acquisition of goods or services. "Unrestricted Subsidiary" means (i) any Subsidiary of the Company that at the time of determination shall be designated an Unrestricted Subsidiary by the Board of Directors in the manner provided below, and (ii) any Subsidiary of an Unrestricted Subsidiary. The Board of Directors may designate any Subsidiary of the Company (including any newly acquired or newly formed Subsidiary of the Company) to be an Unrestricted Subsidiary unless such Subsidiary or any of its Subsidiaries owns any Capital Stock or Indebtedness of, or owns or holds any Lien on any property of, the Company or any other Subsidiary of the Company that is not a Subsidiary of the Subsidiary to be so designated; PROVIDED, HOWEVER, that (i) either (A) the Subsidiary to be so designated has total consolidated assets of $1,000 or less or (B) if such Subsidiary has total consolidated assets greater than $1,000, then such designation would be permitted under "Limitation on Restricted Payments" and (ii) the holders of any Indebtedness of such Subsidiary do not have direct or indirect recourse against the Company or any Restricted Subsidiary of the Company and neither the Company nor any Restricted Subsidiary of the Company otherwise has any liability for any payment obligations in respect of such Indebtedness except as permitted under "--Certain Covenants--Limitation on Indebtedness." The Board of Directors may designate any Unrestricted Subsidiary to be a Restricted Subsidiary; PROVIDED, HOWEVER, that immediately after giving effect to such designation (x) the Company could Incur $1.00 of additional Indebtedness under clause (a) of "--Certain Covenants--Limitation on Indebtedness" and (y) no Default shall have occurred and be continuing. Any such designation by the Board of Directors shall be evidenced to the Trustee by promptly filing with the Trustee a copy of the Board Resolution giving effect to such designation and an Officers' Certificate certifying that such designation complied with the foregoing provisions. Notwithstanding the foregoing, any Unrestricted Subsidiary (as determined in accordance with clauses (i) through (ii) of the first sentence of this definition) may but is not obligated to provide a Guarantee for the Notes. 82 "U.S. Government Obligations" means direct obligations (or certificates representing an ownership interest in such obligations) of the United States of America (including any agency or instrumentality thereof) for the payment of which the full faith and credit of the United States of America is pledged and which are not callable or redeemable at the issuer's option. "Voting Stock" of a corporation means all classes of Capital Stock of such corporation then outstanding and normally entitled to vote in the election of directors. "Wholly Owned Subsidiary" means a Restricted Subsidiary of the Company all the Capital Stock of which (other than directors' qualifying shares) is owned by the Company or another Wholly Owned Subsidiary. BOOK-ENTRY DELIVERY AND FORM The exchange notes will be issued only in fully registered form, without interest coupons, in denominations of $1,000 and integral multiples thereof. The exchange notes will not be issued in bearer form. GLOBAL NOTES. The exchange notes will be represented by one or more Notes in registered, global form without interest coupons (collectively, the "Global Note"). The Global Note will be deposited upon issuance with the Trustee as custodian for DTC, in New York, New York, and registered in the name of DTC or its nominee, or will remain in the custody of the Trustee pursuant to a customary custodian arrangement. Interests in the Global Note may only be exchanged for certificated notes in the limited circumstances specified under "--Exchange of Book-Entry Notes for Certificated Notes." Except as set forth below, the Global Note may be transferred, in whole and not in part, only to another nominee of DTC or to a successor of DTC or its nominee. In addition, transfer of beneficial interests in the Global Note will be subject to the applicable rules and procedures of DTC and its direct or indirect participants, which may change from time to time. EXCHANGE OF BOOK-ENTRY NOTES FOR CERTIFICATED NOTES. A beneficial interest in a Global Note may not be exchanged for a Note in certificated form unless (1) DTC (a) notifies the Company that it is unwilling or unable to continue as Depositary for the Global Note or (b) has ceased to be a clearing agency registered under the Exchange Act, and in either case the Company thereupon fails to appoint a successor Depositary for 90 days, (2) the Company, at its option, notifies the Trustee in writing that it elects to cause the issuance of the Notes in certificated form, or (3) there shall have occurred and be continuing an Event of Default or any event which after notice or lapse of time or both would be an Event of Default with respect to the Notes. In all cases, certificated Notes delivered in exchange for any Global Note or beneficial interests therein will be registered in the names, and issued in any approved denominations, requested by or on behalf of the Depositary (in accordance with its customary procedures). Any certificated Note issued in exchange for an interest in a Global Note will bear the legend restricting transfers that is borne by such Global Note. Any such exchange will be effected through the DWAC system and an appropriate adjustment will be made in the records of the security registrar to reflect a decrease in the principal amount of the relevant Global Note. CERTAIN BOOK-ENTRY PROCEDURES FOR GLOBAL NOTES. The descriptions of the operations and procedures of DTC that follow are provided solely as a matter of convenience. These operations and procedures are solely within the control of the respective settlement systems and are subject to change by them 83 from time to time. The Company takes no responsibility for these operations and procedures and urges investors to contact the system or their participants directly to discuss these matters. DTC has advised the Company that it is: - a limited purpose trust company organized under the laws of the State of New York, - a "banking organization" within the meaning of the New York Banking Law, - a member of the Federal Reserve System, and - a "clearing corporation" within the meaning of the Uniform Commercial Code and a "Clearing Agency" registered pursuant to the provisions of Section 17A of the Exchange Act. DTC was created to hold securities for its participants ("participants") and facilitate the clearance and settlement of securities transactions between participants through electronic book-entry changes in accounts of its participants, thereby eliminating the need for physical transfer and delivery of certificates. Participants include securities brokers and dealers, banks, trust companies and clearing corporations and may include certain other organizations. Indirect access to the DTC system is available to other entities such as banks, brokers, dealers and trust companies that clear through or maintain a custodial relationship with a participant, either directly or indirectly ("indirect participants"). DTC has advised the Company that its current practice, upon the issuance of the Global Note, is to credit, on its internal system, the respective principal amount of the individual beneficial interests represented by such Global Note to the accounts with DTC of the participants through which such interests are to be held. Ownership of beneficial interest in the Global Note will be shown on, and the transfer of that ownership will be effected only through, records maintained by DTC or its nominees (with respect to interest of participants) and the records of participants and indirect participants (with respect to interests of persons other than participants). As long as DTC, or its nominee, is the registered holder of a Global Note, DTC or such nominee, as the case may be, will be considered the sole owner and holder of the Notes represented by such Global Note for all purposes under the Indenture and the Notes. Except in the limited circumstances described above under "--Exchange of Book-Entry Notes for Certificated Notes," owners of beneficial interests in a Global Note will not be entitled to have any portions of such Global Note registered in their names, and will not receive or be entitled to receive physical delivery of Notes in definitive form and will not be considered the owners or Holders of the Global Note (or any Notes represented thereby) under the Indenture or the Notes. Investors may hold their interests in the Global Note directly through DTC, if they are participants in such system, or indirectly through organizations which are participants in such system. All interests in a Global Note will be subject to the procedures and requirements of DTC. The laws of some states require that certain persons take physical delivery in definitive form of securities that they own. Consequently, the ability to transfer beneficial interests in a Global Note to such persons may be limited to that extent. Because DTC can act only on behalf of its participants, which in turn act on behalf of indirect participants and certain banks, the ability of a person having beneficial interests in a Global Note to pledge such interest to persons or entities that do not participate in the DTC system, or otherwise take actions in respect of such interests, may be affected by the lack of a physical certificate evidencing such interests. Payments of the principal of, premium, if any, and interest on the Global Note will be made to DTC or its nominee as the registered owner thereof. Neither the Company, the Trustee nor any of their respective agents will have any responsibility or liability for any aspect of the records relating to or payments made on account of beneficial ownership interest in the Global Note or for maintaining, supervising or reviewing any records relating to such beneficial ownership interests. 84 The Company expects that DTC or its nominee, upon receipt of any payment of principal of, premium, if any, or interest in respect of a Global Note representing any Notes held by it or its nominee, will credit participants' accounts with payments in amounts proportionate to their respective beneficial interests in the principal amount of such Global Note for such Notes as shown on the records of DTC or its nominee. The Company also expects that payments by participants to owners of beneficial interests in such Global Note held through such participants will be governed by standing instructions and customary practices, as is now the case with securities held for the accounts of customers registered in "street name." Such payments will be the responsibility of such participants. None of the Company or the Trustee will be liable for any delay by DTC or any of its participants in identifying the beneficial owners of the Notes, and the Company and the Trustee may conclusively rely on and will be protected in relying on instructions from DTC or its nominee as the registered owner of the Notes for all purposes. DTC has advised the Company that it will take any action permitted to be taken by a holder of Notes only at the direction of one or more participants to whose accounts with DTC interests in the Global Note are credited and only in respect of such portion of the aggregate principal amount of the Notes as to which such participant or participants has or have given such direction. However, if there is an Event of Default under the Notes, DTC reserves the right to exchange the Global Note for legended Notes in certificated form, and to distribute such Notes to its participants. Although DTC has agreed to the foregoing procedures in order to facilitate transfer of beneficial ownership interests in the Global Notes among participants of DTC, they are under no obligation to perform or continue to perform such procedures, and such procedures may be discontinued or changed at any time. None of the Company, the Trustee nor any of their respective agents will have any responsibility for the performance by DTC or its participants or indirect participants of their respective obligations under the rules and procedures governing their operations, including maintaining, supervising or reviewing the records relating to or payments made on account of, beneficial ownership interests in Global Notes. SAME DAY SETTLEMENT. Interests in the Global Note will trade in DTC's Same-Day Funds Settlement System and secondary market trading activity in such interests will therefore settle in immediately available funds, subject in all cases to the rules and procedures of DTC and its participants. Transfers between participants in DTC will be effected in accordance with DTC's procedures, and will be settled in same-day funds. 85 PLAN OF DISTRIBUTION Except as described below, a broker-dealer may not participate in the exchange offer in connection with a distribution of the exchange notes. Each broker-dealer that receives exchange notes for its own account pursuant to the exchange offer must acknowledge that it will deliver a prospectus in connection with any resale of the exchange notes. This prospectus, as it may be amended or supplemented from time to time, may be used by a broker-dealer in connection with resales of exchange notes received for its own account in exchange for outstanding notes where those outstanding notes were acquired as a result of market-making activities or other trading activities. Michaels Stores has agreed that it will make this prospectus, as amended or supplemented, available to any broker-dealer for use in connection with any resale subject to the conditions described under "The Exchange Offer--Resale of the Exchange Notes." Michaels Stores will not receive any proceeds from any sale of exchange notes by broker-dealers. Exchange notes received by broker-dealers for their own account pursuant to the exchange offer may be sold from time to time in one or more transactions in the over-the-counter market, in negotiated transactions, through the writing of options on the exchange notes or a combination of those methods of resale, at market prices prevailing at the time of resale, at prices related to the prevailing market prices, or negotiated prices. Any resale may be made directly to purchasers or through brokers or dealers who may receive compensation in the form of commissions or concessions from any broker-dealer and/or the purchasers of any exchange notes. Any broker or dealer that participates in a distribution of the exchange notes may be deemed to be an "underwriter" within the meaning of the Securities Act of 1933, and any profit on the resale of exchange notes and any commissions or concessions received by those persons may be deemed to be underwriting compensation under the Securities Act of 1933. The Letter of Transmittal states that by acknowledging that it will deliver and by delivering a prospectus a broker-dealer will not be deemed to admit that it is an "underwriter" within the meaning of the Securities Act of 1933. Michaels Stores has agreed to pay all expenses incident to the exchange offer other than commissions or concessions of any brokers or dealers and expenses of counsel for the holders of the exchange notes and will indemnify the holders of the exchange notes, including any broker-dealers, against some liabilities, including some liabilities under the Securities Act of 1933. LEGAL MATTERS Jones, Day, Reavis & Pogue will pass upon the validity of the exchange notes for Michaels Stores, Inc. EXPERTS Ernst & Young LLP, independent auditors, have audited our consolidated financial statements at February 3, 2001 and January 29, 2000, and for each of the three years in the period ended February 3, 2001, as set forth in their report. We've included our financial statements in the prospectus and elsewhere in the registration statement in reliance on Ernst & Young LLP's report, given on their authority as experts in accounting and auditing. 86 MICHAELS STORES, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
PAGE -------- Audited Financial Statements: Report of Independent Auditors............................ F-2 Consolidated Balance Sheets at February 3, 2001 and January 29, 2000.......................................... F-3 Consolidated Statements of Income for the fiscal years ended February 3, 2001, January 29, 2000, and January 30, 1999................................................ F-4 Consolidated Statements of Cash Flows for the fiscal years ended February 3, 2001, January 29, 2000, and January 30, 1999................................................ F-5 Consolidated Statements of Stockholders' Equity for the fiscal years ended February 3, 2001, January 29, 2000, and January 30, 1999.................................... F-6 Notes to Consolidated Financial Statements for the fiscal years ended February 3, 2001, January 29, 2000, and January 30, 1999........................................ F-7 Unaudited Supplemental Quarterly Financial Data for the fiscal years ended February 3, 2001 and January 29, 2000.................................................... F-20 Unaudited Financial Statements: Consolidated Balance Sheets at May 5, 2001 and February 3, 2001...................................................... F-21 Consolidated Statements of Income for the three months ended May 5, 2001 and April 29, 2000.................... F-22 Consolidated Statements of Cash Flows for the three months ended May 5, 2001 and April 29, 2000.................... F-23 Notes to Consolidated Financial Statements for the three months ended May 5, 2001.................................. F-24
F-1 REPORT OF INDEPENDENT AUDITORS The Board of Directors and Stockholders Michaels Stores, Inc. We have audited the accompanying consolidated balance sheets of Michaels Stores, Inc. and subsidiaries (the "Company") as of February 3, 2001 and January 29, 2000, and the related consolidated statements of income, cash flows, and stockholders' equity for each of the three years in the period ended February 3, 2001. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Michaels Stores, Inc. and subsidiaries at February 3, 2001 and January 29, 2000, and the consolidated results of their operations and their cash flows for each of the three years in the period ended February 3, 2001, in conformity with accounting principles generally accepted in the United States. As discussed in Note 2 to the consolidated financial statements, in fiscal 2000 the Company changed its method of accounting for revenue recognition on custom frame sales. /s/ Ernst & Young LLP Dallas, Texas March 5, 2001 F-2 MICHAELS STORES, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS EXCEPT SHARE DATA)
FEBRUARY 3, JANUARY 29, 2001 2000 ----------- ----------- ASSETS CURRENT ASSETS: Cash and equivalents...................................... $ 28,191 $ 77,398 Merchandise inventories................................... 663,700 615,065 Prepaid expenses and other................................ 24,572 19,026 Deferred income taxes and income taxes receivable......... 13,353 11,498 ---------- ---------- Total current assets.................................... 729,816 722,987 ---------- ---------- PROPERTY AND EQUIPMENT, AT COST............................. 543,312 455,285 Less accumulated depreciation............................... (242,307) (209,552) ---------- ---------- 301,005 245,733 ---------- ---------- COSTS IN EXCESS OF NET ASSETS OF ACQUIRED OPERATIONS, NET... 121,256 124,766 OTHER ASSETS................................................ 6,359 3,217 ---------- ---------- 127,615 127,983 ---------- ---------- Total assets................................................ $1,158,436 $1,096,703 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable.......................................... $ 143,224 $ 124,828 Accrued liabilities and other............................. 144,121 136,375 Income taxes payable...................................... 1,663 9,773 ---------- ---------- Total current liabilities............................... 289,008 270,976 ---------- ---------- SENIOR NOTES................................................ 125,000 125,000 CONVERTIBLE SUBORDINATED NOTES.............................. -- 96,940 DEFERRED INCOME TAXES....................................... 18,269 17,990 OTHER LONG-TERM LIABILITIES................................. 21,513 18,999 ---------- ---------- Total long-term liabilities............................. 164,782 258,929 ---------- ---------- 453,790 529,905 ---------- ---------- COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY: Preferred stock, $.10 par value, 2,000,000 shares authorized, none issued................................. -- -- Common stock, $.10 par value, 150,000,000 shares authorized; shares issued of 31,836,840 at February 3, 2001 and 31,573,113 at January 29, 2000................. 3,184 3,157 Additional paid-in capital................................ 429,688 401,414 Retained earnings......................................... 271,774 194,138 Treasury stock, at cost, no shares and 1,509,000 shares, respectively............................................ -- (31,911) ---------- ---------- Total stockholders' equity.............................. 704,646 566,798 ---------- ---------- Total liabilities and stockholders' equity.................. $1,158,436 $1,096,703 ========== ==========
See accompanying notes to consolidated financial statements. F-3 MICHAELS STORES, INC. CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS EXCEPT PER SHARE DATA)
FISCAL YEAR ------------------------------------ 2000 1999 1998 ---------- ---------- ---------- NET SALES................................................ $2,249,440 $1,882,522 $1,573,965 Cost of sales and occupancy expense...................... 1,494,304 1,244,204 1,051,266 ---------- ---------- ---------- GROSS PROFIT............................................. 755,136 638,318 522,699 Selling, general, and administrative expense............. 596,522 503,069 425,690 Store pre-opening costs.................................. 10,197 11,077 7,897 Litigation settlement.................................... -- 1,500 -- ---------- ---------- ---------- OPERATING INCOME......................................... 148,417 122,672 89,112 Interest expense......................................... 18,026 22,654 22,678 Other (income) and expense, net.......................... (3,678) (2,373) (3,890) ---------- ---------- ---------- INCOME BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF ACCOUNTING CHANGE...................................... 134,069 102,391 70,324 Provision for income taxes............................... 53,628 40,090 26,723 ---------- ---------- ---------- INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE..... 80,441 62,301 43,601 Cumulative effect of accounting change for revenue recognition, net of tax of $1,235...................... 1,852 -- -- ---------- ---------- ---------- NET INCOME............................................... $ 78,589 $ 62,301 $ 43,601 ========== ========== ========== EARNINGS PER COMMON SHARE EXCLUDING THE CUMULATIVE EFFECT OF ACCOUNTING CHANGE: Basic.................................................. $ 2.42 $ 2.15 $ 1.49 ========== ========== ========== Diluted................................................ $ 2.35 $ 2.01 $ 1.43 ========== ========== ========== EARNINGS PER COMMON SHARE INCLUDING THE CUMULATIVE EFFECT OF ACCOUNTING CHANGE: Basic.................................................. $ 2.37 $ 2.15 $ 1.49 ========== ========== ========== Diluted................................................ $ 2.29 $ 2.01 $ 1.43 ========== ========== ==========
See accompanying notes to consolidated financial statements. F-4 MICHAELS STORES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
FISCAL YEAR --------------------------------- 2000 1999 1998 --------- --------- --------- OPERATING ACTIVITIES: Net income................................................ $ 78,589 $ 62,301 $ 43,601 Adjustments: Depreciation............................................ 61,841 55,085 45,972 Amortization............................................ 4,106 4,121 4,281 Other................................................... 1,070 969 1,017 Change in assets and liabilities, excluding acquisitions: Merchandise inventories............................... (47,609) (113,826) (115,659) Prepaid expenses and other............................ (5,546) (4,115) (882) Deferred income taxes and other....................... (3,723) 10,508 10,464 Accounts payable...................................... 18,396 18,655 (3,283) Income taxes payable.................................. 21,634 2,540 15,854 Accrued liabilities and other......................... 18,000 24,532 4,673 --------- --------- --------- Net change in assets and liabilities................ 1,152 (61,706) (88,833) --------- --------- --------- Net cash provided by operating activities........... 146,758 60,770 6,038 --------- --------- --------- INVESTING ACTIVITIES: Additions to property and equipment....................... (118,010) (90,860) (77,994) Net proceeds from sales of property and equipment......... 108 101 18,427 Acquisitions.............................................. (2,182) -- -- --------- --------- --------- Net cash used in investing activities............... (120,084) (90,759) (59,567) --------- --------- --------- FINANCING ACTIVITIES: Payment of other long-term liabilities.................... (5,567) (6,100) (5,378) Redemption of convertible subordinated notes.............. (4,206) -- -- Acquisition of treasury stock............................. (156,507) (11,539) (20,372) Proceeds from stock options exercised..................... 89,465 28,760 7,060 Proceeds from issuance of common stock and other.......... 934 142 6,060 --------- --------- --------- Net cash (used in) provided by financing activities........................................ (75,881) 11,263 (12,630) --------- --------- --------- NET DECREASE IN CASH AND EQUIVALENTS........................ (49,207) (18,726) (66,159) CASH AND EQUIVALENTS AT BEGINNING OF PERIOD................. 77,398 96,124 162,283 --------- --------- --------- CASH AND EQUIVALENTS AT END OF PERIOD....................... $ 28,191 $ 77,398 $ 96,124 ========= ========= ========= SUPPLEMENTAL CASH FLOW INFORMATION: Cash paid for interest.................................... $ 14,335 $ 21,271 $ 20,708 ========= ========= ========= Cash paid (refunds received) for income taxes............. $ 31,495 $ 24,463 $ (1,618) ========= ========= =========
See accompanying notes to consolidated financial statements. F-5 MICHAELS STORES, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE THREE YEARS ENDED FEBRUARY 3, 2001 (IN THOUSANDS EXCEPT SHARE DATA)
ADDITIONAL TREASURY NUMBER OF COMMON PAID-IN RETAINED STOCK, SHARES STOCK CAPITAL EARNINGS AT COST TOTAL ---------- -------- ---------- -------- --------- --------- BALANCE AT JANUARY 31, 1998.......... 29,033,908 $2,903 $ 350,977 $ 88,031 $ -- $ 441,911 Exercise of stock options and other............................ 494,122 50 6,900 (560) -- 6,390 Tax benefit from exercise of stock options.......................... -- -- 3,231 -- -- 3,231 Proceeds from Stock Purchase Plan............................. 178,730 18 6,200 -- -- 6,218 Acquisition of treasury stock...... (1,145,000) -- -- -- (20,372) (20,372) Net income......................... -- -- -- 43,601 -- 43,601 ---------- ------ --------- -------- --------- --------- BALANCE AT JANUARY 30, 1999.......... 28,561,760 2,971 367,308 131,072 (20,372) 480,979 Exercise of stock options and other............................ 1,866,353 186 28,716 765 -- 29,667 Tax benefit from exercise of stock options.......................... -- -- 5,390 -- -- 5,390 Acquisition of treasury stock...... (364,000) -- -- -- (11,539) (11,539) Net income......................... -- -- -- 62,301 -- 62,301 ---------- ------ --------- -------- --------- --------- BALANCE AT JANUARY 29, 2000.......... 30,064,113 3,157 401,414 194,138 (31,911) 566,798 Exercise of stock options and other............................ 4,488,031 449 89,953 (953) -- 89,449 Conversion of Subordinated Notes... 2,445,696 245 96,328 -- -- 96,573 Tax benefit from exercise of stock options.......................... -- -- 29,744 -- -- 29,744 Acquisition of treasury stock...... (5,161,000) -- -- -- (156,507) (156,507) Retirement of treasury stock....... -- (667) (187,751) -- 188,418 -- Net income......................... -- -- -- 78,589 -- 78,589 ---------- ------ --------- -------- --------- --------- BALANCE AT FEBRUARY 3, 2001.......... 31,836,840 $3,184 $ 429,688 $271,774 $ -- $ 704,646 ========== ====== ========= ======== ========= =========
See accompanying notes to consolidated financial statements. F-6 MICHAELS STORES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES DESCRIPTION OF BUSINESS Michaels Stores, Inc. (together with its subsidiaries, unless the text otherwise requires, the "Company") owns and operates a chain of 628 specialty retail stores in 48 states, Canada and Puerto Rico featuring arts, crafts, framing, floral, decorative wall decor, and seasonal merchandise for the hobbyist and do-it-yourself home decorator. A Michaels store typically carries approximately 40,000 items. The Company's wholly-owned subsidiary, Aaron Brothers, Inc., operates a chain of 119 framing and art supply stores. Aaron Brothers stores are located primarily on the West Coast. The Company also owns and operates Star Decorators' Wholesale Warehouse ("Star Wholesale"), a single wholesale operation located in Dallas, Texas, offering merchandise primarily to interior decorators/designers, wedding/event planners, florists, hotels, restaurants, and commercial display companies. FISCAL YEAR The Company reports on the basis of a 52 or 53-week fiscal year, which ends on the Saturday closest to January 31. Fiscal 2000 ended February 3, 2001 and contained 53 weeks. Fiscal 1999 ended January 29, 2000 and fiscal 1998 ended January 30, 1999, and each contained 52 weeks. CONSOLIDATION The consolidated financial statements include the accounts of the Company and all wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated. ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires the Company to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. CASH AND EQUIVALENTS Cash and equivalents are generally comprised of highly liquid instruments with original maturities of three months or less. Cash equivalents are carried at cost, which approximates fair value. The Company records interest income earned from its cash and equivalents as a component of other (income) and expense, net, in its financial statements. Interest income was $3,866,000, $2,374,000, and $3,942,000 for fiscal 2000, 1999, and 1998, respectively. MERCHANDISE INVENTORIES Store merchandise inventories are valued as determined by a retail inventory method at the lower of average cost or market. Distribution center inventories are valued at the lower of cost or market determined by the first-in, first-out method. PROPERTY AND EQUIPMENT Property and equipment is recorded at cost. Depreciation is provided on a straight-line basis over the estimated useful lives of the assets. Useful lives of buildings, fixtures and equipment, leasehold improvements, and capital leases for computer equipment are generally estimated to be 30, 8, 10 and F-7 MICHAELS STORES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) 5 years, respectively. Amortization of assets recorded under capital leases and leasehold improvements is included in depreciation expense. COSTS IN EXCESS OF NET ASSETS OF ACQUIRED OPERATIONS Costs in excess of net assets of acquired operations are being amortized over 40 years on a straight-line basis. Accumulated amortization was $29,003,000 and $25,317,000 as of the end of fiscal 2000 and 1999, respectively. IMPAIRMENT OF LONG-LIVED ASSETS The Company periodically reviews long-lived assets for impairment by comparing the carrying value of the assets with their estimated future undiscounted cash flows. If it is determined that an impairment loss has occurred, the loss would be recognized during that period. The impairment loss is calculated as the difference between asset carrying values and the present value of estimated net cash flows or comparable market values, giving consideration to recent operating performance and pricing trends. In fiscal 2000, 1999, and 1998, the Company had no significant impairment losses related to long-lived assets. ESTIMATING FAIR VALUE OF FINANCIAL INSTRUMENTS The $125 million of Senior Notes due June 2006 are estimated at fair market value based on dealer quotes at each balance sheet date. RESERVE FOR CLOSED FACILITIES The Company maintains a reserve for future rental obligations, carrying costs, and other closing costs related to closed facilities, primarily closed and relocated stores. The following is a detail of account activity (in thousands):
FISCAL YEAR ------------------------------ 2000 1999 1998 -------- -------- -------- Balance at beginning of fiscal year......................... $8,765 $8,557 $7,278 Additions charged to costs and expenses..................... 6,302 4,076 4,840 Payment of rental obligations and other..................... (7,068) (3,868) (3,561) ------ ------ ------ Balance at end of fiscal year............................... $7,999 $8,765 $8,557 ====== ====== ======
ADVERTISING COSTS Advertising costs are expensed in the period in which the advertising first occurs. Co-op advertising funds are recognized when the Company has performed its obligations under the co-op advertising agreements. Advertising expense, net of co-op advertising funds, was $82,519,000, $69,745,000, and $58,928,000 for fiscal 2000, 1999, and 1998, respectively, and is included in selling, general, and administrative expense. F-8 MICHAELS STORES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) STORE PRE-OPENING COSTS The Company expenses all start-up activity costs as incurred, which primarily include store pre-opening costs. REVENUE RECOGNITION Revenue from sales of the Company's merchandise is recognized at the time of the merchandise sale, excluding revenue from the sale of custom frames. The Company allows for merchandise to be returned under most circumstances. The Company does not provide a reserve for estimated returns, as the amount does not have a material impact on the financial statements. In fiscal 2000, the Company recorded the cumulative effect of a change in accounting principle related to revenue recognition from the sale of custom frames. The Company now recognizes the sale of custom frames at the time the frame is picked up by the customer. For a detailed description, see Note 2 of Notes to Consolidated Financial Statements. RECLASSIFICATIONS Certain reclassifications have been made to prior periods to conform to current presentations. F-9 MICHAELS STORES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) EARNINGS PER SHARE The following table sets forth the computation of basic and diluted earnings per common share:
FISCAL YEAR ------------------------------ 2000 1999 1998 -------- -------- -------- (IN THOUSANDS EXCEPT PER SHARE DATA) NUMERATOR: Net income (1).............................................. $78,589 $62,301 $43,601 Assumed add-back of interest on convertible subordinated debt less tax benefit of $2,386........................... -- 3,893 -- ------- ------- ------- Net income per diluted share computation.................... $78,589 $66,194 $43,601 ======= ======= ======= DENOMINATOR: Denominator for basic earnings per common share--weighted average shares............................................ 33,209 29,006 29,218 Effect of dilutive securities: Convertible subordinated debt............................. -- 2,551 -- Employee stock options.................................... 1,069 1,428 1,360 ------- ------- ------- Denominator for diluted earnings per common share--weighted average shares adjusted for dilutive securities........... 34,278 32,985 30,578 ======= ======= ======= BASIC EARNINGS PER COMMON SHARE: Before cumulative effect of accounting change............. $ 2.42 $ 2.15 $ 1.49 Cumulative effect of accounting change.................... (0.05) -- -- ------- ------- ------- Net income................................................ $ 2.37 $ 2.15 $ 1.49 ======= ======= ======= DILUTED EARNINGS PER COMMON SHARE: Before cumulative effect of accounting change............. $ 2.35 $ 2.01 $ 1.43 Cumulative effect of accounting change.................... (0.06) -- -- ------- ------- ------- Net income................................................ $ 2.29 $ 2.01 $ 1.43 ======= ======= =======
- ------------------------ (1) Fiscal 2000 net income includes the cumulative effect of a change in accounting principle, net of tax, in the amount of $1,852,000. See Note 2 of Notes to Consolidated Financial Statements. The Company's purchase and subsequent retirement of 5,161,000 shares of its common stock ("Common Stock") in fiscal 2000 reduced the number of weighted average shares outstanding by approximately 1,426,000 shares for fiscal 2000. For fiscal 2000, approximately 1.6 million shares related to the Company's outstanding employee stock options were excluded from the calculation of diluted earnings per share since their exercise prices exceeded the fair market value of the Common Stock. In addition, the convertible subordinated notes were not included in the diluted earnings per share calculation for fiscal 1998 because they were anti-dilutive. F-10 MICHAELS STORES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities," which requires all derivatives to be recorded on the balance sheet at fair value and establishes accounting treatment for certain types of hedging activities. The Company will adopt the requirements of SFAS No. 133 in its fiscal year beginning February 4, 2001. The adoption of SFAS No. 133 will have no material impact on the Company's operating results or financial position. NOTE 2. CHANGE IN ACCOUNTING PRINCIPLE Effective October 29, 2000, the Company changed its method of accounting for custom frame sales in accordance with guidance provided in the Securities and Exchange Commission's Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements." Historically, the Company has recognized sales for custom frame orders at the time that the order was placed by the customer. Under the new accounting method adopted retroactive to January 30, 2000, the Company now effectively recognizes revenue for custom frame orders at the time of delivery. The cumulative effect of the change on prior years resulted in a charge to income of $1.9 million (after reduction for income taxes of $1.2 million) which is included in the results of operations for the first quarter of fiscal 2000. The effect of the change on fiscal 2000 was to recognize $2.6 million in revenue and increase income before the cumulative effect of the accounting change by $685,000. No pro forma disclosures of net income and earnings per share for prior fiscal years, assuming the accounting change was applied retroactively, are provided as the amounts are not materially different from previously reported amounts. NOTE 3. DETAIL OF CERTAIN BALANCE SHEET ACCOUNTS
FEBRUARY 3, JANUARY 29, 2001 2000 ------------ ------------ (IN THOUSANDS) PROPERTY AND EQUIPMENT: Land and buildings........................................ $ 28,868 $ 3,119 Fixtures and equipment.................................... 383,410 312,599 Leasehold improvements.................................... 125,187 112,715 Capital leases............................................ 5,847 26,852 -------- -------- $543,312 $455,285 ======== ======== ACCRUED LIABILITIES AND OTHER: Salaries, bonuses, and other payroll-related costs........ $ 54,722 $ 42,960 Taxes, other than income and payroll...................... 21,116 21,538 Rent...................................................... 7,678 10,233 Deferred revenue.......................................... 4,374 -- Current portion of capital lease obligations.............. 731 6,353 Other..................................................... 55,500 55,291 -------- -------- $144,121 $136,375 ======== ========
F-11 MICHAELS STORES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 4. DEBT The Company completed a public offering of $125 million of Senior Notes (the "Notes") in June 1996. The Notes bear interest at a rate of 10 7/8% payable June 15 and December 15 of each year and mature on June 15, 2006. The Notes are not redeemable prior to June 15, 2001. On or after June 15, 2001, the Notes are redeemable at the option of the Company, in whole or in part, at redemption prices ranging from 105.44% in 2001 to 100.00% in 2004, plus accrued interest to the date of redemption. In addition, the indenture under which the Notes have been issued contains certain covenants, including but not limited to restrictions on (1) debt; (2) payments such as dividends, repurchases of Common Stock, or repurchases of subordinated obligations; (3) distributions from subsidiaries; (4) sales of assets; (5) transactions with affiliates; (6) liens; and (7) mergers, consolidations, and transfers of all or substantially all assets. The fair value, based on dealer quotes, of the outstanding Notes as of February 3, 2001 and January 29, 2000 was $130.6 million and $130.1 million, respectively. In January 1993, the Company issued $97.75 million of convertible subordinated notes ("Subordinated Notes") due January 15, 2003. On June 9, 2000, the Company called for the redemption of the Subordinated Notes on June 29, 2000. The aggregate principal amount of the Subordinated Notes outstanding was $96,935,000. The holders had the option to convert their Subordinated Notes into shares of Common Stock prior to 5:00 p.m., Eastern Time, on June 22, 2000, at a price of $38.00 per share. Alternatively, holders could have their Subordinated Notes redeemed on June 29, 2000 at a total redemption price of $1,051.25 per $1,000 principal amount of Subordinated Notes, which included a premium for early redemption and accrued interest. As a result, the majority of the Subordinated Notes was surrendered by the June 22, 2000 conversion date and was converted into 2,445,565 shares of Common Stock. The remaining Subordinated Notes were redeemed at a total redemption price of $4,206,051 on June 29, 2000. The loss from the redemption was not material. The Company's bank credit facility with Fleet National Bank (formerly BankBoston, N.A.) and other lending institutions (the "Credit Agreement") provides for an unsecured revolving line of credit of $100 million with a $25 million competitive bid feature and a $50 million letter of credit sub-facility, which line of credit may be increased to $125 million under specific conditions. The Credit Agreement contains certain financial covenants, including those related to the ratio of funded debt to total capital, a fixed charge coverage ratio, and a capital expenditure limitation. Interest on all borrowings varies based upon the type of borrowing, our fixed charge coverage ratio, and whether the Company elects to utilize the competitive bid feature available under the Credit Agreement. If the competitive bid procedure is not employed, the interest rate on the Credit Agreement is generally (a) the higher of (i) an annual rate of interest announced from time to time by the lending institution as its "base rate" or (ii) one-half of one percent ( 1/2%) above the Federal Funds Effective Rate or (b) the Eurodollar Rate as defined by the Credit Agreement plus an applicable margin based on our fixed charge coverage ratio. If the competitive bid feature is utilized, loans up to $25 million may be made under the Credit Agreement at competitively bid interest rates offered by lending institutions participating in the facility, which may have the effect of decreasing the amount of interest the Company would otherwise be obligated to pay on such borrowings. The Company is required to pay a facility fee from 0.2% to 0.3% per annum on the unused portion of the revolving line of credit as well as letter of credit fees that vary depending on the fixed charge coverage ratio. We are in compliance with all terms and conditions of the Credit Agreement. No borrowings were outstanding under the Credit Agreement at February 3, 2001 or January 29, 2000. Borrowings available under the Credit Agreement are reduced by the aggregate amount of letters of credit outstanding ($15,094,000 at February 3, 2001). Borrowings in F-12 MICHAELS STORES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 4. DEBT (CONTINUED) fiscal 2000 and fiscal 1999 were outstanding under the Credit Agreement for 47 days and 121 days, respectively, in connection with the inventory buildup for peak selling seasons (with average outstanding borrowings of $25 million and $40 million, respectively, and a weighted average interest rate of 7.80% and 6.29%, respectively). The Credit Agreement expires on August 28, 2001. NOTE 5. INCOME TAXES Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of deferred tax assets and liabilities as of the respective year-end balance sheets are as follows:
FEBRUARY 3, JANUARY 29, 2001 2000 ----------- ----------- (IN THOUSANDS) DEFERRED TAX ASSETS: Net operating loss, general business credit, and alternative minimum tax credit carryforwards............ $11,734 $17,920 Accrued expenses.......................................... 21,332 17,675 Other..................................................... 6,693 4,311 ------- ------- Deferred tax assets..................................... 39,759 39,906 Valuation allowance....................................... (5,408) (5,454) ------- ------- Total deferred tax assets............................... 34,351 34,452 ------- ------- DEFERRED TAX LIABILITIES: Depreciation and amortization............................. 23,672 23,033 Other..................................................... 15,595 17,655 ------- ------- Total deferred tax liabilities.......................... 39,267 40,688 ------- ------- Net deferred tax liabilities................................ $(4,916) $(6,236) ======= =======
F-13 MICHAELS STORES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 5. INCOME TAXES (CONTINUED) The federal and state income tax provision is as follows:
FISCAL YEAR ------------------------------ 2000(1) 1999 1998 -------- -------- -------- (IN THOUSANDS) FEDERAL: Current................................................... $44,877 $24,393 $16,015 Deferred.................................................. 840 11,487 10,620 ------- ------- ------- Total federal income tax provision.......................... 45,717 35,880 26,635 STATE: Current................................................... 7,753 2,921 463 Deferred.................................................. (1,077) 1,289 (375) ------- ------- ------- Total state income tax provision............................ 6,676 4,210 88 ------- ------- ------- Total income tax provision.................................. $52,393 $40,090 $26,723 ======= ======= =======
- ------------------------ (1) The total income tax provision for fiscal 2000 includes a provision on income before the cumulative effect of a change in accounting principle of $53,628,000 and a tax benefit of $1,235,000 resulting from the cumulative effect of a change in accounting principle. Reconciliation between the actual income tax provision and the income tax provision calculated by applying the federal statutory rate is as follows:
FISCAL YEAR ------------------------------ 2000(1) 1999 1998 -------- -------- -------- (IN THOUSANDS) Income tax provision at statutory rate...................... $45,844 $35,837 $24,613 Decrease in federal valuation allowance..................... (46) -- (1,075) Decrease in valuation allowance for state net operating losses, net of federal income tax effect.................. -- (1,571) (2,497) State income taxes, net of federal income tax effect........ 4,339 4,308 2,554 Utilization of net operating losses previously not benefited................................................. -- -- (1,439) Amortization of intangibles................................. 1,290 1,279 1,331 Other....................................................... 966 237 3,236 ------- ------- ------- Total income tax provision.................................. $52,393 $40,090 $26,723 ======= ======= =======
At February 3, 2001, the Company had state net operating loss carryforwards to reduce future taxable income of approximately $82 million expiring at various dates between fiscal 2001 and fiscal 2018. The Company also has tax credit carryforwards of approximately $500,000 available to offset future income taxes. During fiscal 1999, the Company reduced its valuation allowance by $2.4 million for state net operating losses because it was more likely than not that the assets would be realized. F-14 MICHAELS STORES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 6. STOCKHOLDERS' EQUITY In October 1997, the Company began issuing Common Stock through its Dividend Reinvestment and Stock Purchase Plan (the "Stock Purchase Plan"). The Stock Purchase Plan provides owners of shares of Common Stock and other interested investors with a convenient and economical method to purchase Common Stock. The Stock Purchase Plan also provides the Company with a cost-efficient and flexible mechanism to raise equity capital. The Company may establish a discount of 0% to 5% in certain transactions to purchase shares under the Stock Purchase Plan. During fiscal 2000, 1999, and 1998, the Company issued 411, 982, and 178,730 shares, respectively, through the Stock Purchase Plan, generating $14,000, $27,000, and $6,218,000, respectively, in new equity. In October 1999, we began issuing Common Stock through our Employees Stock Purchase Plan. The plan provides our employees with a convenient and economical means of purchasing Common Stock. The plan also provides us with an additional way to raise equity capital. During fiscal 2000 and 1999, we issued 33,288 and 8,035 shares, respectively, through the plan, generating approximately $922,000 and $208,000, respectively, in proceeds. Prior to October 1999, shares for the Employees Stock Purchase Plan were acquired through open market purchases. In fiscal 1998, the Company repurchased and placed into treasury 1,145,000 shares of Common Stock for an aggregate purchase price of $20.4 million. On July 14, 1999, the Board of Directors authorized the repurchase of up to 5,000,000 shares of Common Stock. Pursuant to this plan, in fiscal 1999, the Company repurchased and placed in treasury 364,000 shares of Common Stock for an aggregate purchase price of $11.5 million. In the first quarter of fiscal 2000, the Company retired all of the Common Stock held in treasury. Subsequent to the first quarter of fiscal 2000, through December 14, 2000, the Company repurchased 4,636,000 shares of Common Stock for an aggregate purchase price of $139.4 million (average of $30.06 per share) of which all shares have been retired. On December 14, 2000, the Company announced the completion of the July 1999 stock repurchase plan. On December 14, 2000, the Board of Directors authorized the repurchase of an additional 1,000,000 shares of outstanding Common Stock. During fiscal 2000, the Company repurchased and retired 525,000 shares under this plan at an aggregate purchase price of $17.2 million (average of $32.67 per share). The Company is restricted by regulations of the Securities and Exchange Commission from making repurchases during specified time periods. In addition, under the agreements governing the Company's outstanding indebtedness, the Company can only repurchase shares if specified financial ratios are maintained. Select employees and key advisors of the Company, including directors, may participate in the 1997 Stock Option Plan (the "Plan"), with an aggregate of approximately 807,000 shares of Common Stock remaining for issuance thereunder. Options issued to employees under the Plan have a five year term and vest over a three year period following the date of grant, while options issued to directors under the Plan have a five year term and vest immediately. The Company has elected to follow the Accounting Principles Board Opinion No. 25, "Accounting For Stock Issued To Employees," and related guidance in accounting for its employee stock options. The exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant and, as a result, the Company does not recognize compensation expense for stock option grants. F-15 MICHAELS STORES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 6. STOCKHOLDERS' EQUITY (CONTINUED) Pro forma information regarding net income and earnings per share, as required by the provisions of SFAS No. 123, "Accounting For Stock-Based Compensation," has been determined as if the Company had accounted for its employee stock options under the fair value method. The fair value for the options was estimated at the date of grant using the Black-Scholes option valuation model with the following weighted-average assumptions:
FISCAL YEAR ---------------------------------- 2000 1999 1998 -------- -------- -------- Risk-free interest rates.................................... 6.24% 5.43% 4.93% Dividend yield.............................................. 0% 0% 0% Expected volatility rates of the Common Stock............... 73.8% 57.2% 58.4% Weighted average expected life of the options (in years).... 2.55 3.20 2.14
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. The Company's employee stock options have characteristics significantly different from those of traded options and changes in the subjective input assumptions can materially affect the fair value estimate. In addition, options vest over several years and additional option grants are expected. As a result, the Company believes the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options and the effects of the following hypothetical calculations are not likely to be representative of similar future calculations. For purposes of pro forma disclosures, the estimated fair value of the options is amortized over the options' vesting periods. The pro forma effects of applying SFAS No. 123 are not indicative of future amounts because this statement does not apply to options granted prior to fiscal 1995. The Company's pro forma information is as follows:
FISCAL YEAR ------------------------------ 2000 1999 1998 -------- -------- -------- (IN THOUSANDS EXCEPT PER SHARE DATA) Pro forma net income(1)..................................... $68,213 $50,188 $36,661 Pro forma earnings per common share: Basic..................................................... 2.05 1.73 1.25 Diluted................................................... 2.01 1.55 1.21
- ------------------------ (1) The fiscal 2000 pro forma net income amount includes the cumulative effect of the change in accounting principle, net of tax. See Note 2 of Notes to Consolidated Financial Statements. F-16 MICHAELS STORES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 6. STOCKHOLDERS' EQUITY (CONTINUED) For fiscal 2000, 1999, and 1998, the Company's stock option activity is summarized below:
FISCAL YEAR --------------------------------------------------------------- 2000 1999 1998 ------------------- ------------------- ------------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE -------- -------- -------- -------- -------- -------- (IN THOUSANDS EXCEPT PRICE PER SHARE DATA) Outstanding at beginning of year............... 7,403 $21.77 6,986 $19.54 6,627 $18.10 Granted........................................ 1,506 39.12 2,587 24.05 1,150 25.89 Exercised...................................... (4,454) 20.08 (1,857) 15.58 (494) 14.79 Forfeited/Expired.............................. (302) 31.77 (313) 27.68 (297) 19.96 ------- ------- ------- ------- ------ ------- Outstanding at end of year..................... 4,153 $29.12 7,403 $21.77 6,986 $19.54 ======= ======= ======= ======= ====== ======= Exercisable at end of year..................... 1,836 $23.71 5,335 $19.86 5,313 $18.39 Weighted average fair value of options granted during the year.............................. $19.14 $10.69 $11.95
The following table summarizes information about stock options outstanding at February 3, 2001:
STOCK OPTIONS STOCK OPTIONS OUTSTANDING EXERCISABLE ---------------------------------- ------------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE REMAINING EXERCISE EXERCISE RANGE OF EXERCISE PRICES SHARES LIFE (YEARS) PRICE SHARES PRICE - ------------------------ -------- ------------ -------- -------- -------- (IN THOUSANDS EXCEPT REMAINING LIFE AND PRICE PER SHARE DATA) $13.74 - 18.32.......... 829 3.1 $17.91 814 $17.91 18.33 - 22.90.......... 747 3.0 22.19 327 22.11 22.91 - 27.48.......... 164 4.3 25.63 14 26.45 27.49 - 32.06.......... 1,087 3.2 29.45 467 29.67 32.07 - 36.65.......... 264 4.2 34.68 203 34.83 36.66 - 41.23.......... 140 4.3 39.93 8 37.38 41.24 - 45.81.......... 922 4.5 41.80 3 41.75 ----- --- ------- ----- ------- 4,153.. 3.6 $29.12 1,836 $23.71 ===== === ======= ===== =======
NOTE 7. RETIREMENT PLANS The Company sponsors a 401(k) savings plan (the "401(k) Plan") for eligible employees of the Company and certain of its subsidiaries. Participation in the 401(k) Plan is voluntary and available to any employee who is 21 years of age and has completed 500 hours of service in a six-month eligibility period. Participants may elect to contribute up to 15% of their compensation on a pre-tax basis and up to 10% on an after-tax basis. In accordance with the provisions of the 401(k) Plan, the Company makes a matching contribution to the account of each participant in an amount equal to 50% of the first 6% of eligible compensation contributed by each participant not to exceed 3% of the participant's total compensation for the year. The Company's matching contribution expense, net of forfeitures, was $1,808,000, $1,475,000, and $1,293,000 for fiscal 2000, 1999, and 1998, respectively. F-17 MICHAELS STORES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 7. RETIREMENT PLANS (CONTINUED) Effective August 1, 1999, the Company adopted the Michaels Stores, Inc. Deferred Compensation Plan (the "Deferred Plan") to provide eligible employees, directors, and certain consultants (plan "participants") the opportunity to defer receipt of current compensation. The amount of compensation deferred by each participant electing to participate in the Deferred Plan will be determined in accordance with the terms of the Deferred Plan, based on elections by the plan participants and paid in accordance with the terms of the Deferred Plan. The Company provides matching contributions equal to 50% of the first 6% of compensation deferred under the Deferred Plan, reduced by the matching contributions credited to the participant under the Company's 401(k) Plan. The participants who are employees will be eligible for a matching contribution only if they participate in the 401(k) Plan and they are deferring to the 401(k) Plan the maximum amount permitted for the Plan Year. The Company's matching contribution expense was $298,000 and $84,000 for fiscal 2000 and 1999, respectively. Deferred amounts and matching contributions are deposited each pay period in a trust that qualifies as a grantor trust under the Internal Revenue Code of 1986, as amended. The funds are invested in individual participant life insurance contracts. The Company is the owner of these contracts and the Company and the participant's designee are beneficiaries. Participants must elect investments for their deferrals and matching contributions from a variety of hypothetical benchmark funds. The return on the underlying investments determines the amount of earnings and losses that are credited or debited to the participant's account. Amounts deferred, matching contributions, and earnings and losses are 100% vested. The Company's obligations under the Deferred Plan are unsecured general obligations of the Company and will rank equally with other unsecured general creditors of the Company. NOTE 8. COMMITMENTS AND CONTINGENCIES COMMITMENTS The Company operates stores and uses distribution centers, office facilities, and equipment that are generally leased under non-cancelable operating leases, the majority of which provide for renewal options. Future minimum annual rental commitments for all non-cancelable operating leases as of February 3, 2001 are as follows (in thousands): For the Fiscal Year: 2001...................................................... $ 172,171 2002...................................................... 171,109 2003...................................................... 158,432 2004...................................................... 140,670 2005...................................................... 123,946 Thereafter................................................ 455,148 ---------- Total minimum rental commitments............................ $1,221,476 ==========
Rental expense applicable to non-cancelable operating leases was $149,630,000, $122,962,000, and $103,735,000 in fiscal 2000, 1999, and 1998, respectively. F-18 MICHAELS STORES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 8. COMMITMENTS AND CONTINGENCIES (CONTINUED) CONTINGENCIES On May 2, 2000, Taiyeb Raniwala, a former assistant manager of the Company, filed a purported class action complaint (the "Raniwala Complaint") against the Company, on behalf of the Company's former and current assistant store managers. The Raniwala Complaint was filed in the Alameda County Superior Court, California and alleges the Company violated certain California laws by erroneously treating its assistant store managers as "exempt" employees who are not entitled to overtime compensation. The Raniwala Complaint seeks back wages, interest, penalties, and attorneys' fees. A hearing for class certification is currently scheduled for June 29, 2001, and a trial is tentatively scheduled for February 25, 2002. The case is in the early phase of discovery. Although the Company believes it has certain meritorious defenses and intends to defend this lawsuit vigorously, there can be no assurance that it will be successful in such defense or that there will not be a materially adverse impact on its future operating results by the final resolution of the lawsuit. On April 14, 1999, Suzanne Collins, a former assistant manager of the Company's subsidiary, Aaron Brothers, Inc., filed a class action complaint (the "Collins Complaint") against Aaron Brothers on behalf of Aaron Brothers' former store managers, assistant store managers, and managers-in-training. The Collins Complaint was filed in Los Angeles County Superior Court, California and alleges that Aaron Brothers violated certain California laws by erroneously treating its store managers, assistant store managers, and managers-in-training as "exempt" employees who are not entitled to overtime compensation. The Collins Complaint seeks back wages, interest, penalties, and attorneys' fees. The hearing for class certification and trial dates has been vacated, pending the appointment of a new judge in the case. The case is currently in the discovery phase. Although Aaron Brothers believes it has certain meritorious defenses and intends to defend this lawsuit vigorously, there can be no assurance that it will be successful in such defense or that there will not be a materially adverse impact on its future operating results by the final resolution of the lawsuit. On January 15, 1999, MJDesigns, Inc. ("MJDesigns"), a competitor, filed a complaint alleging that representatives of the Company disseminated negative information about the financial stability of MJDesigns, which, it was contended, contributed to MJDesigns' bankruptcy filing. On August 5, 1999, the parties reached a settlement, whereby the Company paid $1.5 million to MJDesigns and both parties executed mutual releases. The Company is a defendant from time to time in lawsuits incidental to its business. Based on currently available information, the Company believes that resolution of all known contingencies is uncertain, and there can be no assurance that future costs related to such litigation would not be material to the Company's financial position or results of operations. F-19 MICHAELS STORES, INC. UNAUDITED SUPPLEMENTAL QUARTERLY FINANCIAL DATA (IN THOUSANDS EXCEPT PER SHARE DATA)
FIRST SECOND THIRD FOURTH QUARTER QUARTER QUARTER QUARTER -------- -------- -------- -------- FISCAL 2000: AS RESTATED(1): Net sales........................................... $474,152 $434,059 $525,735 $815,494 Cost of sales and occupancy expense................. 313,333 292,263 344,506 544,202 Operating income.................................... 21,338 11,600 29,328 86,151 Income before cumulative effect of accounting change(1)......................................... 10,082 4,554 15,694 50,111 Net income.......................................... 8,230 4,554 15,694 50,111 Earnings per common share excluding the cumulative effect of accounting change: Basic............................................... $ 0.33 $ 0.13 $ 0.44 $ 1.54 Diluted............................................. $ 0.31 $ 0.13 $ 0.43 $ 1.52 Common shares used in per share calculations: Basic............................................... 30,597 34,035 35,673 32,531 Diluted............................................. 32,317 35,417 36,483 32,896 AS PREVIOUSLY REPORTED: Net sales........................................... $472,548 $438,392 $526,504 $809,408 Cost of sales and occupancy expense................. 312,394 294,721 344,831 540,912 Operating income.................................... 20,673 13,475 29,772 83,355 Net income.......................................... 9,684 5,679 15,960 48,433 Earnings per common share: Basic............................................... $ 0.32 $ 0.17 $ 0.45 $ 1.49 Diluted............................................. $ 0.30 $ 0.16 $ 0.44 $ 1.47 FISCAL 1999: Net sales........................................... $388,544 $359,124 $463,034 $671,820 Cost of sales and occupancy expense................. 262,547 244,859 307,270 429,528 Operating income.................................... 12,851 5,126 22,589 82,106 Net income.......................................... 5,193 28 10,436 46,644 Earnings per common share: Basic............................................... $ 0.18 $ 0.00 $ 0.36 $ 1.58 Diluted............................................. $ 0.18 $ 0.00 $ 0.34 $ 1.41 Common shares used in per share calculations: Basic............................................... 28,584 28,748 29,183 29,511 Diluted(2).......................................... 29,239 30,447 30,933 33,669
- ------------------------ (1) As more fully described in Note 2 of Notes to Consolidated Financial Statements, the Company changed its accounting policy with respect to revenue recognition related to the sale of custom frames effective retroactively as of the beginning of fiscal 2000. As a result, the Company has restated its previously published fiscal 2000 quarterly financial data and recorded a charge of $1.9 million, net of tax, in the first quarter of fiscal 2000 for the cumulative effect of the change on prior years. (2) The convertible subordinated notes were not included in the diluted earnings per common share calculation for the first, second, and third quarters of fiscal 1999 because they were anti-dilutive. The convertible subordinated notes were included in the diluted earnings per common share in the fourth quarter of fiscal 1999. F-20 MICHAELS STORES, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA)
MAY 5, FEBRUARY 3, 2001 2001 ----------- ----------- (UNAUDITED) ASSETS CURRENT ASSETS: Cash and equivalents...................................... $ 21,365 $ 28,191 Merchandise inventories................................... 744,701 663,700 Prepaid expenses and other................................ 21,744 24,572 Deferred income taxes..................................... 13,345 13,353 ---------- ---------- Total current assets.................................... 801,155 729,816 ---------- ---------- PROPERTY AND EQUIPMENT, AT COST............................. 561,214 543,312 Less accumulated depreciation............................... (256,315) (242,307) ---------- ---------- 304,899 301,005 ---------- ---------- COSTS IN EXCESS OF NET ASSETS OF ACQUIRED OPERATIONS, NET... 120,313 121,256 OTHER ASSETS................................................ 8,351 6,359 ---------- ---------- 128,664 127,615 ---------- ---------- Total assets................................................ $1,234,718 $1,158,436 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable.......................................... $ 169,314 $ 143,224 Accrued liabilities and other............................. 146,640 144,121 Borrowings under line of credit........................... 29,200 -- Income taxes payable...................................... 2,621 1,663 ---------- ---------- Total current liabilities............................... 347,775 289,008 ---------- ---------- SENIOR NOTES................................................ 125,000 125,000 DEFERRED INCOME TAXES....................................... 18,269 18,269 OTHER LONG-TERM LIABILITIES................................. 23,283 21,513 ---------- ---------- Total long-term liabilities............................. 166,552 164,782 ---------- ---------- 514,327 453,790 ---------- ---------- COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY: Common stock, $.10 par value, 150,000,000 shares authorized; shares issued and outstanding of 32,172,812 at May 5, 2001 and 31,836,840 at February 3, 2001....... 3,217 3,184 Additional paid-in capital................................ 438,768 429,688 Retained earnings......................................... 278,406 271,774 ---------- ---------- Total stockholders' equity.............................. 720,391 704,646 ---------- ---------- Total liabilities and stockholders' equity.................. $1,234,718 $1,158,436 ========== ==========
See accompanying notes to consolidated financial statements. F-21 MICHAELS STORES, INC. CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
THREE MONTHS ENDED -------------------- MAY 5, APRIL 29, 2001 2000 -------- --------- NET SALES................................................... $524,720 $474,152 Cost of sales and occupancy expense......................... 347,439 313,333 -------- -------- GROSS PROFIT................................................ 177,281 160,819 Selling, general, and administrative expense................ 156,428 136,758 Store pre-opening costs..................................... 1,616 2,723 Litigation settlement....................................... 3,153 -- -------- -------- OPERATING INCOME............................................ 16,084 21,338 Interest expense............................................ 3,778 5,520 Other (income) and expense, net............................. (48) (989) -------- -------- INCOME BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF ACCOUNTING CHANGE......................................... 12,354 16,807 Provision for income taxes.................................. 5,065 6,725 -------- -------- INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE........ 7,289 10,082 Cumulative effect of accounting change for revenue recognition, net of tax of $1,235......................... -- 1,852 -------- -------- NET INCOME.................................................. $ 7,289 $ 8,230 ======== ======== EARNINGS PER COMMON SHARE EXCLUDING THE CUMULATIVE EFFECT OF ACCOUNTING CHANGE: Basic..................................................... $ 0.23 $ 0.33 ======== ======== Diluted................................................... $ 0.22 $ 0.31 ======== ======== EARNINGS PER COMMON SHARE INCLUDING THE CUMULATIVE EFFECT OF ACCOUNTING CHANGE: Basic..................................................... $ 0.23 $ 0.27 ======== ======== Diluted................................................... $ 0.22 $ 0.25 ======== ========
See accompanying notes to consolidated financial statements. F-22 MICHAELS STORES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED)
THREE MONTHS ENDED -------------------- MAY 5, APRIL 29, 2001 2000 -------- --------- OPERATING ACTIVITIES: Net income................................................ $ 7,289 $ 8,230 Adjustments: Depreciation............................................ 15,466 15,456 Amortization............................................ 1,032 1,027 Other................................................... 102 433 Change in assets and liabilities: Merchandise inventories............................... (81,001) (26,792) Prepaid expenses and other............................ 2,828 (685) Deferred income taxes and other....................... (267) 21 Accounts payable...................................... 26,090 22,575 Income taxes payable.................................. 1,998 (4,066) Accrued liabilities and other......................... 1,638 (7,108) -------- -------- Net change in assets and liabilities................ (48,714) (16,055) -------- -------- Net cash (used in) provided by operating activities........................................ (24,825) 9,091 -------- -------- INVESTING ACTIVITIES: Additions to property and equipment....................... (19,040) (17,220) Net proceeds from sales of property and equipment......... 13 24 -------- -------- Net cash used in investing activities............... (19,027) (17,196) -------- -------- FINANCING ACTIVITIES: Net borrowings under bank credit facilities............... 29,200 -- Payment of other long-term liabilities.................... (247) (1,473) Proceeds from stock options exercised..................... 7,777 31,285 Proceeds from issuance of common stock and other.......... 296 195 -------- -------- Net cash provided by financing activities........... 37,026 30,007 -------- -------- NET (DECREASE) INCREASE IN CASH AND EQUIVALENTS............. (6,826) 21,902 CASH AND EQUIVALENTS AT BEGINNING OF PERIOD................. 28,191 77,398 -------- -------- CASH AND EQUIVALENTS AT END OF PERIOD....................... $ 21,365 $ 99,300 ======== ========
See accompanying notes to consolidated financial statements. F-23 MICHAELS STORES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE MONTHS ENDED MAY 5, 2001 (UNAUDITED) NOTE 1. BASIS OF PRESENTATION The consolidated financial statements include the accounts of Michaels Stores, Inc. and its wholly-owned subsidiaries (collectively, the "Company"). All significant intercompany accounts and transactions have been eliminated. The accompanying consolidated financial statements are unaudited (except for the Consolidated Balance Sheet as of February 3, 2001) and have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals and other items, as disclosed) considered necessary for a fair presentation have been included. Because of the seasonal nature of the Company's business, the results of operations for the three months ended May 5, 2001 are not indicative of the results to be expected for the entire year. These interim financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended February 3, 2001. All references herein to "fiscal 2001" relate to the 52 weeks ending February 2, 2002, and all references to "fiscal 2000" relate to the 53 weeks ended February 3, 2001. In addition, all references herein to "the first quarter of fiscal 2001" relate to the 13 weeks ended May 5, 2001, and all references to "the first quarter of fiscal 2000" relate to the 13 weeks ended April 29, 2000. NOTE 2. CHANGE IN ACCOUNTING PRINCIPLE Effective October 29, 2000, the Company changed its method of accounting for custom frame sales in accordance with guidance provided in the SEC's Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements." Historically, the Company has recognized sales for custom frame orders at the time the customer placed the order. Under the new accounting method adopted retroactive to January 30, 2000, the Company now effectively recognizes revenue for custom frame orders at the time of delivery. The cumulative effect of the change on fiscal years prior to fiscal 2000 resulted in a non-cash charge to income of $1.9 million (after reduction for income taxes of $1.2 million), which is included in the results of operations for the first quarter of fiscal 2000. In addition, the Company has given retroactive effect to this change in accounting principle by restatement of the Company's previously published financial statements for the first quarter of fiscal 2000. The effect of the change on the first quarter of fiscal 2000 was to recognize $1.6 million in revenue and increase income before the cumulative effect of the accounting change by $398,000. F-24 MICHAELS STORES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE THREE MONTHS ENDED MAY 5, 2001 (UNAUDITED) NOTE 3. EARNINGS PER SHARE The following table sets forth the computation of basic and diluted earnings per common share:
THREE MONTHS ENDED -------------------- MAY 5, APRIL 29, 2001 2000 -------- --------- (IN THOUSANDS, EXCEPT PER SHARE DATA) NUMERATOR: Income before cumulative effect of accounting change...... $7,289 $10,082 Cumulative effect of accounting change, net of tax........ -- 1,852 ------ ------- Net income................................................ $7,289 $ 8,230 ====== ======= DENOMINATOR: Denominator for basic earnings per share-weighted average shares.................................................. 31,872 30,597 Effect of dilutive securities: Employee stock options.................................. 655 1,720 ------ ------- Denominator for diluted earnings per share-weighted average shares adjusted for dilutive securities......... 32,527 32,317 ====== ======= BASIC EARNINGS PER COMMON SHARE: Income before cumulative effect of accounting change...... $ 0.23 $ 0.33 Cumulative effect of accounting change, net of tax........ -- (0.06) ------ ------- Net income................................................ $ 0.23 $ 0.27 ====== ======= DILUTED EARNINGS PER COMMON SHARE: Income before cumulative effect of accounting change...... $ 0.22 $ 0.31 Cumulative effect of accounting change, net of tax........ -- (0.06) ------ ------- Net income................................................ $ 0.22 $ 0.25 ====== =======
NOTE 4. CREDIT AGREEMENT Effective May 1, 2001, the Company completed a new $200 million unsecured bank credit facility with Fleet National Bank and other lending institutions (the "Credit Agreement"), which replaced the previous $100 million unsecured bank credit facility. The Credit Agreement has a term of three years (with a maturity extension for one additional year available under certain conditions) and contains a $25 million competitive bid feature and a $70 million letter of credit sub-facility. The Credit Agreement contains certain financial covenants, including a balance sheet leverage ratio, a cash flow coverage ratio, a cash flow leverage ratio, and a capital expenditure limitation. Interest on all borrowings varies based upon the type of borrowing, the fixed charge coverage ratio, and whether the Company elects to utilize the competitive bid feature available under the Credit Agreement. If the competitive bid feature is not utilized, the interest rate on borrowings under the F-25 MICHAELS STORES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE THREE MONTHS ENDED MAY 5, 2001 (UNAUDITED) NOTE 4. CREDIT AGREEMENT (CONTINUED) Credit Agreement is generally (a) the higher of (i) an annual rate of interest announced from time to time by Fleet National Bank, as agent, as its "base rate" or (ii) one-half of one percent ( 1/2%) above the Federal Funds Effective Rate or (b) the Eurodollar Rate, as defined by the Credit Agreement, plus an applicable margin based on our fixed charge coverage ratio. If the competitive bid feature is utilized, loans up to $25 million may be made under the Credit Agreement at competitively bid interest rates offered by lending institutions participating in the facility, which may have the effect of decreasing the amount of interest the Company would otherwise be obligated to pay on such borrowings. The Company is required to pay a facility fee from 0.2% to 0.35% per annum on the unused portion of the revolving line of credit as well as letter of credit fees that vary depending on the fixed charge coverage ratio. The Company is in compliance with all terms and conditions of the Credit Agreement. Borrowings outstanding under the Credit Agreement were $29.2 million as of May 5, 2001. Borrowings available under the Credit Agreement are reduced by the aggregate amount of letters of credit outstanding under the Credit Agreement ($8.7 million at May 5, 2001). Borrowings in the first quarter of fiscal 2001 were outstanding for 79 days, with average outstanding borrowings of $13.0 million and a weighted average interest rate of 7.33%. NOTE 5. LEGAL PROCEEDINGS On May 2, 2000, Taiyeb Raniwala ("Raniwala"), a former assistant manager of the Company, filed a purported class action complaint (the "Raniwala Complaint") against us, on behalf of our former and current assistant store managers. The Raniwala Complaint was filed in the Alameda County Superior Court, California and alleges we violated certain California laws by erroneously treating our assistant store managers as "exempt" employees who are not entitled to overtime compensation. Based on these allegations, the Raniwala Complaint asserts we: (1) violated certain California Wage Orders; (2) violated Section 17200 of the California Business and Professions Code; and (3) engaged in conversion. The Raniwala Complaint seeks back wages, interest, penalties, and attorneys' fees. On July 20, 2000, Raniwala filed an amended complaint to correct certain deficiencies in the original Complaint (the "Amended Raniwala Complaint"). On September 25, 2000, we filed our answer to the Amended Raniwala Complaint. On June 6, 2001, we negotiated a tentative settlement with Raniwala. Pursuant to the terms of the settlement, in exchange for a full release of claims, we are obligated to pay a maximum of $3.0 million covering all claims and attorneys' fees, plus estimated payroll taxes of approximately $153,000, which amounts were accrued in the first quarter of fiscal 2001. The specific terms of the settlement are currently being finalized between the parties and must then be approved by the Alameda County Superior Court. While we believe that it is likely that the settlement will be approved, we can provide no assurance to that effect. On April 14, 1999, Suzanne Collins ("Collins"), a former assistant manager of our subsidiary, Aaron Brothers, Inc. ("Aaron Brothers"), filed a class action complaint (the "Collins Complaint") against Aaron Brothers on behalf of Aaron Brothers' former store managers, assistant store managers, and managers-in-training. The Collins Complaint was filed in the Los Angeles County Superior Court, F-26 MICHAELS STORES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE THREE MONTHS ENDED MAY 5, 2001 (UNAUDITED) NOTE 5. LEGAL PROCEEDINGS (CONTINUED) California and alleges that Aaron Brothers violated certain California laws by erroneously treating its store managers, assistant store managers, and managers-in-training as "exempt" employees who are not entitled to overtime compensation. Based on these allegations, the Collins Complaint asserts that Aaron Brothers: (1) violated certain California Labor Codes; (2) violated Section 17200 of the California Business and Professions Code; and (3) engaged in conversion. The Collins Complaint seeks back wages, interest, penalties, punitive damages, and attorneys' fees. On May 30, 2001, Collins filed a motion to amend the Collins Complaint (the "Amended Collins Complaint"), which is scheduled for a hearing on June 25, 2001. If granted, the Amended Collins Complaint would: (1) expand the purported class to include all current Aaron Brothers salaried store managers, assistant store managers, and managers-in-training based in California; (2) add a new plaintiff as a class representative; and (3) add two additional causes of action for injunctive and declaratory relief. The Court has set a status conference in the case for July 11, 2001. At the July 11, 2001 status conference, it is anticipated that the Court will set a hearing date to determine whether the case should proceed as a class action lawsuit. A trial date has not yet been scheduled. The case is currently in the discovery phase. There can be no assurance that Aaron Brothers will be successful in defending this litigation or that future operating results will not be materially adversely affected by the final resolution of the lawsuit. We are a defendant from time to time in lawsuits incidental to our business. Based on currently available information, we believe that resolution of all known contingencies, including the litigation described above, is uncertain, and there can be no assurance that future costs of such litigation would not be material to our financial position or results of operations. NOTE 6. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities," which requires all derivatives to be recorded on the balance sheet at fair value and establishes accounting treatment for certain types of hedging activities. The Company adopted the requirements of SFAS No. 133 beginning in fiscal 2001. The adoption of SFAS No. 133 had no material impact on the Company's operating results or financial position for the first quarter of fiscal 2001. F-27 - ----------------------------------------- - ----------------------------------------- $200,000,000 [LOGO] 9 1/4% SENIOR NOTES DUE 2009 -------------- PROSPECTUS -------------- AUGUST , 2001 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 20. INDEMNIFICATION OF DIRECTORS AND OFFICERS Michaels' certificate of incorporation limits the liability of Michaels' directors to the maximum extent permitted by Delaware law. Delaware law provides that a director of a corporation will not be personally liable for monetary damages for breach of that individual's fiduciary duties as a director except for liability for (1) a breach of the director's duty of loyalty to the corporation or its stockholders, (2) any act or omission not in good faith or that involves intentional misconduct or a knowing violation of the law, (3) unlawful payments of dividends or unlawful stock repurchases or redemptions, or (4) any transaction from which the director derived an improper personal benefit. This limitation of liability does not apply to liabilities arising under federal securities laws and does not affect the availability of equitable remedies such as injunctive relief or rescission. Section 145 of the Delaware General Corporation Law provides that a corporation may indemnify directors and officers, as well as other employees and individuals, against attorneys' fees and other expenses, judgments, fines and amounts paid in settlement actually and reasonably incurred by such person in connection with any threatened, pending or completed actions, suits or proceedings in which such person was or is a party or is threatened to be made a party by reason of such person being or having been a director, officer, employee or agent of the corporation. The Delaware General Corporation Law provides that Section 145 is not exclusive of other rights to which those seeking indemnification may be entitled under any bylaw, agreement, vote of stockholders or disinterested directors, or otherwise. Michaels' certificate of incorporation requires that Michaels indemnify its directors and officers, and any other person who is or was serving at the request of Michaels as a director, officer, employee or agent of another corporation or of a partnership, joint venture, trust or other enterprise, to the fullest extent permitted by Delaware law. Michaels' certificate of incorporation also requires that Michaels advance expenses incurred by such a person in connection with the defense of any action or proceeding arising out of that person's status or service to Michaels. The bylaws of Michaels require that it indemnify its directors to the fullest extent permitted by Delaware law and may, if and to the extent authorized by Michaels' board of directors, so indemnify its officers and any other person whom it has the power to indemnify against any liability, expense or other matter whatsoever. As authorized by its certificate of incorporation, Michaels has procured insurance that purports (a) to insure it against certain costs of indemnification that may be incurred by it pursuant to the provisions referred to above or otherwise and (b) to insure the directors and officers of Michaels against certain liabilities incurred by them in the discharge of their functions as directors and officers except for liabilities arising from their own malfeasance. ITEM 21. EXHIBITS The following is a list of all exhibits filed as a part of this registration statement on Form S-4, including those incorporated by reference.
EXHIBIT NUMBER DESCRIPTION OF EXHIBITS --------------------- ----------------------- 3.1(ii) Amended and Restated Bylaws of Michaels Stores, Inc. 4.1 Form of Common Stock Certificate (previously filed as Exhibit 4.1 to Michaels' Annual Report on Form 10-K for the year ended January 30, 1994, Commission File No. 000-11822, filed April 29, 1994, and incorporated herein by reference)
II-1
EXHIBIT NUMBER DESCRIPTION OF EXHIBITS --------------------- ----------------------- 4.2 Indenture, dated as of June 26, 1996, by and between Michaels Stores, Inc. and The Bank of New York (previously filed as Exhibit 4 to Form 10-Q for the quarter ended July 28, 1996, filed by Registrant on September 30, 1996) (File No. 000-11822) 4.3 Indenture, dated as of July 6, 2001, by and between Michaels Stores, Inc. and The Bank of New York, as Trustee 4.4 Registration Rights Agreement, dated as of July 6, 2001, by and among Michaels Stores, Inc. and Merrill Lynch, Pierce, Fenner & Smith Incorporated, Credit Suisse First Boston Corporation, Deutsche Banc Alex. Brown Inc., Fleet Securities, Inc. and Wells Fargo Brokerage Services, LLC 5.1 Opinion of Jones, Day, Reavis & Pogue 12.1 Ratio of Earnings to Fixed Charges 23.1 Consent of Ernst & Young LLP 23.2 Consent of Jones, Day, Reavis & Pogue (included in Exhibit 5.1) 24.1 Power of attorney 25.1 Statement of Eligibility under the Trust Indenture Act of 1939 on Form T-1. 99.1 Letter of Transmittal 99.2 Notice of Guaranteed Delivery 99.3 Letter regarding Exchange Offer 99.4 Letter to Depository Trust Company Participants
ITEM 22. UNDERTAKINGS (a) The undersigned registrant hereby undertakes: (1) To file, during any period in which offers or sales are being made, a post-effective amendment to this registration statement: (i) To include any prospectus required by Section 10(a)(3) of the Securities Act of 1933; (ii) To reflect in the prospectus any facts or events arising after the effective date of the registration statement (or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in the registration statement. Notwithstanding the foregoing, any increase or decrease in volume of securities offered (if the total dollar value of securities offered would not exceed that which was registered) and any deviation from the low or high end of the estimated maximum offering range may be reflected in the form of prospectus filed with the Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume and price represent no more than a 20% change in the maximum aggregate offering price set forth in the "Calculation of Registration Fee" table in the effective registration statement; and (iii) To include any material information with respect to the plan of distribution not previously disclosed in the registration statement or any material change to such information in the registration statement; provided, however, that paragraphs (1)(i) and (1)(ii) do not apply if the registration statement is on Form S-3 or Form S-8, and the information required to be included in a post-effective amendment by those paragraphs is contained in periodic reports filed with or furnished to the Commission by the registrant pursuant to Sections 13 or II-2 15(d) of the Securities Exchange Act of 1934 that are incorporated by reference in the registration statement. (2) That, for the purpose of determining any liability under the Securities Act of 1933, each such post-effective amendment shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. (3) To remove from registration by means of a post-effective amendment any of the securities being registered which remain unsold at the termination of the offering. (b) The undersigned registrant hereby undertakes that, for purposes of determining any liability under the Securities Act of 1933, each filing of the registrant's annual report pursuant to Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934 (and, where applicable, each filing of an employee benefit plan's annual report pursuant to Section 15(d) of the Securities Exchange Act of 1934) that is incorporated by reference in the registration statement shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. (c) Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue. (d) The undersigned registrant hereby undertakes to respond to requests for information that is incorporated by reference into the prospectus pursuant to Items 4, 10(b), 11, or 13 of this form, within one business day of receipt of such request, and to send the incorporated documents by first class mail or other equally prompt means. This includes information contained in documents filed subsequent to the effective date of the registration statement through the date of responding to the request. (e) The undersigned registrant hereby undertakes to supply by means of a post-effective amendment all information concerning a transaction, and the company being acquired involved therein, that was not the subject of and included in the registration statement when it became effective. II-3 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the Registrant has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Irving, State of Texas, on August 1, 2001. MICHAELS STORES, INC. By: /s/ BRYAN M. DECORDOVA ----------------------------------------- Bryan M. DeCordova EXECUTIVE VICE PRESIDENT-CHIEF FINANCIAL OFFICER
Pursuant to the requirements of the Securities Act of 1933, this Registration Statement has been signed below by the following persons in the capacities indicated as of August 1, 2001.
SIGNATURES TITLE ---------- ----- * Chairman of the Board of Directors - -------------------------------------------- Charles J. Wyly, Jr. * Vice Chairman of the Board of Directors - -------------------------------------------- Sam Wyly * President and Chief Executive Officer - -------------------------------------------- (Principal Executive Officer) R. Michael Rouleau /s/ BRYAN M. DECORDOVA Executive Vice President-Chief Financial - -------------------------------------------- Officer (Principal Financial and Accounting Bryan M. DeCordova Officer) Director - -------------------------------------------- Richard E. Hanlon * Director - -------------------------------------------- Richard Marcus Director - -------------------------------------------- Elizabeth A. VanStory
* The undersigned by signing his name hereto does sign and execute this Registration Statement pursuant to the Powers of Attorney executed by the above-named directors and officers of the Registrant, which are being filed herewith the SEC on behalf of such directors and officers. By: /s/ BRYAN M. DECORDOVA -------------------------------------- Bryan M. DeCordova ATTORNEY-IN-FACT
II-4 INDEX TO EXHIBITS
EXHIBIT NUMBER DESCRIPTION OF EXHIBIT --------------------- ---------------------- 3.1(ii) Amended and Restated Bylaws of Michaels Stores, Inc. 4.1 Form of Common Stock Certificate (previously filed as Exhibit 4.1 to Michaels' Annual Report on Form 10-K for the year ended January 30, 1994, Commission File No. 000-11822, filed April 29, 1994, and incorporated herein by reference) 4.2 Indenture, dated as of June 26, 1996, by and between Michaels Stores, Inc. and The Bank of New York (previously filed as Exhibit 4 to Form 10-Q for the quarter ended July 28, 1996, filed by Registrant on September 30, 1996) (File No. 000-11822) 4.3 Indenture, dated as of July 6, 2001, by and between Michaels Stores, Inc. and The Bank of New York, as Trustee 4.4 Registration Rights Agreement, dated as of July 6, 2001, by and among Michaels Stores, Inc. and Merrill Lynch, Pierce, Fenner & Smith Incorporated, Credit Suisse First Boston Corporation, Deutsche Banc Alex. Brown Inc., Fleet Securities, Inc. and Wells Fargo Brokerage Services, LLC 5.1 Opinion of Jones, Day, Reavis & Pogue 12.1 Ratio of Earnings to Fixed Charges 23.1 Consent of Ernst & Young LLP 23.2 Consent of Jones, Day, Reavis & Pogue (included in Exhibit 5.1) 24.1 Power of attorney 25.1 Statement of Eligibility under the Trust Indenture Act of 1939 on Form T-1. 99.1 Letter of Transmittal 99.2 Notice of Guaranteed Delivery 99.3 Letter regarding Exchange Offer 99.4 Letter to Depository Trust Company Participants
EX-3.1(II) 3 a2055355zex-3_1ii.txt EXHIBIT 3.1(II) EXHIBIT 3.1(ii) AMENDED AND RESTATED BYLAWS OF MICHAELS STORES, INC. ARTICLE I OFFICES SECTION 1. REGISTERED OFFICE. The initial registered office of the corporation shall be at such place as is designated in the Certificate of Incorporation (herein, as amended from time to time, so called) and thereafter the registered office may be at such other place as the Board of Directors may from time to time designate by resolution. SECTION 2. OTHER OFFICES. The corporation may also have offices at such other places both within and without the State of Delaware as the Board of Directors may from time to time determine or the business of the corporation may require. ARTICLE II STOCKHOLDERS SECTION 1. MEETINGS. All meetings of the stockholders for the election of Directors shall be held at the principal office of the corporation or at such other place, within or without the State of Delaware, as may be fixed from time to time by the Board of Directors. Meetings of stockholders for any other purpose may be held at such time and place, within or without the State of Delaware, as shall be stated in the notice of the meeting or in a duly executed waiver of notice thereof. The Chairman, Vice Chairman, Chief Executive Officer or President, or such other officer of the corporation designated by the Board of Directors, will call meetings of the stockholders to order and will act as presiding officer thereof. Except as otherwise provided by the General Corporation Law of the State of Delaware (herein called the "Act") or the Certificate of Incorporation or unless otherwise determined by the Board of Directors prior to the meeting, the presiding officer of the meeting of the stockholders will also determine the order of business and have the authority in his sole discretion to regulate the conduct of the meeting, including, without limitation, by imposing restrictions on the persons (other than stockholders of the corporation or their duly appointed proxies) who may attend any such meeting of the stockholders, by ascertaining whether any stockholder or the stockholder's proxy may be excluded from any meeting of the stockholders based upon any determination, by the presiding officer, in his sole discretion, that any such person has unduly disrupted or is likely to disrupt the proceedings at the meeting of the stockholders and by determining the circumstances in which any person may make a statement or ask questions at any meeting of the stockholders. SECTION 2. ANNUAL MEETING. (a) An annual meeting of the stockholders shall be held on such date in each fiscal year of the corporation as the Board of Directors will select, if not a legal holiday, and if a legal holiday, then on the next secular day following, at which meeting the stockholders shall elect members of the Board of Directors, and transact such other business as may properly be brought before the meeting. (b) At an annual meeting of the stockholders, only such business will be conducted or considered as is properly brought before the meeting. To be properly brought before an annual meeting, business must be (i) specified in the notice of meeting (or any supplement thereto) given by or at the direction of the Board of Directors (or any duly authorized committee thereof), (ii) otherwise properly brought before the annual meeting by or at the direction of the Board of Directors (or any duly authorized committee thereof) or (iii) otherwise properly brought before the annual meeting by any stockholder of the corporation (A) who is a stockholder of record on the date of the giving of the notice provided for in this Section 2 and on the record date for the determination of stockholders entitled to vote at such annual meeting and (B) who complies with the notice procedures set forth in this Section 2. In addition to any other applicable requirements, for business to be properly brought before an annual meeting by a stockholder, the stockholder must have given timely notice thereof in proper written form to the Secretary of the corporation. To be timely, a stockholder's notice must be delivered to or mailed and received at the principal executive offices of the corporation not less than sixty nor more than ninety days prior to the date on which the corporation first mailed its proxy materials for the prior year's annual meeting of stockholders; provided, however, that in the event that the annual meeting is called for a date that is not within thirty days before or after the anniversary of the prior year's annual meeting, notice by the stockholder to be timely must be so received not later than the close of business on the tenth calendar day following the date on which public disclosure of the date of the annual meeting was made. In no event will the public disclosure of an adjournment of an annual meeting commence a new time period for the giving of a stockholder's notice as described above. For purposes of the foregoing, the date on which the corporation first mailed its proxy materials to stockholders will be the date so described in such proxy materials. Notwithstanding the foregoing, for a stockholder's notice regarding the nomination of directors to be timely, the requirements of Article Seven of the Certificate of Incorporation must be met. (c) A stockholder's notice to the Secretary shall set forth as to each matter the stockholder proposes to bring before the annual meeting (i) a brief description of the business desired to be brought before the annual meeting and the reasons for conducting such business at the annual meeting, (ii) the name and address, as they appear on the corporation's books, of the stockholder proposing such business, (iii) the class and number of shares of the corporation which are beneficially owned by the stockholder or of record by such stockholder, (iv) a description of all arrangements or understandings between such stockholder and any other person or persons (including their names) in connection with the proposal of such business by such stockholder and any material interest of the stockholder in such business and (v) a representation that such stockholder intends to appear in person or by proxy at the annual meeting to bring such business before the meeting. (d) No business shall be conducted at an annual meeting except in accordance with the procedures set forth in this Section 2. If the presiding officer of an annual meeting determines that business was not properly brought before the meeting in accordance with the provisions of this Section 2, such presiding officer shall declare to the meeting that the business was not properly brought before the meeting and such business shall not be transacted. 2 SECTION 3. LIST OF STOCKHOLDERS. At least ten days before each meeting of stockholders, a complete list of the stockholders entitled to vote at said meeting, arranged in alphabetical order, with the address of and the number of voting shares held by each, shall be prepared by the officer or agent having charge of the stock transfer books. Nothing contained in this Section shall require the corporation to include electronic mail addresses or other electronic contact information on such list. Such list shall be open to the examination of any stockholder, for any purpose germane to the meeting, for a period of at least ten days prior to the meeting: (i) on a reasonably accessible electronic network, provided that the information required to gain access to such list is provided with the notice of the meeting; or (ii) during ordinary business hours, at the principal place of business of the corporation. In the event that the corporation determines to make the list available on an electronic network, the corporation may take reasonable steps to ensure that such information is available only to stockholders of the corporation. If the meeting is to be held at a place, then the list shall be produced and kept at the time and place of the meeting during the whole time thereof, and may be inspected by any stockholder who is present. If the meeting is to be held solely by means of remote communication, then the list shall also be open to the examination of any stockholder during the whole time of the meeting on a reasonably accessible electronic network, and the information required to access such list shall be provided with the notice of the meeting. The Board of Directors may fix in advance a record date for the purpose of determining stockholders entitled to notice of or to vote at a meeting of stockholders, such record date to be not less than ten nor more than sixty days prior to such meeting. In the absence of any action by the Board of Directors, the close of business on the day next preceding the day on which notice is given shall be the record date. SECTION 4. SPECIAL MEETINGS. Special meetings of the stockholders, for any purpose or purposes, unless otherwise prescribed by the Act, or by the Certificate of Incorporation, or by these Bylaws (herein, as amended from time to time, so called), may be called by the Board of Directors. At a special meeting of stockholders, only such business may be conducted or considered as is properly brought before the meeting. To be properly brought before a special meeting, business must be (i) specified in the notice of the meeting (or any supplement thereto) given by or at the direction of the Board in accordance with these Bylaws or (ii) otherwise properly brought before the meeting by the presiding officer or by or at the direction of a majority of the Board. The determination of whether any business sought to be brought before any special meeting of the stockholders is properly brought before such meeting in accordance with this Section 4 will be made by the presiding officer of such meeting. If the presiding officer determines that any business is not properly brought before such meeting, he will so declare to the meeting and such business will not be conducted or considered. SECTION 5. NOTICE. Notice stating the place, if any, day and hour of any meeting of the stockholders and, in case of a special meeting, the purpose or purposes for which the meeting is called, shall be delivered not less than ten nor more than sixty days before the date of the meeting, either personally, by a form of electronic transmission consented to by the stockholder, or by mail, by or at the direction of the Secretary, or the officer or person calling the meeting, to each stockholder of record entitled to vote at the meeting. Such notice shall include the means of remote communication, if any, by which stockholders and proxyholders may be deemed to be present in person and vote at such meeting. 3 SECTION 6. QUORUM. At all meetings of the stockholders, the presence in person or by proxy of the holders of a majority of the shares issued and outstanding and entitled to vote shall be necessary and sufficient to constitute a quorum for the transaction of business except as otherwise provided by the Act, by the Certificate of Incorporation or by these Bylaws. If, however, such quorum shall not be present or represented at any meeting of the stockholders, the stockholders entitled to vote thereat, present in person or represented by proxy, shall have the power to adjourn the meeting from time to time, without notice other than announcement at the meeting, until a quorum shall be present or represented, provided, however, that if the adjournment is for more than thirty days, or if after the adjournment a new record date is fixed for the adjourned meeting, a notice of the adjourned meeting shall be given to each stockholder of record entitled to vote at the meeting. At such adjourned meeting at which a quorum shall be present or represented, any business may be transacted which might have been transacted at the meeting as originally notified. SECTION 7. VOTING. When a quorum is present at any meeting, the vote of the holders of a majority of the shares which have voting power present in person or represented by proxy at such meeting and which have actually voted shall decide any questions brought before such meeting, unless the question is one upon which, by express provision of the Act or of the Certificate of Incorporation or of these Bylaws (including, but not limited to, Article III of these Bylaws), a different vote is required, in which case such express provision shall govern and control the decision of such question. The stockholders present in person or represented by proxy at a duly organized meeting may continue to transact business until adjournment, notwithstanding the withdrawal of enough stockholders to leave less than a quorum. For purposes of determining under this Section 7 the decision of any question brought before the meeting, shares which abstain, by proxy or in person, in the vote on such decision, shares represented by proxy which withholds authority to vote for, against or with respect to such decision, and shares held of record by a broker or other nominee with respect to which such broker or nominee does not have authority to vote such shares on such question shall not be considered to have been actually voted. SECTION 8. PROXY. Each outstanding share, regardless of class, shall be entitled to one vote on each matter submitted to a vote at a meeting of stockholders, except to the extent that the voting rights of the shares of any class or classes are limited or denied by the Certificate of Incorporation. At any meeting of the stockholders, every stockholder having the right to vote shall be entitled to vote in person or by proxy appointed by an instrument in writing subscribed by such stockholder, or by his duly authorized attorney in fact, and bearing a date not more than three years prior to said meeting, unless said instrument provides for a longer period. Such proxy shall be filed with the Secretary of the corporation prior to or at the time of the meeting. A duly elected proxy shall be irrevocable if, and only as long as, it is coupled with an interest sufficient in law to support an irrevocable power. A proxy may be made irrevocable regardless of whether the interest with which it is coupled is an interest in the stock itself or an interest in the corporation generally. 4 ARTICLE III BOARD OF DIRECTORS SECTION 1. BOARD OF DIRECTORS. The business and affairs of the corporation shall be managed by its Board of Directors who may exercise all such powers of the corporation and do all such lawful acts and things as are not by the Act or by the Certificate of Incorporation or by these Bylaws directed or required to be exercised or done by the stockholders. SECTION 2. NUMBER OF DIRECTORS; ELECTION. The exact number of Directors shall be fixed by resolution of the Board of Directors from time to time, none of whom need be stockholders or residents of the State of Delaware. The Directors shall be elected by plurality vote at the annual meeting of the stockholders, except as may be provided from time to time in the Certificate of Incorporation (or, in the case of vacancies, below), and each Director elected shall hold office until his successor shall be elected and shall qualify. SECTION 3. VACANCIES AND NEW DIRECTORSHIPS. Any Director may be removed either for or without cause, as provided in the Certificate of Incorporation. Newly created directorships resulting from any increase in the number of directors and any vacancies occurring in the Board of Directors for any reason will be filled by the vote of a majority of the Directors then in office, although less than a quorum, or, if there is no remaining Director, by the stockholders. Each successor Director so chosen shall hold office until the next election of the class for which such directors shall have been chosen and until their successors shall be elected and qualified. ARTICLE IV MEETINGS OF THE BOARD SECTION 1. MEETINGS. The Directors of the corporation may hold their meetings, both regular and special, at such times and places as are fixed from time to time by resolution of the Board of Directors. SECTION 2. ANNUAL MEETING. The first meeting of each newly elected Board of Directors shall be held without further notice immediately following the annual meeting of stockholders, and at the same place, unless by unanimous consent of the Directors then elected and serving such time or place shall be changed. SECTION 3. REGULAR MEETINGS. Regular meetings of the Board of Directors may be held without notice at such time and place as shall from time to time be determined by resolution of the Board. SECTION 4. SPECIAL MEETINGS. Special meetings of the Board of Directors may be called by the Chairman of the Board, the Vice Chairman of the Board or by a majority of the Directors in office. The purpose of any special meeting shall be specified in the notice or any waiver of notice. Each notice of a meeting of the Board of Directors may be delivered personally or by telephone to a Director not later than the day before the day on which the meeting is to be held; sent to a Director at his residence or usual place of business, or at any 5 other place of which he will have notified the corporation by telegram, telex, cable, wireless, facsimile, electronic transmission or similar means at least 24 hours before the time at which the meeting is to be held; or posted to him at such place by prepaid first class or air mail, as appropriate, at least three days before the day on which the meeting is to be held. Notice of a meeting of the Board of Directors need not be given to any Director who submits a signed waiver of notice, whether before or after the meeting, or who attends the meeting without protesting, prior to or at its commencement, the lack of notice to him. SECTION 5. QUORUM. At all meetings of the Board of Directors the presence of a majority of the number of Directors then constituting the Board of Directors shall be necessary and sufficient to constitute a quorum for the transaction of business, and the affirmative vote of at least a majority of the Directors present at any meeting at which there is a quorum shall be the act of the Board of Directors, except as may be otherwise specifically provided by the Act or by the Certificate of Incorporation or by these Bylaws. If a quorum shall not be present at any meeting of Directors, the Directors present thereat may adjourn the meeting from time to time without notice other than announcement at the meeting, until a quorum shall be present. SECTION 6. EXECUTIVE COMMITTEE. The Board of Directors may, by resolution passed by a majority of the whole Board, designate an Executive Committee, to consist of two or more Directors of the corporation, one of whom shall be designated as chairman, who shall preside at all meetings of such Committee. To the extent provided in the resolution of the Board of Directors, the Executive Committee shall have and may exercise all of the authority of the Board of Directors in the management of the business and affairs of the corporation, except where action of the Board of Directors as a whole is expressly required by the Act or by the Certificate of Incorporation and shall have power to authorize the seal of the corporation to be affixed to all papers which may require it. The Executive Committee shall keep regular minutes of its proceedings and report the same to the Board of Directors when required. Any member of the Executive Committee may be removed, for or without cause, by the affirmative vote of a majority of the whole Board of Directors. If any vacancy or vacancies occur in the Executive Committee caused by death, resignation, retirement, disqualification, removal from office or otherwise, the vacancy shall the filled by the affirmative vote of a majority of the whole Board of Directors. SECTION 7. OTHER COMMITTEES. The Board of Directors may, by resolution passed by a majority of the whole Board, designate other committees, each committee to consist of two or more Directors of the corporation, which committees shall have such power and authority and shall perform such functions as may be provided in such resolution. Such committee or committees shall have such name or names as may be designated by the Board and shall keep regular minutes of their proceedings and report the same to the Board of Directors when required. SECTION 8. ACTION BY CONSENT. Any action required or permitted to be taken at any meeting of the Board of Directors, the Executive Committee or any other committee of the Board of Directors, may be taken without such a meeting if a consent in writing, setting forth the action so taken, is signed by all the members of the Board of Directors or the Executive Committee or such other committee, as the case may be and the writing or writings are filed with the minutes of proceedings of the Board or Committee. 6 SECTION 9. COMPENSATION OF DIRECTORS. Directors, as such, shall not receive any stated salary for their services, but may receive such compensation and reimbursements as may be determined from time to time by resolution of the Board; provided that nothing herein contained shall be construed to preclude any Director from serving the corporation in any other capacity and receiving compensation therefor. ARTICLE V NOTICE OF MEETINGS SECTION 1. FORM OF NOTICE. Whenever under the provisions of the Act or of the Certificate of Incorporation or of these Bylaws, notice is required to be given to any Director or stockholder, and no provision is made as to how such notice shall be given, it shall not be construed to mean personal notice, but any such notice may be given (a) in writing, by mail, postage prepaid, addressed to such Director or stockholder at such address as appears on the books of the corporation or (b) by electronic transmission to any (i) Director or (ii) stockholder who consents to receipt by such means. Any notice required or permitted to be given by mail shall be deemed to be given at the time when the same be thus deposited in the United States mails as aforesaid. SECTION 2. WAIVER. Whenever any written notice is required to be given to any stockholder or Director of the corporation, under the provisions of the Act or of the Certificate of Incorporation or of these Bylaws, a waiver thereof in writing signed by the person or persons entitled to such notice, whether before or after the time stated in such notice, shall be deemed equivalent to the giving of such notice. SECTION 3. TELEPHONE MEETINGS. Members of the Board of Directors or members of any committee designated by the Board of Directors may participate in and hold meetings of such Board or committee by means of conference telephone or other communications equipment by means of which all persons participating in the meeting can hear each other. ARTICLE VI OFFICERS SECTION 1. IN GENERAL. The officers of the corporation shall be elected by the Board of Directors and shall be a Chief Executive Officer, a President, a Vice President, a Secretary and a Treasurer. The Board of Directors may also elect a Chairman of the Board, Vice Chairman of the Board, additional Vice Presidents, Assistant Vice Presidents, a Controller, and one or more Assistant Secretaries and Assistant Treasurers. Any two or more offices may be held by the same person. Any of the offices may be left vacant from time to time as the Board may determine. SECTION 2. ELECTION. The Board of Directors, at its first meeting after each annual meeting of stockholders, or at any other time, may elect a Chief Executive Officer, a President, 7 one or more Vice Presidents, a Secretary and a Treasurer, none of whom need be a member of the Board of Directors. SECTION 3. OTHER OFFICERS AND AGENTS. The Board of Directors may also elect and appoint such other officers and agents as it shall deem necessary, who shall be elected and appointed for such terms and shall exercise such powers and perform such duties as shall be determined from time to time by the Board. SECTION 4. SALARIES. The salaries of all officers and agents of the corporation shall be fixed by the Board of Directors or by the Executive Committee, if so authorized by the Board. SECTION 5. TERM OF OFFICE AND REMOVAL. Each officer of the corporation shall hold office until his death, or his resignation or removal from office, or the election and qualification of his successor, whichever shall first occur. Any officer or agent elected or appointed by the Board of Directors may be removed by the Board of Directors, whenever in its judgment the best interest of the corporation will be served thereby. If the office of any officer becomes vacant for any reason, the vacancy may be filled by the Board of Directors. SECTION 6. CHAIRMAN OF THE BOARD. The Chairman of the Board, if any, shall preside at all meetings of the Board at which he may be present and shall be ex officio a member of all standing committees and shall perform such other duties as may be assigned to him by the Board of Directors. SECTION 7. VICE CHAIRMAN OF THE BOARD. The Vice Chairman of the Board, if any, shall have such powers and perform such duties as the Board of Directors or the Executive Committee may from time to time prescribe. In the absence or disability of the Chairman of the Board, the Vice Chairman of the Board shall perform the duties and exercise the powers of the Chairman of the Board. SECTION 8. CHIEF EXECUTIVE OFFICER. The Chief Executive Officer of the corporation shall have, subject only to the Board of Directors and the Executive Committee, general and active management and supervision of the business and affairs of the corporation and shall see that all orders and resolutions of the Board of Directors and the Executive Committee are carried into effect. He shall have all powers and duties of supervision and management usually vested in the general manager of a corporation, including, without limitation, the supervision and direction of all other officers of the corporation (other than the Chairman of the Board and the Vice Chairman of the Board) and the power to appoint and discharge agents and employees. SECTION 9. PRESIDENT. The President shall have, subject only to the Board of Directors and the Executive Committee and, if the President is not also the Chief Executive Officer, the Chief Executive Officer, general charge of the business, affairs and property of the corporation, and control over its officers, agents and employees. The President shall perform such other duties as from time to time may be assigned to him by the Board of Directors or the Executive Committee or, if the President is not also the Chief Executive Officer, the Chief Executive Officer of the corporation. 8 SECTION 10. VICE PRESIDENTS. Each Vice President shall have such power and perform such duties as the Board of Directors or the Executive Committee may from time to time prescribe, or as the Chief Executive Officer or President may from time to time delegate to him. In the absence or disability of the President, a Vice President designated by the Board of Directors shall perform the duties and exercise the powers of the President. SECTION 11. SECRETARY. The Secretary shall attend all meetings of the stockholders and record all votes and the minutes of all proceedings in a book to be kept for that purpose. The Secretary shall perform like duties for the Board of Directors and the Executive Committee when required. He shall give, or cause to be given, notice of all meetings of the stockholders and special meetings of the Board of Directors and shall perform such other duties as may be prescribed by the Board of Directors or the Executive Committee or the Chief Executive Officer, under whose supervision he shall be. He shall keep in safe custody the seal of the corporation. SECTION 12. ASSISTANT SECRETARIES. Each Assistant Secretary shall have such power and perform such duties as the Board of Directors may from time to time prescribe. Unless otherwise provided by the Board of Directors, in the absence or disability of the Secretary, any Assistant Secretary may perform the duties and exercise the powers of the Secretary. SECTION 13. TREASURER. The Treasurer shall have the custody of all corporate funds and securities, shall keep full and accurate accounts of receipts and disbursements of the corporation, and shall deposit all moneys and other valuable effects in the name and to the credit of the corporation in such depositories as may be designated by the Board of Directors. He shall disburse the funds of the corporation as may be ordered by the Board of Directors, taking proper vouchers for such disbursements, shall render to the Chief Executive Officer and Directors, at the regular meetings of the Board, or whenever they may require it, an account of all his transactions as Treasurer and of the financial condition of the corporation, and shall perform such other duties as the Board of Directors may prescribe. SECTION 14. ASSISTANT TREASURERS. Each Assistant Treasurer shall have such powers and perform such duties as the Board of Directors may from time to time prescribe. Unless otherwise provided by the Board of Directors, in the absence or disability of the Treasurer, any Assistant Treasurer may perform the duties and exercise the powers of the Treasurer. SECTION 15. CONTROLLER. The Controller shall share with the Treasurer responsibility for the financial and accounting books and records of the corporation, shall report to the Treasurer, and shall perform such other duties as the Board of Directors or the Executive Committee or the Chief Executive Officer may from time to time prescribe. SECTION 16. BONDING. If required by the Board of Directors, all or certain of the officers shall give the corporation a bond, in such form, in such sum, and with such surety or sureties as shall be satisfactory to the Board, for the faithful performance of the duties of their office and for the restoration to the corporation, in case of their death, resignation, retirement or removal from office, of all books, papers, vouchers, money and other property of whatever kind in their possession or under their control belonging to the corporation. 9 ARTICLE VII CERTIFICATES OF SHARES SECTION 1. FORM OF CERTIFICATES. Certificates, in such form as may be determined by the Board of Directors, representing shares to which stockholders are entitled shall be delivered to each stockholder. Such certificates shall be consecutively numbered and shall be entered in the stock book of the corporation as they are issued. Each certificate shall state on the face thereof the holder's name, the number, class of shares, and the par value of such shares or a statement that such shares are without par value. They shall be signed by the Chairman of the Board or the Vice Chairman of the Board, or the President or a Vice President, and by the Treasurer or an Assistant Treasurer, or the Secretary or an Assistant Secretary, and may be sealed with the seal of the corporation or a facsimile thereof. If any certificate is countersigned by a transfer agent, or an assistant transfer agent or registered by a registrar, either of which is other than the corporation or an employee of the corporation, the signatures of the corporation's officer may be facsimiles. In case any officer or officers who have signed, or whose facsimile signature or signatures have been used on such certificates, shall cease to be such officer or officers of the corporation, whether because of death, resignation or otherwise, before such certificate or certificates have been delivered by the corporation or its agents, such certificate or certificates may nevertheless be adopted by the corporation and be issued and delivered as though the person or persons who signed such certificate or certificates or whose facsimile signature or signatures have been used thereon had not ceased to be such officer or officers of the corporation. SECTION 2. LOST CERTIFICATES. The Board of Directors may direct that a new certificate be issued in place of any certificate theretofore issued by the corporation alleged to have been lost, stolen or destroyed and the Board of Directors may require the owner of such lost, stolen or destroyed certificate, or his legal representative, to give the corporation a bond, in such form, in such sum, and with such surety or sureties as it may direct as indemnity against any claim that may be made against the corporation with respect to the certificate alleged to have been lost, stolen or destroyed. SECTION 3. TRANSFER OF SHARES. Shares of stock shall be transferable only on the books of the corporation by the holder thereof in person or by his duly authorized attorney, lawfully constituted in writing. No transfer shall be made which is inconsistent with law. SECTION 4. REGISTERED STOCKHOLDERS. The corporation shall be entitled to treat the holder of record of any share or shares of stock as the holder in fact thereof and, accordingly, shall not be bound to recognize any equitable or other claim to or interest in such share or shares on the part of any other person, whether or not it shall have express or other notice thereof, except as otherwise provided by law. 10 ARTICLE VIII GENERAL PROVISIONS SECTION 1. DIVIDENDS. Dividends upon the outstanding shares of the corporation, subject to the provisions of the Certificate of Incorporation, if any, may be declared by the Board of Directors at any regular or special meeting. Dividends may be declared and paid in cash, in property, or in shares of the corporation, subject to the provisions of the Act and the Certificate of Incorporation. The Board of Directors may fix in advance a record date for the purpose of determining stockholders entitled to receive payment of any dividend, such record date to be not more than sixty days prior to the payment date of such dividend, or the Board of Directors may close the stock transfer books for such purpose for a period of not more than sixty days prior to the payment date of such dividend. In the absence of any action by the Board of Directors, the date upon which the Board of Directors adopts the resolution declaring such dividend shall be the record date. SECTION 2. RESERVES. There may be created by resolution of the Board of Directors out of the net profits of the corporation such reserve or reserves as the Directors from time to time, in their discretion, think proper to provide for contingencies, or to equalize dividends, or to repair or maintain any property of the corporation, or for such other purpose as the Directors shall think beneficial to the corporation, and the Directors may modify or abolish any such reserve in the manner in which it was created. SECTION 3. FISCAL YEAR. The fiscal year of the corporation shall be fixed by resolution of the Board of Directors. SECTION 4. SEAL. The corporation shall have a seal, and said seal may be used by causing it or a facsimile thereof to be impressed or affixed or reproduced or otherwise. Any officer of the corporation shall have authority to affix the seal to any document requiring it. SECTION 5. ANNUAL STATEMENT. The Board of Directors shall present at each annual meeting, and when called for by vote of the stockholders at any special meeting of the stockholders, a full and clear statement of the business and condition of the corporation. SECTION 6. CHECKS. All checks or demands for money and notes of the corporation shall be signed by such officer or officers or such other person or persons as the Board of Directors may from time to time designate. SECTION 7. TIME PERIODS. In applying any provision of these Bylaws that requires that an act be done or not be done a specified number of days prior to an event or that an act be done during a period of a specified number of days prior to an event, calendar days will be used unless otherwise specified, the day of the doing of the act will be excluded and the day of the event will be included. 11 ARTICLE IX INDEMNITY SECTION 1. INDEMNIFICATION. The corporation shall indemnify its directors and officers to the fullest extent permitted by the Act and the Certificate of Incorporation and may, if and to the extent authorized by the Board of Directors, so indemnify any other person whom it has the power to indemnify against any liability, expense or other matter whatsoever. SECTION 2. INDEMNIFICATION ADDITIONAL TO OTHER RIGHTS. The rights of indemnification provided for in this Article IX shall be in addition to any rights to which any such Director, officer or employee may be entitled under any agreement, vote of stockholders, the Certificate of Incorporation, or as a matter of law or otherwise. ARTICLE X AMENDMENTS SECTION 1. BY STOCKHOLDERS. These Bylaws may be amended or repealed by the vote of stockholders entitled to at least a majority of the votes which all stockholders are entitled to cast thereon, at any regular or special meeting of the stockholders, duly convened after notice to the stockholders of the purpose. SECTION 2. BY THE BOARD OF DIRECTORS. These Bylaws may also be amended or repealed by the Board of Directors by the vote of a majority of Directors, except as such power may be limited by any one or more bylaws adopted by the stockholders. Adopted: June 29, 2001 /s/ MARK V. BEASLEY ----------------------------- Mark V. Beasley, Secretary 12 EX-4.3 4 a2055355zex-4_3.txt EXHIBIT 4.3 Exhibit 4.3 MICHAELS STORES, INC. 9 1/4% Senior Notes Due 2009 INDENTURE Dated as of July 6, 2001 THE BANK OF NEW YORK, as Trustee CROSS REFERENCE TABLE
TIA Indenture Section Section 310(a)(1)................................................................7.10 (a)(2)................................................................7.10 (a)(3)................................................................N.A. (a)(4)..................................................................A. (b)..............................................................7.8; 7.10 (c)...................................................................N.A. 311(a)...................................................................7.11 (b)...................................................................7.11 312(a)....................................................................2.5 (b)..............................................................2.5; 10.3 (c)...................................................................10.3 313(a)...................................................................10.3 (b)(1).................................................................7.6 (b)(2)................................................................N.A. (c)...................................................................10.2 (d)....................................................................7.6 314(a)........................................................4.2; 4.10; 10.2 (b)...................................................................N.A. (c)(1)................................................................10.4 (c)(2)................................................................10.4 (c)(3)................................................................N.A. (d)...................................................................N.A. (e)...................................................................10.5 (f)...................................................................4.10 315(a)....................................................................7.1 (b).............................................................7.5; 10.2 (c)....................................................................7.1 (d)....................................................................7.1 (e)...................................................................6.11 316(a) (last sentence)...................................................10.6 (a)(1)(A)..............................................................6.5 (a)(1)(B)..............................................................6.4 (a)(2)................................................................N.A. (b)....................................................................6.7 317(a)(1).................................................................6.8 (a)(2).................................................................6.9 (b)....................................................................2.4 318(a)...................................................................10.1
N.A. means Not Applicable. - --------------- Note: This Cross-Reference Table shall not, for any purpose, be deemed to be a part of the Indenture. TABLE OF CONTENTS
PAGE ARTICLE I DEFINITIONS AND INCORPORATION BY REFERENCE.................................................. 1 SECTION 1.1 Definitions...................................................................... 1 SECTION 1.2 Other Definitions................................................................19 SECTION 1.3 Incorporation by Reference of Trust Indenture Act................................20 SECTION 1.4 Rules of Construction............................................................20 ARTICLE II THE SECURITIES.............................................................................21 SECTION 2.1 Form and Dating..................................................................21 SECTION 2.2 Execution and Authentication; Title and Terms....................................22 SECTION 2.3 Registrar and Paying Agent.......................................................23 SECTION 2.4 Paying Agent To Hold Money in Trust..............................................23 SECTION 2.5 Securityholder Lists.............................................................24 SECTION 2.6 Transfer and Exchange............................................................24 SECTION 2.7 Replacement Securities...........................................................26 SECTION 2.8 Outstanding Securities...........................................................27 SECTION 2.9 Temporary Securities.............................................................27 SECTION 2.10 Cancellation.....................................................................27 SECTION 2.11 Defaulted Interest...............................................................28 SECTION 2.12 CUSIP Numbers....................................................................28 ARTICLE III REDEMPTION................................................................................28 SECTION 3.1 Notices to Trustee...............................................................28 SECTION 3.2 Selection of Securities To Be Redeemed...........................................28 SECTION 3.3 Notice of Redemption.............................................................29 SECTION 3.4 Effect of Notice of Redemption...................................................30 SECTION 3.5 Deposit of Redemption Price......................................................30 SECTION 3.6 Securities Redeemed in Part......................................................30 ARTICLE IV COVENANTS..................................................................................31 SECTION 4.1 Payment of Securities............................................................31 SECTION 4.2 SEC Reports......................................................................31 SECTION 4.3 Limitation on Indebtedness.......................................................31 SECTION 4.4 Limitation on Restricted Payments................................................34 -i- TABLE OF CONTENTS (Continued) PAGE SECTION 4.5 Limitation on Restrictions on Distributions from Restricted Subsidiaries.........37 SECTION 4.6 Limitation on Sales of Assets and Subsidiary Stock...............................38 SECTION 4.7 Limitation on Transactions with Affiliates.......................................41 SECTION 4.8 Change of Control................................................................42 SECTION 4.9 Compliance Certificate...........................................................44 SECTION 4.10 Further Instruments and Acts.....................................................44 SECTION 4.11 Limitation on Liens..............................................................44 SECTION 4.12 Limitation on Sale/Leaseback Transactions........................................44 SECTION 4.13 Limitation on Sale of Subsidiary Preferred Stock.................................45 SECTION 4.14 Corporate Existence..............................................................45 SECTION 4.15 Fall Away Event..................................................................45 ARTICLE V SUCCESSOR COMPANY...........................................................................47 SECTION 5.1 When the Company May Merge or Transfer Assets....................................47 ARTICLE VI DEFAULTS AND REMEDIES......................................................................48 SECTION 6.1 Events of Default. An "Event of Default" occurs if:.............................48 SECTION 6.2 Acceleration.....................................................................50 SECTION 6.3 Other Remedies...................................................................50 SECTION 6.4 Waiver of Past Defaults..........................................................50 SECTION 6.5 Control by Majority..............................................................51 SECTION 6.6 Limitation on Suits..............................................................51 SECTION 6.7 Rights of Holders To Receive Payment.............................................51 SECTION 6.8 Collection Suit by Trustee.......................................................52 SECTION 6.9 Trustee May File Proofs of Claim.................................................52 SECTION 6.10 Priorities.......................................................................52 SECTION 6.11 Undertaking for Costs............................................................52 SECTION 6.12 Waiver of Stay or Extension Laws.................................................53 SECTION 6.13 Restoration of Rights and Remedies...............................................53 SECTION 6.14 Rights and Remedies Cumulative...................................................53 SECTION 6.15 Delay or Omission Not Waiver.....................................................53 -ii- TABLE OF CONTENTS (Continued) PAGE SECTION 6.16 Remedies Subject to Applicable Law...............................................54 ARTICLE VII TRUSTEE...................................................................................54 SECTION 7.1 Duties of Trustee................................................................54 SECTION 7.2 Rights of Trustee................................................................55 SECTION 7.3 Individual Rights of Trustee.....................................................56 SECTION 7.4 Trustee's Disclaimer.............................................................56 SECTION 7.5 Notice of Defaults...............................................................56 SECTION 7.6 Reports by Trustee to Holders....................................................57 SECTION 7.7 Compensation and Indemnity.......................................................57 SECTION 7.8 Replacement of Trustee...........................................................58 SECTION 7.9 Successor Trustee by Merger......................................................59 SECTION 7.10 Eligibility; Disqualification....................................................59 SECTION 7.11 Preferential Collection of Claims Against Company................................60 ARTICLE VIII DISCHARGE OF INDENTURE; DEFEASANCE.......................................................60 SECTION 8.1 Satisfaction and Discharge of Indenture; Defeasance..............................60 SECTION 8.2 Conditions to Defeasance.........................................................61 SECTION 8.3 Application of Trust Money.......................................................63 SECTION 8.4 Repayment to Company.............................................................63 SECTION 8.5 Indemnity for Government Obligations.............................................63 SECTION 8.6 Reinstatement....................................................................63 ARTICLE IX AMENDMENTS.................................................................................64 SECTION 9.1 Without Consent of Holders.......................................................64 SECTION 9.2 With Consent of Holders..........................................................64 SECTION 9.3 Compliance with Trust Indenture Act..............................................65 SECTION 9.4 Revocation and Effect of Consents and Waivers....................................65 SECTION 9.5 Notation on or Exchange of Securities............................................66 SECTION 9.6 Trustee To Sign Amendments.......................................................66 ARTICLE X MISCELLANEOUS...............................................................................66 SECTION 10.1 Trust Indenture Act Controls.....................................................66 SECTION 10.2 Notices..........................................................................66 -iii- TABLE OF CONTENTS (Continued) PAGE SECTION 10.3 Communication by Holders with Other Holders......................................67 SECTION 10.4 Certificate and Opinion as to Conditions Precedent...............................67 SECTION 10.5 Statements Required in Certificate or Opinion....................................68 SECTION 10.6 Form of Documents Delivered to Trustee...........................................68 SECTION 10.7 Act of Holders...................................................................69 SECTION 10.8 When Securities Disregarded......................................................69 SECTION 10.9 Rules by Trustee, Paying Agent and Registrar.....................................70 SECTION 10.10 Legal Holidays...................................................................70 SECTION 10.11 Governing Law....................................................................70 SECTION 10.12 No Recourse Against Others.......................................................70 SECTION 10.13 Successors.......................................................................70 SECTION 10.14 Multiple Originals...............................................................70 SECTION 10.15 Table of Contents; Headings......................................................71 SECTION 10.16 Severability Clause..............................................................71 SECTION 10.17 Benefits of the Indentures.......................................................71 SECTION 10.18 Independence of Covenants........................................................71 SECTION 10.19 Schedules and Exhibits...........................................................71 SECTION 10.20 Counterparts.....................................................................71 SECTION 10.21 Interest and Charges.............................................................71
-iv- INDENTURE dated as of July 6, 2001, between MICHAELS STORES, INC., a Delaware corporation (the "Company"), and THE BANK OF NEW YORK, a New York banking corporation (the "Trustee"). RECITALS OF THE COMPANY The Company has duly authorized the creation of an issue of 9 1/4% Senior Notes due 2009, (the "Series A Securities"), and an issue of 9 1/4% Senior Notes due 2009, that may be exchanged in the Exchange Offer (as defined below) for the Series A Securities (the "Series B Securities") (the Series B Securities together with the Series A Securities and the Additional Securities (as defined below) whether Series A Securities or Series B Securities, the "Securities"), of substantially the tenor and amount hereinafter set forth, and to provide therefor the Company has duly authorized the execution and delivery of this Indenture and the Securities; This Indenture is subject to, and shall be governed by, the provisions of the Trust Indenture Act that are required to be part of and to govern indentures qualified under the Trust Indenture Act; All acts and things necessary have been done to make (i) the Securities, when duly issued and executed by the Company and authenticated and delivered hereunder, the valid obligations of the Company, and (ii) this Indenture a valid and legally binding agreement of the Company in accordance with the terms of this Indenture; NOW, THEREFORE, THIS INDENTURE WITNESSETH: For and in consideration of the premises and the purchase of the Securities by the Holders thereof, it is mutually covenanted and agreed, for the equal and proportionate benefit of all Holders of the Securities, as follows: ARTICLE I DEFINITIONS AND INCORPORATION BY REFERENCE SECTION 1.1 Definitions. "Acquired Indebtedness" means Indebtedness of a Person (i) existing at the time such Person becomes a Restricted Subsidiary or (ii) assumed in connection with the acquisition of assets from such Person, in each case, other than Indebtedness incurred in connection with, or in contemplation of, such Person becoming a Restricted Subsidiary or such acquisition, as the case may be. Acquired Indebtedness shall be deemed to be incurred on the date of the related acquisition of assets from any Person or the date the acquired Person becomes a Restricted Subsidiary, as the case may be. "Additional Assets" means (i) any property or assets (other than inventory in the ordinary course of business and other than Indebtedness and Capital Stock) in a Related -1- Business; (ii) the Capital Stock of a Person that becomes a Restricted Subsidiary as a result of the acquisition of such Capital Stock by the Company or another Restricted Subsidiary; or (iii) Capital Stock constituting a minority interest in any Person that at such time is a Restricted Subsidiary; provided, however, that, in the case of clauses (ii) and (iii), such Restricted Subsidiary is primarily engaged in a Related Business. "Additional Securities" means up to $50.0 million aggregate principal amount of Securities (other than the Initial Securities) issued under this Indenture in accordance with Sections 2.2 and 3.6 hereof, as part of the same series as the Initial Securities. "Affiliate" of any specified Person means any other Person, directly or indirectly, controlling or controlled by or under direct or indirect common control with such specified Person. For the purposes of this definition, "control" when used with respect to any Person means the power to direct the management and policies of such Person, directly or indirectly, whether through the ownership of voting securities, by contract or otherwise; and the terms "controlling" and "controlled" have meanings correlative to the foregoing. For purposes of Article IV only, "Affiliate" shall also mean any beneficial owner of shares representing 10% or more of the total voting power of the Voting Stock (on a fully diluted basis) of the Company or of rights or warrants to purchase such Voting Stock (whether or not currently exercisable) and any Person who would be an Affiliate of any such beneficial owner pursuant to the first sentence hereof. "Asset Disposition" means any sale, lease, transfer or other disposition (or series of related sales, leases, transfers or dispositions) of shares of Capital Stock of a Restricted Subsidiary (other than directors' qualifying shares), property or other assets (each referred to for the purposes of this definition as a "disposition") by the Company or any of its Restricted Subsidiaries (including any disposition by means of a merger, consolidation or similar transaction) other than (i) a disposition by a Restricted Subsidiary to the Company or by the Company or a Restricted Subsidiary to a Wholly Owned Subsidiary, (ii) a disposition of property, assets, inventory or Temporary Cash Investments in the ordinary course of business, (iii) for purposes of Section 4.6 only, a disposition that constitutes a Restricted Payment permitted by Section 4.4, (iv) a disposition of duplicative or excessive real property where less than 75% of the consideration received is in the form of cash or Temporary Cash Investments, which disposition occurs within one year of the acquisition thereof and (v) any disposition of assets or series of related dispositions with an aggregate fair market value (as determined in good faith) of less than $5 million. "Asset Swap" means the exchange by the Company or a Restricted Subsidiary of a portion of its property, business or assets, for property, business or assets or Capital Stock of a Person, which all or substantially all of whose assets are a type used in the business of the Company on the date of the Indenture or in a Related Business, or a combination of any property, business or assets or Capital Stock of such a Person and cash or Temporary Cash Investments. "Attributable Indebtedness" in respect of a Sale/Leaseback Transaction means, as at the time of determination, the present value (discounted at the interest rate borne by the -2- Securities, compounded annually) of the total obligations of the lessee for rental payments during the remaining term of the lease included in such Sale/Leaseback Transaction (including any period for which such lease has been extended); provided, however, that "Attributable Indebtedness" shall not include any such obligations to the extent they relate to the lease of stores, warehouses, offices or distribution facilities, including without limitation, the fixtures appertaining thereto, unless such obligations are required to be recorded on the Company's balance sheet in accordance with GAAP. "Average Life" means, as of the date of determination, with respect to any Indebtedness or Preferred Stock, the quotient obtained by dividing (i) the sum of the product of the numbers of years from the date of determination to the dates of each successive scheduled principal payment of such Indebtedness or redemption or similar payment with respect to such Preferred Stock multiplied by the amount of such payment by (ii) the sum of all such payments. "Board of Directors" means the Board of Directors or equivalent governing body of a Person (or the general partner of such Person, as the case may be) or any committee thereof duly authorized to act on behalf of such Board or equivalent governing body. "Board Resolution" means a copy of a resolution certified by the Secretary or an Assistant Secretary of the Company to have been duly adopted by the Board of Directors and, which is in full force and effect on the date of such certification, and delivered to the Trustee. "Business Day" means a day other than a Saturday, Sunday or other day on which banking institutions in New York State are authorized or required by law to close. "Capitalized Lease Obligation" means an obligation that is required to be classified and accounted for as a capitalized lease for financial reporting purposes in accordance with GAAP, and the amount of Indebtedness represented by such obligation shall be the capitalized amount of such obligation determined in accordance with GAAP; and the Stated Maturity thereof shall be the date of the last payment of rent or any other amount due under such lease. "Capital Stock" of any Person means any and all shares, interests, rights to purchase, warrants, options, participations or other equivalents of or interests in (however designated) equity of such Person, including any Preferred Stock, but excluding any debt securities convertible into such equity. "Change of Control" means the occurrence of any of the following events with respect to the Company: (i) (A) any "person" (as such term is used in Sections 13(d) and 14(d) of the Exchange Act), other than one or more Permitted Holders, is or becomes the "beneficial owner" (as defined in Rules 13d-3 and 13d-5 under the Exchange Act), directly or indirectly, of more than 35% of the total voting power of the Voting Stock of the Company and (B) the Permitted Holders "beneficially own" (as defined in Rules 13d-3 and 13d-5 under the Exchange Act), directly or -3- indirectly, in the aggregate a lesser percentage of the total voting power of the Voting Stock of the Company than such other person and do not have the right or ability by voting power, contract or otherwise to elect or designate for election a majority of the Board of Directors of the Company (for the purposes of this clause, such other person shall be deemed to beneficially own any Voting Stock of a specified corporation held by a parent corporation, if such other person "beneficially owns" (as defined in Rules 13d-3 and 13d-5 under the Exchange Act), directly or indirectly, more than 35% of the voting power of the Voting Stock of such parent corporation and the Permitted Holders "beneficially own" (as defined in Rules 13d-3 and 13d-5 under the Exchange Act), directly or indirectly, in the aggregate a lesser percentage of the voting power of the Voting Stock of such parent corporation and do not have the right or ability by voting power, contract or otherwise to elect or designate for election a majority of the board of directors of such parent corporation); (ii) during any period of two consecutive years, individuals who at the beginning of such period constituted the Board of Directors of the Company (together with any new directors whose election by such Board of Directors or whose nomination for election by the shareholders of the Company was approved by a vote of 66-2/3% of the directors of the Company then still in office who were either directors at the beginning of such period or whose election or nomination for election was previously so approved) cease for any reason to constitute a majority of the Board of Directors of the Company then in office; (iii) any sale, lease, exchange or other transfer (in one transaction or a series of related transactions) of all, or substantially all, the assets of the Company to any Person or group of Persons (other than to any Wholly Owned Subsidiary of the Company); or (iv) the merger or consolidation of the Company with or into another corporation with the effect that either (A) immediately after such transaction any person (as defined in clause (i) above) (other than a Permitted Holder) shall have become the "beneficial owner" (as defined in clause (i) above) of securities of the surviving corporation of such merger or consolidation representing a majority of the voting power of the Voting Stock of the surviving corporation or (B) the securities of the Company that are outstanding immediately prior to such transaction and which represent 100% of the voting power of the Voting Stock of the Company are changed into or exchanged for cash, securities or property, unless pursuant to such transaction such securities are changed into or exchanged for, in addition to any other consideration, (1) securities of the surviving corporation that represent immediately after such transaction, at least a majority of the voting power of the Voting Stock of the surviving corporation or (2) securities that represent immediately after such transaction at least a majority of the voting power of the Voting Stock of the corporation that owns, directly or -4- indirectly, 100% of the voting power of the Voting Stock of the surviving corporation of that transaction. "Code" means the Internal Revenue Code of 1986, as amended. "Commodity Price Protection Agreement" means any forward contract, commodity swap, commodity option or other similar financial agreement or arrangement relating to, or the value which is dependent upon, fluctuations in commodity prices. "Consolidated Coverage Ratio" as of any date of determination means the ratio of (i) the aggregate amount of EBITDA for the period of the most recent four consecutive fiscal quarters for which financial statements are available to (ii) Consolidated Interest Expense for such period; provided, however, that (1) if the Company or any Restricted Subsidiary has Incurred any Indebtedness since the beginning of such period that remains outstanding or if the transaction giving rise to the need to calculate the Consolidated Coverage Ratio is an Incurrence of Indebtedness, or both, EBITDA and Consolidated Interest Expense for such period shall be calculated after giving effect on a pro forma basis to such Indebtedness as if such Indebtedness had been Incurred on the first day of such period and the discharge of any other Indebtedness repaid, repurchased, defeased or otherwise discharged with the proceeds of such new Indebtedness as if such discharge had occurred on the first day of such period, (2) if since the beginning of such period the Company or any Restricted Subsidiary shall have made any Asset Disposition or if the transaction giving rise to the need to calculate the Consolidated Coverage Ratio is an Asset Disposition, the EBITDA for such period shall be reduced by an amount equal to the EBITDA (if positive) directly attributable to the assets which are the subject of such Asset Disposition for such period, or increased by an amount equal to the EBITDA (if negative) directly attributable thereto for such period and Consolidated Interest Expense for such period shall be reduced by an amount equal to the Consolidated Interest Expense directly attributable to any Indebtedness of the Company or any Restricted Subsidiary repaid, repurchased, defeased or otherwise discharged with respect to the Company and its continuing Restricted Subsidiaries in connection with such Asset Disposition for such period (or, if the Capital Stock of any Restricted Subsidiary is sold, the Consolidated Interest Expense for such period directly attributable to the Indebtedness of such Restricted Subsidiary to the extent the Company and its continuing Restricted Subsidiaries are no longer liable for such Indebtedness after such sale), (3) if since the beginning of such period the Company or any Restricted Subsidiary (by merger or otherwise) shall have made an Investment in any Restricted Subsidiary (or any Person which becomes a Restricted Subsidiary) or an acquisition of assets, including any acquisition of assets occurring in connection with a transaction causing a calculation to be made hereunder, which constitutes all or substantially all of an operating unit of a business, EBITDA and Consolidated Interest Expense for such period shall be calculated after giving pro forma effect thereto (including the Incurrence of any Indebtedness) as if such Investment or acquisition occurred on the first day of such period and (4) if since the beginning of such period any Person (that subsequently became a Restricted Subsidiary or was merged with or into the Company or any Restricted Subsidiary since the beginning of such period) shall have made any Asset Disposition or any Investment that would have required an adjustment pursuant to clause (2) or (3) above if made by the Company or a Restricted Subsidiary during such period, EBITDA and Consolidated Interest -5- Expense for such period shall be calculated after giving pro forma effect thereto as if such Asset Disposition or Investment occurred on the first day of such period. For purposes of this definition, whenever pro forma effect is to be given to an acquisition of assets, the amount of income or earnings relating thereto and the amount of Consolidated Interest Expense associated with any Indebtedness Incurred in connection therewith, the pro forma calculations shall be determined in good faith by a responsible financial or accounting officer of the Company. If any Indebtedness bears a floating rate of interest and is being given pro forma effect, the interest expense on such Indebtedness shall be calculated as if the rate in effect on the date of determination had been the applicable rate for the entire period (taking into account any Interest Rate Agreement applicable to such Indebtedness if such Interest Rate Agreement has a remaining term in excess of 12 months). "Consolidated Interest Expense" means, for any period, the total interest expense of the Company and its consolidated Restricted Subsidiaries, plus, to the extent not included in such interest expense, (i) interest expense attributable to capital leases, (ii) amortization of debt discount and debt issuance costs, (iii) non-cash interest expense, (iv) commissions, discounts and other fees and charges owed with respect to letters of credit and bankers' acceptance financing, (v) interest actually paid by the Company or any such Restricted Subsidiary under any Guarantee of Indebtedness or other obligation of any other Person, (vi) net costs associated with Hedging Obligations (including amortization of fees), (vii) Preferred Stock dividends in respect of all Preferred Stock of the Company and its Subsidiaries held by Persons other than the Company or a Wholly Owned Subsidiary and (viii) the cash contributions to any employee stock ownership plan or similar trust to the extent such contributions are used by such plan or trust to pay interest or fees to any Person (other than the Company) in connection with Indebtedness Incurred by such plan or trust; provided, however, that there shall be excluded therefrom any such interest expense of any Unrestricted Subsidiary to the extent the related Indebtedness is not Guaranteed or paid by the Company or any Restricted Subsidiary. "Consolidated Net Income" means, for any period, the net income (loss) of the Company and its consolidated Subsidiaries in accordance with GAAP; provided, however, that there shall not be included in such Consolidated Net Income: (i) any net income (loss) of any Person if such Person is not a Restricted Subsidiary, except that (A) subject to the limitations contained in (iv) below the Company's equity in the net income of any such Person for such period shall be included in such Consolidated Net Income up to the aggregate amount of cash actually distributed by such Person during such period to the Company or a Restricted Subsidiary as a dividend or other distribution (subject, in the case of a dividend or other distribution to a Restricted Subsidiary, to the limitations contained in clause (iii) below) and (B) the Company's equity in a net loss of any such Person (other than an Unrestricted Subsidiary) for such period shall be included in determining such Consolidated Net Income, (ii) any net income (loss) of any Person acquired by the Company or a Restricted Subsidiary in a pooling of interests transaction for any period prior to the date of such acquisition, -6- (iii) any net income of any Restricted Subsidiary if such Restricted Subsidiary is subject to restrictions, directly or indirectly, on the payment of dividends or the making of distributions by such Restricted Subsidiary, directly or indirectly, to the Company, except that (A) subject to the limitations contained in (iv) below the Company's equity in the net income of any such Restricted Subsidiary for such period shall only be included in such Consolidated Net Income up to the aggregate amount of cash that could have been distributed by such Restricted Subsidiary during such period to the Company or another Restricted Subsidiary as a dividend (subject, in the case of a dividend to another Restricted Subsidiary, to the limitation contained in this clause) and (B) the Company's equity in a net loss of any such Restricted Subsidiary for such period shall be included in determining such Consolidated Net Income, (iv) any gain (but not loss) realized upon the sale or other disposition of any property, plant or equipment of the Company or its consolidated Subsidiaries (including pursuant to any Sale/Leaseback Transaction) which is not sold or otherwise disposed of in the ordinary course of business and any gain (but not loss) realized upon the acquisition or disposition of any securities of any Person, (v) any extraordinary gain or loss net of taxes (less all fees and expenses relating thereto), (vi) the cumulative effect of a change in accounting principles, (vii) any gain or loss, net of taxes, realized upon the termination of any employee pension benefit plan, and (viii) any net gain arising from the extinguishment, under GAAP, of any Indebtedness of any Person. "Consolidated Tangible Net Worth" of any Person means, at any time, for such Person and its Restricted Subsidiaries on a consolidated basis, an amount computed equal to (a) the consolidated stockholders' equity of the Person and its Restricted Subsidiaries, minus, (b) all Intangible Assets of the Person and its Restricted Subsidiaries, in each case as of such time. "Credit Agreement" means the Revolving Credit Agreement, dated as of May 1, 2001, among the Company, Fleet National Bank and the lenders parties thereto, as it may be amended, extended, renewed, refinanced, substituted or replaced from time to time (including increases in principal amount thereof to the extent permitted under the Securities, the addition of one or more lenders to an existing facility or the replacement or inclusion of one or more lenders in a new facility) in one or more agreements. "Currency Agreement" means in respect of a Person any foreign exchange contract, currency swap agreement or other similar agreement as to which such Person is a party or a beneficiary. -7- "Default" means any event which is, or after notice or passage of time or both would be, an Event of Default. "Depositary" means, with respect to the Securities issued in the form of one or more Book-Entry Securities, The Depository Trust Company ("DTC"), its nominees and successors, or another Person designated as Depositary by the Company, which must be a clearing agency registered under the Exchange Act. "Designated Noncash Consideration" means the fair market value of non-cash consideration received by the Company or any of its Restricted Subsidiaries in connection with an Asset Disposition that is so designated pursuant to an Officer's Certificate, setting forth the basis of the valuation. "Disqualified Stock" means, with respect to any Person, any Capital Stock which by its terms (or by the terms of any security into which it is convertible or for which it is exchangeable) or upon the happening of any event (i) matures or is mandatorily redeemable pursuant to a sinking fund obligation or otherwise, (ii) is convertible or exchangeable for Indebtedness or Disqualified Stock or (iii) is redeemable at the option of the holder thereof, in whole or in part, in each case on or prior to the first anniversary of the Stated Maturity of the Securities (other than upon a change of control or sale of assets by the Company in circumstances where the Holders of the Securities would have similar rights). "EBITDA" for any period means the sum of Consolidated Net Income for such period, plus the following to the extent deducted in calculating such Consolidated Net Income: (i) income tax expense, (ii) Consolidated Interest Expense, (iii) depreciation expense, (iv) amortization expense, and (v) all other non-cash items reducing Consolidated Net Income (excluding any non-cash items to the extent they represent an accrual of, or reserve for, cash disbursements for any subsequent period), less all non-cash items increasing such Consolidated Net Income, in each case for such period. Notwithstanding the foregoing, the income tax expense, depreciation expense and amortization expense of a Restricted Subsidiary of the Company shall be included in EBITDA only to the extent (and in the same proportion) that the net income of such Subsidiary was included in calculating Consolidated Net Income and only if a corresponding amount would be permitted at the date of determination to be distributable to the Company by such Subsidiary as a dividend. "Equity Offering" means an offering for cash of common stock of the Company. "Exchange Act" means the Securities Exchange Act of 1934, as amended. "Exchange Offer" means the exchange offer by the Company of Series B Securities for Series A Securities to be effected pursuant to Section 2.1 of the Registration Rights Agreement. "Exchange Offer Registration Statement" means the registration statement under the Securities Act contemplated by Section 2.1 of the Registration Rights Agreement. -8- "Fall Away Event" means the Securities shall have achieved Investment Grade status and the Company delivers to the Trustee an Officer's Certificate certifying that the foregoing condition has been satisfied. "Foreign Restricted Subsidiary" means a Restricted Subsidiary that is organized and existing under the laws of any country or other jurisdiction other than the United States of America, any State thereof or the District of Columbia and substantially all of the assets of which are located outside the United States of America. "GAAP" means generally accepted accounting principles in the United States of America as in effect as of the date of the Indenture, including those set forth in the opinions and pronouncements of the Accounting Principles Board of the American Institute of Certified Public Accountants and statements and pronouncements of the Financial Accounting Standards Board or in such other statements by such other entity as approved by a significant segment of the accounting profession. All ratios and computations based on GAAP contained in the Indenture shall be computed in conformity with GAAP. "Guarantee" means any obligation, contingent or otherwise, of any Person directly or indirectly guaranteeing any Indebtedness or other obligation of any other Person and any obligation, direct or indirect, contingent or otherwise, of such Person (i) to purchase or pay (or advance or supply funds for the purchase or payment of) such Indebtedness or other obligation of such other Person (whether arising by virtue of partnership arrangements, or by agreement to keep-well, to purchase assets, goods, securities or services, to take-or-pay, or to maintain financial statement conditions or otherwise) or (ii) entered into for purposes of assuring in any other manner the obligee of such Indebtedness or other obligation of the payment thereof or to protect such obligee against loss in respect thereof (in whole or in part); provided, however, that the term "Guarantee" shall not include endorsements for collection or deposit in the ordinary course of business. The term "Guarantee" used as a verb has a corresponding meaning. "Guarantor" means any guarantor of the Notes. "Hedging Obligations" of any Person means the obligations of such Person pursuant to any Interest Rate Agreement, Currency Agreement, or Commodity Price Protection Agreement. "Holder" or "Securityholder" means the Person in whose name a Security is registered on the Registrar's books. "Incur" means issue, assume, Guarantee, incur or otherwise become liable for; provided, however, that any Indebtedness or Capital Stock of a Person existing at the time such Person becomes a Subsidiary (whether by merger, consolidation, acquisition or otherwise) shall be deemed to be incurred by such Subsidiary at the time it becomes a Subsidiary. "Indebtedness" means, with respect to any Person on any date of determination (without duplication), -9- (i) the principal of and premium, if any, in respect of indebtedness of such Person for borrowed money; (ii) the principal of and premium, if any, in respect of obligations of such Person evidenced by bonds, debentures, notes or other similar instruments; (iii) all obligations of such Person in respect of letters of credit or other similar instruments (including reimbursement obligations with respect thereto); (iv) all obligations of such Person to pay the deferred and unpaid purchase price of property or services (except Trade Payables), which purchase price is due more than six months after the date of placing such property in service or taking delivery and title thereto or the completion of such services; (v) all Capitalized Lease Obligations and all Attributable Indebtedness of such Person; (vi) the amount of all obligations of such Person with respect to the redemption, repayment or other repurchase of any Disqualified Stock or, with respect to any Restricted Subsidiary, any Preferred Stock (but excluding, in each case, any accrued dividends); (vii) all Indebtedness of other Persons secured by a Lien on any asset of such Person, whether or not such Indebtedness is assumed by such Person; provided, however, that the amount of such Indebtedness shall be the lesser of (A) the fair market value of such asset at such date of determination and (B) the amount of such Indebtedness of such other Persons; (viii) all Indebtedness of other Persons to the extent Guaranteed by such Person; and (ix) to the extent not otherwise included in this definition, Hedging Obligations of such Person. The amount of Indebtedness of any Person at any date shall be the outstanding balance at such date of all unconditional obligations as described above and the maximum liability, upon the occurrence of the contingency giving rise to the obligation, of any contingent obligations at such date. "Indenture" means this instrument as originally executed (including all exhibits and schedules thereto) and as it may from time to time be as amended or supplemented by one or more supplemental indentures entered into pursuant to the applicable provisions hereof or otherwise in accordance with the terms hereof. -10- "Initial Securities" means the first $200.0 million aggregate principal amount of the Securities issued under this Indenture on the date hereof, which may be exchanged under the Exchange Offer for Series B Securities. "Initial Purchasers" means Merrill Lynch, Pierce, Fenner & Smith Incorporated, Credit Suisse First Boston Corporation, Deutsche Banc Alex. Brown Inc., Fleet Securities, Inc. and Wells Fargo Brokerage Services, LLC. "Intangible Assets" means intellectual property, goodwill and other intangible assets, in each case determined in accordance with GAAP. "Interest Rate Agreement" means with respect to any Person any interest rate protection agreement, interest rate future agreement, interest rate option agreement, interest rate swap agreement, interest rate cap agreement, interest rate collar agreement, interest rate hedge agreement or other similar agreement or arrangement as to which such Person is party or a beneficiary. "Investment" in any Person means any direct or indirect advance, loan (other than advances to customers in the ordinary course of business that are recorded as accounts receivable on the balance sheet of such Person) or other extension of credit (including by way of Guarantee or similar arrangement) or capital contribution to (by means of any transfer of cash or other property to others or any payment for property or services for the account or use of others), or any purchase or acquisition of Capital Stock, Indebtedness or other similar instruments issued or owned by such Person and all other items that would be classified as investments on a balance sheet prepared in accordance with GAAP. For purposes of the definition of "Unrestricted Subsidiary" and Section 4.4, (i) "Investment" shall include the portion (proportionate to the Company's equity interest in such Subsidiary) of the fair market value of the net assets of any Subsidiary of the Company at the time that such Subsidiary is designated an Unrestricted Subsidiary; provided, however, that upon a redesignation of such Subsidiary as a Restricted Subsidiary, the Company shall be deemed to continue to have a permanent "Investment" in an Unrestricted Subsidiary in an amount (if positive) equal to (x) the Company's "Investment" in such Subsidiary at the time of such redesignation less (y) the portion (proportionate to the Company's equity interest in such Subsidiary) of the fair market value of the net assets of such Subsidiary at the time that such Subsidiary is so redesignated a Restricted Subsidiary; and (ii) any property transferred to or from an Unrestricted Subsidiary shall be valued at its fair market value at the time of such transfer, in each case as determined in good faith by the Board of Directors and evidenced by a resolution of such Board of Directors certified in an Officers' Certificate to the Trustee. "Investment Grade" means BBB- or higher by Standard & Poor's Ratings Group and its successors and Baa3 or higher by Moody's Investors Service, Inc. and its successors. "Issue Date" means the date on which any Securities are first issued under this Indenture. -11- "Letter of Credit Facility" means the Master Commercial Letter of Credit Reimbursement Agreement, dated as of May 1, 2001, among the Company and Fleet National Bank, as it may be amended, extended, renewed refinanced, substituted, or replaced from time to time (including increases in principal or notational amount thereof to the extent permitted under the Securities or the addition of one or more lenders to an existing facility or the replacement or inclusion of one or more lenders in a new facility) in one or more agreements. "Lien" means any mortgage, pledge, security interest, encumbrance, lien or charge of any kind (including any conditional sale or other title retention agreement or lease in the nature thereof). "Net Available Cash" from an Asset Disposition means cash payments received (including any cash payments received by way of deferred payment of principal pursuant to a note or installment receivable or otherwise, but only as and when received, but excluding any other consideration received in the form of assumption by the acquiring Person of Indebtedness or other obligations relating to such properties or assets or received in any other non-cash form and excluding Designated Non-cash Consideration and Asset Swaps except to the extent they are converted into cash) therefrom, in each case net of (i) all legal, title and recording tax expenses, commissions and other fees and expenses incurred, and all federal, state, provincial, foreign and local taxes required to be paid or accrued as a liability under GAAP, as a consequence of such Asset Disposition, (ii) all payments made on any Indebtedness which is secured by any assets subject to such Asset Disposition, in accordance with the terms of any Lien upon such assets, or which must by its terms, or in order to obtain a necessary consent to such Asset Disposition, or by applicable law be repaid out of the proceeds from such Asset Disposition, (iii) all distributions and other payments required to be made to minority interest holders in Subsidiaries or joint ventures as a result of such Asset Disposition, (iv) the deduction of appropriate amounts to be provided by the seller as a reserve, in accordance with GAAP, against any liabilities associated with the assets disposed of in such Asset Disposition and retained by the Company or any Restricted Subsidiary after such Asset Disposition and (v) in the case of an Asset Disposition by a Foreign Restricted Subsidiary, any amount which, as a result of applicable law, may not be legally paid as a dividend, or distributed or otherwise paid or repatriated to the Company or its Subsidiaries. "Net Cash Proceeds" with respect to any issuance or sale of Capital Stock, means the cash proceeds of such issuance or sale net of attorneys' fees, accountants' fees, underwriters' or placement agents' fees, discounts or commissions and brokerage, consultant and other fees and expenses actually incurred in connection with such issuance or sale and net of taxes paid or payable as a result thereof. "Officer" means the Chairman of the Board, any Vice Chairman, the Chief Executive Officer, the Chief Financial Officer, the President, any Executive Vice President, any Senior Vice President, the Vice President-Finance (or any such other officer that performs similar duties), the Secretary or Treasurer of the Company. "Officers' Certificate" means a certificate signed by two Officers, one of which is the Chairman of the Board, the Chief Executive Officer, the Chief Financial Officer, the -12- President, any Executive Vice President, any Senior Vice President, or the Vice President-Finance (or any such other officer that performs similar duties). "Opinion of Counsel" means a written opinion from legal counsel who is reasonably acceptable to the Trustee. The counsel may be an employee of or counsel to the Company or the Trustee. Opinions of Counsel required to be delivered under this Indenture may have qualifications customary for opinions of the type required and counsel delivering such opinions of Counsel may rely on certificates of the Company or government or other officials customary for opinions of the type required, including certificates certifying as to matters of fact. "Permitted Holders" means Sam Wyly, Charles J. Wyly, Jr., Evan A. Wyly, trusts established by or for the benefit of any such Persons or any of their lineal descendants, entities controlled by any such trusts, and their respective Affiliates. "Permitted Investment" means an Investment by the Company or any Restricted Subsidiary in (i) the Company, a Restricted Subsidiary or a Person which will, upon the making of such Investment, become a Restricted Subsidiary; provided, however, that the primary business of such Restricted Subsidiary is a Related Business; (ii) another Person if as a result of such Investment such other Person is merged or consolidated with or into, or transfers or conveys all or substantially all its assets to, the Company or a Restricted Subsidiary; provided, however, that such Person's primary business is a Related Business; (iii) Temporary Cash Investments; (iv) receivables owing to the Company or any Restricted Subsidiary, if created or acquired in the ordinary course of business and payable or dischargeable in accordance with customary trade terms; provided, however, that such trade terms may include such concessionary trade terms as the Company or any such Restricted Subsidiary deems reasonable under the circumstances; (v) payroll, travel and similar advances to cover matters that are expected at the time of such advances ultimately to be treated as expenses for accounting purposes and that are made in the ordinary course of business; (vi) loans or advances to employees made in the ordinary course of business consistent with past practice of the Company or such Restricted Subsidiary; (vii) stock, obligations or securities received in settlement of debts created in the ordinary course of business and owing to the Company or any Restricted Subsidiary or in satisfaction of judgments; (viii) any Investment to the extent the consideration therefore consists of Qualified Capital Stock of the Company; (ix) advances to vendors in the ordinary course of business in an aggregate principal amount at any one time outstanding not to exceed $5 million; (x) the form of payment pursuant to deferred compensation plans for former and current directors, officers, consultants and employees; and (xi) in addition to items (i)-(x) above, an amount not to exceed 2.5% of the Company's Consolidated Tangible Net Worth in the aggregate at any one time outstanding. "Permitted Liens" means, with respect to any Person, (a) pledges or deposits by such Person under workmen's compensation laws, unemployment insurance laws or similar legislation, or good faith deposits in connection with bids, tenders, contracts (other than for the payment of Indebtedness) or leases to which such Person is a party, or deposits to secure public or statutory obligations of such Person or deposits of cash or United States government bonds to secure surety or appeal bonds to which such Person is a party, or deposits as security for -13- contested taxes or import duties or for the payment of rent, in each case Incurred in the ordinary course of business; (b) Liens imposed by law, such as carriers', warehousemen's and mechanics' Liens, in each case for sums not yet due or being contested in good faith by appropriate proceedings or other Liens arising out of judgments or awards against such Person with respect to which such Person shall then be proceeding with an appeal or other proceedings for review and landlords' Liens; (c) Liens for property taxes not yet due or payable or subject to penalties for non-payment or which are being contested in good faith by appropriate proceedings; (d) Liens in favor of issuers of surety bonds or letters of credit issued pursuant to the request of and for the account of such Person in the ordinary course of its business; (e) minor survey exceptions, minor encumbrances, easements or reservations of, or rights of others for, licenses, rights-of-way, sewers, electric lines, telegraph and telephone lines and other similar purposes, or zoning or other restrictions as to the use of real properties or Liens incidental to the conduct of the business of such Person or to the ownership of its properties which were not Incurred in connection with Indebtedness and which do not in the aggregate materially adversely affect the value of said properties or materially impair their use in the operation of the business of such Person; (f) Liens securing Hedging Obligations so long as the related Indebtedness is, and is permitted to be under the Indenture, secured by a Lien on the same property securing such Hedging Obligations; (g) leases and subleases of real property which do not interfere with the ordinary conduct of the business of the Company or any of its Restricted Subsidiaries, and which are made on customary and usual terms applicable to similar properties; (h) Liens existing as of the date of the Indenture and Liens created by the Indenture; (i) Liens created solely for the purpose of securing Purchase Money Debt Incurred after the Issue Date; provided, however, that (A) the aggregate principal amount of Indebtedness secured by such Liens shall not exceed the lesser of cost or fair market value of the assets or property so acquired or constructed, (B) the Indebtedness secured by such Liens shall have otherwise been permitted to be issued under the Indenture and (C) such Liens shall not encumber any other assets or property of the Company or any of its Restricted Subsidiaries and shall attach to such assets or property within 90 days of the construction, acquisition or improvement of such assets or property; (j) Liens on the assets or property of a Restricted Subsidiary of the Company existing at the time such Restricted Subsidiary became a Subsidiary of the Company and not incurred as a result of (or in connection with or in anticipation of) such Restricted Subsidiary becoming a Subsidiary of the Company; provided, however, that (A) any such Lien does not by its terms cover any property or assets after the time such Restricted Subsidiary becomes a Subsidiary which were not covered immediately prior to such time, (B) the Incurrence of the Indebtedness secured by such Lien shall have otherwise been permitted to be Incurred under the Indenture, and (C) such Liens do not extend to or cover any other property or assets of the Company or any of its Restricted Subsidiaries; (k) Liens to secure Capitalized Lease Obligations permitted to be Incurred under this Indenture; (1) Liens to secure Indebtedness permitted to be Incurred the Indenture which is recourse solely to the assets securing such Indebtedness; provided that (i) the fair market value, as determined in good faith, of the assets subject to such Liens (determined at the time such Liens are granted) does not exceed an amount equal to 125% of the amount of such Indebtedness and (ii) the aggregate principal amount outstanding of all Indebtedness secured by such Liens at the time when such additional Indebtedness is Incurred shall not exceed 5% of the Company's Consolidated Tangible Net Worth; and (m) Liens extending, renewing or replacing in whole or in part a Lien permitted by the Indenture; provided, however, that (A) such Liens do not extend -14- beyond the property subject to the existing Lien and improvements and construction on such property and (B) the Indebtedness secured by the Lien may not exceed the Indebtedness secured at the time by the existing Lien; "Person" means any individual, corporation, partnership, limited liability company, partnership, joint venture, association, joint-stock company, trust, unincorporated organization, government or any agency or political subdivision thereof or any other entity. "Preferred Stock", as applied to any Person, means Capital Stock of any class or classes (however designated) which is preferred as to the payment of dividends or distributions, or as to the distribution of assets upon any voluntary or involuntary liquidation or dissolution of such Person, over shares of Capital Stock of any other class of such Person. "principal" of a Security means the principal of the Security plus the premium, if any, payable on the Security which is due or overdue or is to become due at the relevant time. "Prospectus" means the prospectus included in a Registration Statement, including any preliminary prospectus, and any such prospectus as amended or supplemented by any prospectus supplement, including any such prospectus supplement with respect to the terms of the offering of any portion of the Series A Securities covered by a Shelf Registration Statement, and by all other amendments and supplements to a prospectus, including post-effective amendments, and in each case including all material incorporated by reference therein. "Public Market" means any time after (x) the common stock of the Company is then registered with the SEC pursuant to Section 12(b) or 12(g) of the Exchange Act and traded either on a national securities exchange or in the National Association of Securities Dealers Automated Quotation System and (y) at least 20% of the total issued and outstanding Voting Stock of the Company has been distributed by means of an effective registration statement under the Securities Act. "Qualified Capital Stock" of any Person means any and all Capital Stock of such Person other than Disqualified Stock. "Refinancing Indebtedness" means Indebtedness that refunds, refinances, replaces, renews, repays or extends (including pursuant to any defeasance or discharge mechanism) (collectively, "refinances," and "refinanced" shall have a correlative meaning) any Indebtedness existing on the Issue Date or Incurred in compliance with the Indenture (including Indebtedness of the Company that refinances Indebtedness of any Restricted Subsidiary and Indebtedness of any Restricted Subsidiary that refinances Indebtedness of another Restricted Subsidiary) including Indebtedness that refinances Refinancing Indebtedness; provided, however, that (i) the Refinancing Indebtedness has a Stated Maturity no earlier than the Stated Maturity of the Indebtedness being refinanced, (ii) the Refinancing Indebtedness has an Average Life at the time such Refinancing Indebtedness is Incurred that is equal to or greater than the Average Life of the Indebtedness being refinanced and (iii) such Refinancing Indebtedness is Incurred in an aggregate principal amount (or if issued with original issue discount, an aggregate issue price) that is equal to (or, to the extent of any applicable premium in connection with a -15- refinancing, greater than) or less than the sum of the aggregate principal amount (or if issued with original issue discount, the aggregate accreted value) then outstanding of the Indebtedness being refinanced; provided further, however, that Refinancing Indebtedness shall not include (x) Indebtedness of a Restricted Subsidiary that refinances Indebtedness of the Company other than Indebtedness owed to such Restricted Subsidiary by the Company, (y) Indebtedness of a non-Guarantor Restricted Subsidiary that refinances Indebtedness of a Guarantor or (z) Indebtedness of the Company or a Restricted Subsidiary that refinances Indebtedness of an Unrestricted Subsidiary. "Registration Rights Agreement" means the Registration Rights Agreement, dated as of July 6, 2001 among the Company and the Initial Purchasers. "Registration Statement" means any registration statement of the Company which covers any of the Series A Securities or Series B Securities pursuant to the provisions of the Registration Rights Agreement, and all amendments and supplements to any such Registration Statement, including post-effective amendments, in each case including the Prospectus contained therein, all exhibits thereto and all material incorporated by reference therein. "Related Business" means any business related, ancillary or complementary to the businesses of the Company and the Restricted Subsidiaries on the applicable date. "Restricted Subsidiary" means any Subsidiary of the Company other than an Unrestricted Subsidiary. "Sale/Leaseback Transaction" means an arrangement relating to property now owned or hereafter acquired whereby the Company or a Restricted Subsidiary transfers such property to a Person and the Company or a Restricted Subsidiary leases it from such Person. "SEC" means the Securities and Exchange Commission, as from time to time constituted, created under the Exchange Act, or if at any time after the execution of this Indenture the SEC is not existing and performing the duties now assigned to it under the TIA, then the body performing such duties at such time. "Secured Indebtedness" means any Indebtedness of the Company secured by a Lien. "Securities" has the meaning set forth in the Recitals. "Senior Indebtedness" means all Indebtedness of the Company (including, without limitation, Indebtedness under the Credit Agreement, and fees, costs and expenses incurred thereunder), including interest thereon, whether outstanding on the Issue Date or thereafter Incurred, unless in the instrument creating or evidencing the same or pursuant to which the same is outstanding it is provided that such obligations are subordinated in right of payment to the Securities; provided, however, that Senior Indebtedness shall not include (1) any obligation of the Company to any Subsidiary, (2) any liability for federal, state, local or other taxes owed or owing by the Company, (3) any accounts payable or other liability to trade -16- creditors arising in the ordinary course of business (including Guarantees thereof or instruments evidencing such liabilities), (4) any Indebtedness, Guarantee or obligation of the Company which is subordinate or junior expressly by its written terms in any respect to any other Indebtedness, Guarantee or obligation of the Company, including any Subordinated Obligations, (5) any obligations with respect to any Capital Stock, (6) Indebtedness which, when Incurred and without respect to any election under Section 1111(b) of Title II United States Code, is without recourse to the Company, or (7) any Indebtedness Incurred in violation of this Indenture. "Shelf Registration Statement" means a "shelf" registration statement of the Company pursuant to Section 2.2 of the Registration Rights Agreement, which covers all of the Registrable Securities (as defined in the Registration Rights Agreement) on an appropriate form under Rule 415 under the Securities Act, or any similar rule that may be adopted by the Commission, and all amendments and supplements to such registration statement, including post-effective amendments, in each case including the Prospectus contained therein, all exhibits thereto and all material incorporated by reference therein. "Significant Subsidiary" means any Restricted Subsidiary that would be a "Significant Subsidiary" of the Company within the meaning of Rule 1-02 under Regulation S-X promulgated by the SEC as of the date of the Indenture. "Stated Maturity" means, with respect to any security, the date specified in such security as the fixed date on which the payment of principal of such security is due and payable, including pursuant to any mandatory redemption provision (but excluding any provision providing for the repurchase of such security at the option of the holder thereof upon the happening of any contingency beyond the control of the issuer unless such contingency has occurred). "Subordinated Obligation" means any Indebtedness of the Company (whether outstanding on the Issue Date or thereafter Incurred) which is subordinate or junior in right of payment to the Securities pursuant to a written agreement. "Subsidiary" of any Person means any corporation, association, partnership or other business entity of which more than 50% of the total voting power of shares of Capital Stock or other interests (including partnership interests) entitled (without regard to the occurrence of any contingency) to vote in the election of directors, managers or trustees thereof is at the time owned or controlled, directly or indirectly, by (i) such Person, (ii) such Person and one or more Subsidiaries of such Person, or (iii) one or more Subsidiaries of such Person. "Temporary Cash Investments" means any of the following: (i) any investment in direct obligations of the United States of America or any agency thereof or obligations Guaranteed by the United States of America or any agency thereof, (ii) investments in time deposit accounts, certificates of deposit and money market deposits maturing within 180 days of the date of acquisition thereof issued by a bank or trust company which is organized under the laws of the United States of America, any state thereof or any foreign country recognized by the United States of America having capital, surplus and undivided profits aggregating in excess of $250,000,000 (or the foreign currency equivalent thereof) and whose long-term debt is rated "A" -17- (or such similar equivalent rating) or higher by at least one nationally recognized statistical rating organization (as defined in Rule 436 under the Securities Act), (iii) repurchase obligations with a term of not more than 30 days for underlying securities of the types described in clause (i) above entered into with a bank or trust company meeting the qualifications described in clause (ii) above, (iv) investments in commercial paper, maturing not more than 365 days after the date of acquisition, issued by a Person (other than an Affiliate of the Company) organized and in existence under the laws of the United States of America, any State thereof or any foreign country recognized by the United States of America with a rating at the time as of which any investment therein is made of "P-1" (or higher) according to Moody's Investors Service, Inc. or "A-1" (or higher) according to Standard & Poor's Ratings Group, (v) investments in securities with maturities of six months or less from the date of acquisition issued or fully guaranteed by any state, commonwealth or territory of the United States of America, or by any political subdivision or taxing authority thereof, and rated at least "A" by Standard & Poor's Ratings Group or "A" by Moody's Investors Service, Inc., and (vi) investments in mutual funds whose investment guidelines restrict such funds' investments to investments which are substantially similar to those described in clauses (i)-(v) above. "10 7/8% Senior Notes" means the Company's 10 7/8% Senior Notes due 2006. "TIA" means the Trust Indenture Act of 1939, as amended, or any successor statute. "Total Assets" means, as of any date, the Company's total consolidated assets as of such date, as determined in accordance with GAAP. "Trade Payables" means, with respect to any Person, any accounts payable or any indebtedness or monetary obligation to trade creditors created, assumed or Guaranteed by such Person arising in the ordinary course of business in connection with the acquisition of goods or services. "Trustee" means the party named as such in the Indenture until a successor replaces it pursuant to the applicable provisions of this Indenture and, thereafter, means the successor. "Trust Officer" shall mean, when used with respect to the Trustee, any officer within the corporate trust department of the Trustee, including any vice president, assistant vice president, assistant secretary, assistant treasurer, trust officer or any other officer of the Trustee who customarily performs functions similar to those performed by the Persons who at the time shall be such officers, respectively, or to whom any corporate trust matter is referred because of such person's knowledge of and familiarity with the particular subject and who shall have direct responsibility for the administration of the Indenture. "Uniform Commercial Code" means the New York Uniform Commercial Code as in effect from time to time. -18- "Unrestricted Subsidiary" means (i) any Subsidiary of the Company that at the time of determination shall be designated an Unrestricted Subsidiary by the Board of Directors in the manner provided below, and (ii) any Subsidiary of an Unrestricted Subsidiary. The Board of Directors may designate any Subsidiary of the Company (including any newly acquired or newly formed Subsidiary of the Company) to be an Unrestricted Subsidiary unless such Subsidiary or any of its Subsidiaries owns any Capital Stock or Indebtedness of, or owns or holds any Lien on any property of, the Company or any other Subsidiary of the Company that is not a Subsidiary of the Subsidiary to be so designated; provided, however, that (i) either (A) the Subsidiary to be so designated has total consolidated assets of $1,000 or less or (B) if such Subsidiary has total consolidated assets greater than $1,000, then such designation would be permitted under Section 4.4 and (ii) the holders of any Indebtedness of such Subsidiary do not have direct or indirect recourse against the Company or any Restricted Subsidiary of the Company and neither the Company nor any Restricted Subsidiary of the Company otherwise has any liability for any payment obligations in respect of such Indebtedness except as permitted under Section 4.3. The Board of Directors may designate any Unrestricted Subsidiary to be a Restricted Subsidiary; provided, however, that immediately after giving effect to such designation (x) the Company could Incur $1.00 of additional Indebtedness under clause (a) of Section 4.3 and (y) no Default shall have occurred and be continuing. Any such designation by the Board of Directors shall be evidenced to the Trustee by promptly filing with the Trustee a copy of the Board Resolution giving effect to such designation and an Officers' Certificate certifying that such designation complied with the foregoing provisions. Notwithstanding the foregoing, any Unrestricted Subsidiary (as determined in accordance with clauses (i) through (ii) of the first sentence of this definition) may but is not obligated to provide a Guarantee for the Securities. "U.S. Government Obligations" means direct obligations (or certificates representing an ownership interest in such obligations) of the United States of America (including any agency or instrumentality thereof) for the payment of which the full faith and credit of the United States of America is pledged and which are not callable or redeemable at the issuer's option. "Voting Stock" of a corporation means all classes of Capital Stock of such corporation then outstanding and normally entitled to vote in the election of directors. "Wholly Owned Subsidiary" means a Restricted Subsidiary of the Company all the Capital Stock of which (other than directors' qualifying shares) is owned by the Company or another Wholly Owned Subsidiary. SECTION 1.2 Other Definitions.
Defined in Term Section "Affiliate Transaction".................................................4.7 "Bankruptcy Law"........................................................6.1 "covenant defeasance option".........................................8.1(b) "Custodian".............................................................6.1 -19- "Event of Default.......................................................6.1 "Global Securities".....................................................2.1 "legal defeasance option"............................................8.1(b) "Legal Holiday"........................................................10.8 "Notice of Default".....................................................6.1 "Offer"..............................................................4.6(b) "Offer Amount"....................................................4.6(c)(2) "Offer Period"....................................................4.6(c)(2) "Participants"..........................................................2.6 "Paying Agent"..........................................................2.3 "Permitted Indebtedness".............................................4.3(b) "Purchase Date"...................................................4.6(c)(1) "Purchase Money Debt"................................................4.3(b) "Registrar".............................................................2.3 "Restricted Payment".................................................4.4(a) "Securities Register"...................................................2.3 "Series A Securities"..............................................Recitals "Series B Securities"..............................................Recitals "Successor Company".....................................................5.1
SECTION 1.3 Incorporation by Reference of Trust Indenture Act. This Indenture is subject to the mandatory provisions of the TIA which are incorporated by reference in and made a part of this Indenture. The following TIA terms have the following meanings: "Commission" means the SEC. "indenture securities" means the Securities. "indenture security holder" means a Securityholder. "indenture to be qualified" means this Indenture. "indenture trustee" or "institutional trustee" means the Trustee. "obligor" on the indenture securities means the Company and any other obligor on the indenture securities. All other TIA terms used in this Indenture that are defined by the TIA, defined by TIA reference to another statute or defined by SEC rule have the meanings assigned to them by such definitions. SECTION 1.4 Rules of Construction. Unless the context otherwise requires: -20- (1) a term has the meaning assigned to it; (2) an accounting term not otherwise defined has the meaning assigned to it in accordance with GAAP; (3) "including" means including without limitation; (4) words in the singular include the plural and words in the plural include the singular; (5) unsecured Indebtedness shall not be deemed to be subordinate or junior to secured Indebtedness merely by virtue of its nature as unsecured Indebtedness; (6) the principal amount of any noninterest bearing or other discount security at any date shall be the principal amount thereof that would be shown on a balance sheet of the issuer dated such date prepared in accordance with GAAP; (7) the principal amount of any Preferred Stock shall be (i) the maximum liquidation value of such Preferred Stock or (ii) the maximum mandatory redemption or mandatory repurchase price with respect to such Preferred Stock, whichever is greater; (8) all references to $, US$, U.S. dollars, dollars or United States dollars shall refer to the lawful currency of the United States; and (9) all references herein to particular Sections or Articles refer to this Indenture unless otherwise so indicated. ARTICLE II THE SECURITIES SECTION 2.1 Form and Dating. The Series A Securities and the Trustee's certificate of authentication shall be substantially in the form of Exhibit A, which is hereby incorporated in and expressly made a part of this Indenture. The Series B Securities and the Trustee's certificate of authentication shall be substantially in the form of Exhibit B, which is hereby incorporated in and expressly made a part of this Indenture. The Securities may have notations, legends or endorsements required by law, stock exchange rule, agreements to which the Company is subject, if any, or usage (provided that any such notation, legend or endorsement is in a form acceptable to the Company). Each Security shall be dated the date of its authentication. The terms of the Series A Securities and Series B Securities set forth in Exhibits A and B, respectively, are part of the terms of this Indenture. -21- (i) Global Securities. The Securities shall be issued initially in the form of one or more permanent Global Securities ("Global Securities") in definitive, fully registered form without interest coupons in substantially the form of Exhibit A or Exhibit B, as the case may be, which shall be deposited on behalf of the purchasers of the Securities represented thereby with the Trustee, at its principal corporate trust office in New York City, as custodian for the Depositary, and registered in the name of the Depositary or a nominee of the Depositary, duly executed by the Company and authenticated by the Trustee as hereinafter provided. The aggregate principal amount of the Global Securities may from time to time be increased or decreased by adjustments made on the records of the Trustee and the Depositary or its nominee in the limited circumstances hereinafter provided. (ii) Certificated Securities. Except as provided in Section 2.6, owners of beneficial interests in Global Securities will not be entitled to receive physical delivery of certificated securities. SECTION 2.2 Execution and Authentication; Title and Terms. An Officer of the Company shall sign the Securities for the Company by manual or facsimile signature. Securities shall be dated the date of their authentication. If an officer whose signature is on a Security no longer holds that office at the time the Trustee authenticates the Security, the Security shall be valid nevertheless. A Security shall not be valid until an authorized signatory of the Trustee manually signs the certificate of authentication on the Security. The signature shall be conclusive evidence that the Security has been authenticated under this Indenture. The aggregate principal amount of Securities which may be outstanding at any one time under this Indenture is limited to $250.0 million in principal amount (of which $200.0 million may be Initial Securities and Series B Securities exchanged therefor, and up to $50.0 million may be issued as Additional Securities). The Additional Securities may be issued as Series A Securities (which may be subsequently exchanged for Series B Securities) or Series B Securities at the option of the Company. The Initial Securities and Series B Securities exchanged therefor, and any Additional Securities subsequently issued under this Indenture shall be treated as a single class for all purposes under this Indenture, including, without limitation, waivers, amendments, redemptions and offers to purchase. The Trustee shall authenticate and make available for delivery Securities for original issue upon a written order of the Company signed by an Officer of the Company. Such order shall specify the amount of the Securities to be authenticated and the date on which the original issue of Securities is to be authenticated. The aggregate principal amount of Securities outstanding at any time may not exceed that amount except as provided in this Section 2.2 or Section 2.7. -22- The Trustee may appoint an authenticating agent acceptable to the Company to authenticate the Securities, upon the consent of the Company to such appointment. Unless limited by the terms of such appointment, an authenticating agent may authenticate Securities whenever the Trustee may do so. Each reference in this Indenture to authentication by the Trustee includes authentication by such agent. An authenticating agent has the same rights as any Registrar, Paying Agent or agent for service of notices and demands. SECTION 2.3 Registrar and Paying Agent. The Company shall maintain an office or agency where Securities may be presented for registration of transfer or for exchange (the "Registrar") and an office or agency where Securities may be presented for payment (the "Paying Agent"). The Registrar, acting on behalf of and as agent for the Company, shall keep a register (the "Securities Register") of the Securities and of their transfer and exchange. The Company may have one or more co-registrars and one or more additional paying agents. The term "Paying Agent" includes any additional paying agent. The Company shall enter into an appropriate agency agreement with any Registrar, Paying Agent or co-registrar not a party to this Indenture, which shall incorporate the terms of the TIA. The agreement shall implement the provisions of this Indenture that relate to such agent. The Company shall notify the Trustee of the name and address of any such agent. If the Company fails to maintain a Registrar or Paying Agent, the Trustee shall act as such and shall be entitled to appropriate compensation therefor pursuant to Section 7.7. The Company or any of its domestically incorporated Wholly Owned Subsidiaries may act as Paying Agent, Registrar, co-registrar or transfer agent. The Company initially appoints the Trustee as Registrar and Paying Agent in connection with the Securities. SECTION 2.4 Paying Agent To Hold Money in Trust. On or prior to each due date of the principal and interest on any Security, the Company shall deposit with the Paying Agent a sum sufficient to pay such principal and interest when so becoming due. The Company shall require each Paying Agent (other than the Trustee) to agree in writing that the Paying Agent shall hold in trust for the benefit of Securityholders or the Trustee all money held by the Paying Agent for the payment of principal of or interest on the Securities and shall notify the Trustee of any default by the Company in making any such payment. If the Company or a Subsidiary acts as Paying Agent, it shall segregate the money held by it as Paying Agent and hold it as a separate trust fund. The Company at any time may, for purpose of obtaining the satisfaction and discharge of this Indenture or for any other purpose, require a Paying Agent to pay all money held by it to the Trustee and to account for any funds disbursed by the Paying Agent. Upon complying with this Section, the Paying Agent shall have no further liability for the money delivered to the Trustee. -23- SECTION 2.5 Securityholder Lists. The Trustee shall preserve in as current a form as is reasonably practicable the most recent list available to it of the names and addresses of Securityholders. If the Trustee is not the Registrar, the Company shall furnish to the Trustee, in writing at least five Business Days before each interest payment date and at such other times as the Trustee may request in writing, a list in such form and as of such date as the Trustee may reasonably require of the names and addresses of Securityholders; provided that as long as the Trustee is the Registrar, no such list need be furnished. SECTION 2.6 Transfer and Exchange. The Securities shall be issued in registered form and shall be transferable only upon the surrender of a Security for registration of transfer. When a Security is presented to the Registrar or a co-registrar with a request to register a transfer, the Registrar and the Trustee may require a Holder, among other things, to furnish appropriate endorsements and transfer documents and the Registrar shall record in the Securities Register the transfer as requested if the relevant requirements of the Uniform Commercial Code are met, and thereupon one or more new Securities in the same aggregate principal amount shall be issued to the designated assignee or transferee and the old Security will be returned to the Company. When Securities are presented to the Registrar or a co-registrar with a request to exchange them for an equal principal amount of Securities of other denominations, the Registrar shall make the exchange as requested, in the same manner, if the same requirements are met. To permit registration of transfers and exchanges, the Company shall execute and the Trustee shall authenticate Securities at the Registrar's or co-registrar's request. The Company may require payment of a sum sufficient to pay all taxes, assessments or other governmental charges in connection with any transfer or exchange pursuant to this Section. The Company shall not be required to make and the Registrar need not register transfers or exchanges of Securities selected for redemption (except, in the case of Securities to be redeemed in part, the portion thereof not to be redeemed) or any Securities for a period of 15 days before a selection of Securities to be redeemed or 15 days before an interest payment date. Prior to the due presentation for registration of transfer of any Security, the Company, the Trustee, the Paying Agent, the Registrar or any co-registrar may deem and treat the person in whose name a Security is registered as the absolute owner of such Security for the purpose of receiving payment of principal of and interest on such Security and for all other purposes whatsoever, whether or not such Security is overdue, and none of the Company, the Trustee, the Paying Agent, the Registrar or any co-registrar shall be affected by notice to the contrary. All Securities issued upon any transfer or exchange pursuant to the terms of this Indenture will evidence the same debt and will be entitled to the same benefits under this Indenture as the Securities surrendered upon such transfer or exchange. With respect to Global Securities: -24- (1) Each Global Security authenticated under this Indenture shall be registered in the name of the Depositary designated for such Global Security or a nominee thereof and deposited with such Depositary or a nominee thereof or custodian therefor, and each such Global Security shall constitute a single Security for all purposes of this Indenture. (2) A Global Security may not be transferred except as a whole by the Depositary to a nominee of the Depositary or by a nominee of the Depositary to the Depositary. A Global Security is exchangeable for certificated Securities only if (i) the Depositary notifies the Company that it is unwilling or unable to continue as a Depositary for such Global Security or if at any time the Depositary ceases to be a clearing agency registered under the Exchange Act and in either case the Company fails to appoint a successor Depositary within 90 days, (ii) the Company, at its option, executes and delivers to the Trustee a notice that such Global Security shall be so transferable, registrable, and exchangeable, and such transfers shall be registrable or (iii) there shall have occurred and be continuing an Event of Default or an event which, with the giving of notice or lapse of time or both, would constitute an Event of Default with respect to the Securities represented by such Global Security. Any Global Security that is exchangeable for certificated Securities pursuant to the preceding sentence will be transferred to, and registered and exchanged for, certificated Securities in authorized denominations, without legends applicable to a Global Security, and registered in such names as the Depositary holding such Global Security may direct. Subject to the foregoing, a Global Security is not exchangeable, except for a Global Security of like denomination to be registered in the name of the Depositary or its nominee. In the event that a Global Security becomes exchangeable for certificated Securities, (i) certificated Securities will be issued only in fully registered form in denominations of $1,000 or integral multiples thereof, (ii) payment of principal, any repurchase price, and interest on the certificated Securities will be payable, and the transfer of the certificated Securities will be registrable, at the office or agency of the Company maintained for such purposes, and (iii) no service charge will be made for any registration or transfer or exchange of the certificated Securities, although the Company may require payment of a sum sufficient to cover any tax or governmental charge imposed in connection therewith. (3) Securities issued in exchange for a Global Security or any portion thereof shall have an aggregate principal amount equal to that of such Global Security or portion thereof to be so exchanged, shall be registered in such names and be in such authorized denominations as the Depositary shall designate and shall bear the applicable legends provided for herein. Any Global Security to be exchanged in whole shall be surrendered by the Depositary to the Trustee. With respect to any Global Security to be exchanged in part, either such Global Security shall be so surrendered for exchange or, if the Trustee is acting as custodian for the Depositary or its nominee with respect to such Global Security, -25- the principal amount thereof shall be reduced, by an amount equal to the portion thereof to be so exchanged, by means of an appropriate adjustment made on the records of the Trustee. Upon any such surrender or adjustment, the Trustee shall authenticate and deliver the Security issuable on such exchange to or upon the order of the Depositary or an authorized representative thereof. (4) Every Security authenticated and delivered upon registration of transfer of, or in exchange for or in lieu of, a Global Security or any portion mutilated thereof, whether pursuant to this Section, Section 2.7 or 2.9 or otherwise, shall be authenticated and delivered in the form of, and shall be, a Global Security, unless such Security is registered in the name of a Person other than the Depositary for such Global Security or a nominee thereof. Members of, or participants in, the Depositary ("Participants") shall have no rights under this Indenture with respect to any Global Security held on their behalf by the Depositary or by the Trustee as the custodian of the Depositary or under such Global Security, and the Depositary may be treated by the Company, the Trustee and any agent of the Company or the Trustee as the absolute owner of such Global Security for all purposes whatsoever. Notwithstanding the foregoing, nothing herein shall prevent the Company, the Trustee or any agent of the Company or the Trustee from giving effect to any written certification, proxy or other authorization (which may be in electronic form or other form acceptable to the Trustee) furnished by the Depositary or impair, as between the Depositary and its Participants, the operation of customary practices of such Depositary governing the exercise of the rights of a holder of a beneficial interest in any Global Security. SECTION 2.7 Replacement Securities. If a mutilated Security is surrendered to the Trustee or Registrar or if the Holder of a Security claims that the Security has been lost, destroyed or wrongfully taken, the Company shall issue and the Trustee shall authenticate a replacement Security if the requirements of the Uniform Commercial Code are met and the Holder satisfies any other reasonable requirements of the Trustee and the Company. If reasonably requested by the Trustee and the Company, such Holder shall furnish an indemnity bond sufficient in the judgment of the Company and the Trustee to protect the Company, the Trustee, the Paying Agent, the Registrar and any co-registrar from any loss which any of them may suffer if a security is replaced. The Company and the Trustee may charge the Holder for their expenses in replacing a Security. Every replacement Security is an obligation of the Company under this Indenture. The provisions of this Section are exclusive and shall preclude (to the extent lawful) all other rights and remedies with respect to the replacement or payment of mutilated, destroyed, lost or stolen Securities. -26- SECTION 2.8 Outstanding Securities. Securities outstanding at any time are all Securities authenticated by the Trustee except for those canceled by it, those delivered to it for cancellation and those described in this Section as not outstanding. A Security does not cease to be outstanding because the Company or an Affiliate of the Company holds the security. If a Security is replaced pursuant to Section 2.7, it ceases to be outstanding unless the Trustee and the Company receive proof satisfactory to them that the replaced Security is held by a bona fide purchaser. If the Paying Agent segregates and holds in trust, in accordance with this Indenture, on a redemption date or maturity date or, pursuant to Section 8.1(a), within 91 days prior thereto, money sufficient to pay all principal and interest payable on that redemption or maturity date with respect to the Securities (or portions thereof) to be redeemed or maturing, as the case may be, then on and after such date such Securities (or portions thereof) cease to be outstanding and on and after such redemption or maturity date interest on them ceases to accrue. SECTION 2.9 Temporary Securities. Until definitive Securities are ready for delivery, the Company may prepare and the Trustee shall authenticate temporary Securities. Temporary Securities shall be substantially in the form of definitive Securities but may have variations that the Company considers appropriate for temporary Securities. Without unreasonable delay, the Company shall prepare and the Trustee shall authenticate definitive Securities and deliver them in exchange for temporary securities upon surrender of the temporary Securities at the office or agency of the Company designated for such purpose pursuant to Section 2.3, without charge to the Holder. Upon surrender for cancellation of any one or more temporary Securities, the Company shall execute and the Trustee shall authenticate and deliver in exchange therefor a like principal amount of definitive Securities of authorized denominations. Until so exchanged the temporary Securities shall in all respects be entitled to the same benefits under this Indenture as definitive Securities. SECTION 2.10 Cancellation. The Company at any time may deliver Securities to the Trustee for cancellation. The Registrar and the Paying Agent shall forward to the Trustee any Securities surrendered to them for registration of transfer, exchange or payment. The Trustee and no one else shall cancel all Securities surrendered for registration of transfer, exchange, payment or cancellation and deliver such canceled Securities to the Company. The Trustee shall from time to time provide the Company a list of all Securities that have been canceled as requested by the Company. The Company may not issue new Securities to replace Securities it has redeemed, paid or delivered to the Trustee for cancellation. -27- SECTION 2.11 Defaulted Interest. If the Company defaults in a payment of interest on the Securities, the Company shall pay defaulted interest (plus interest on such defaulted interest to the extent lawful) in any lawful manner. The Company may pay the defaulted interest to the persons who are Securityholders on a subsequent special record date. The Company shall fix or cause to be fixed any such special record date and payment date to the reasonable satisfaction of the Trustee and shall promptly mail to each Securityholder a notice that states the special record date, the payment date and the amount of defaulted interest to be paid. SECTION 2.12 CUSIP Numbers. The Company in issuing the Securities may use "CUSIP" numbers (if then generally in use), and, if so, the Trustee shall use "CUSIP" numbers in notices of redemption as a convenience to Holders; provided that any such notice may state that no representation is made as to the correctness of such numbers either as printed on the Securities or as contained in any notice of a redemption and that reliance may be placed only on the other identification numbers printed on the Securities, and any such redemption shall not be affected by any defect in or omission of such numbers. The Company will promptly notify the Trustee of any change in the CUSIP numbers. ARTICLE III REDEMPTION SECTION 3.1 Notices to Trustee. If the Company elects to redeem Securities pursuant to paragraph 5 of the Securities, they shall notify the Trustee in writing of the redemption date, the principal amount of Securities to be redeemed and the paragraph of the Securities pursuant to which the redemption will occur. The Company shall give each notice to the Trustee provided for in this Section at least 45 days before the redemption date unless the Trustee consents to a shorter period. Such notice shall be accompanied by an Officers' Certificate from the Company to the effect that such redemption will comply with the provisions herein. SECTION 3.2 Selection of Securities To Be Redeemed. If fewer than all the Securities are to be redeemed, the Trustee shall select the Securities to be redeemed pro rata or by lot or by a method that complies with applicable legal and securities exchange requirements, if any, and that the Trustee considers fair and appropriate and in accordance with methods generally used at the time of selection by fiduciaries in similar circumstances. The Trustee shall make the selection from outstanding Securities not previously called for redemption. The Trustee may select for redemption portions of the principal of -28- Securities that have denominations larger than $1,000. Securities and portions of them the Trustee selects shall be in amounts of $1,000 or a whole multiple of $1,000. Provisions of this Indenture that apply to Securities called for redemption also apply to portions of Securities called for redemption. The Trustee shall notify the Company promptly of the Securities or portions of Securities to be redeemed. In the event the Company is required to make an offer to redeem Securities pursuant to Sections 4.6 or 4.8 and the amount available for such offer is not evenly divisible by $1,000, the Trustee shall promptly refund to the Company any remaining funds, which in no event will exceed $1,000. SECTION 3.3 Notice of Redemption. At least 30 days but not more than 60 days before a date for redemption of securities, the Company shall mail a notice of redemption by first-class mail to the registered address appearing in the Security Register of each Holder of Securities to be redeemed. The notice shall identify the Securities (including CUSIP numbers, if any) to be redeemed and shall state: (1) the redemption date; (2) the redemption price; (3) the name and address of the Paying Agent; (4) that Securities called for redemption must be surrendered to the Paying Agent to collect the redemption price; (5) if fewer than all the outstanding Securities are to be redeemed, the identification and principal amounts of the particular Securities to be redeemed; (6) that, unless the Company defaults in making such redemption payment, interest on Securities (or portion thereof) called for redemption ceases to accrue on and after the redemption date; (7) the paragraph of the Securities pursuant to which the Securities called for redemption are being redeemed; (8) that no representation is made as to the correctness or accuracy of the CUSIP number, if any, listed in such notice or printed on the Securities; and (9) the procedures that a Holder must follow to surrender the securities to be redeemed. At the Company's written request, the Trustee shall give the notice of redemption in the Company's name and at the Company's expense. In such event, the Company shall provide the Trustee with the information required by this Section. -29- SECTION 3.4 Effect of Notice of Redemption. Once notice of redemption is mailed, Securities called for redemption become due and payable on the redemption date and at the redemption price stated in the notice. Upon surrender to the Paying Agent, such Securities shall be paid at the redemption price stated in the notice, plus accrued interest to the redemption date. Such notice if mailed in the manner herein provided shall be conclusively presumed to have been given, whether or not the Holder receives such notice. Failure to give notice or any defect in the notice to any Holder shall not affect the validity of the notice to any other Holder. If any Security called for redemption shall not be so paid on the redemption date upon surrender thereof for redemption in accordance with this Indenture, the principal and premium, if any, shall, until paid, bear interest from the redemption date at the rate borne by such Security. SECTION 3.5 Deposit of Redemption Price. Prior to 11:00 a.m. (New York City time) on the redemption date, the Company shall deposit with the Trustee or Paying Agent (or, if the Company or a Subsidiary is the Paying Agent, shall segregate and hold in trust) money sufficient to pay the redemption price of and accrued interest (if any) on all Securities or portions thereof to be redeemed on that date other than Securities or portions of Securities called for redemption which have been delivered by the Company to the Trustee for cancellation. The Paying Agent shall promptly mail or deliver to Holders of Securities so redeemed payment in an amount equal to the redemption price of the Securities purchased from each such Holder. SECTION 3.6 Securities Redeemed in Part. Upon surrender of a Security that is redeemed in part (with, if the Company or the Trustee so requires, due endorsement by, or a written instrument of transfer in form satisfactory to the Company and the Trustee duly executed by, the Holder thereof or his attorney duly authorized in writing), the Company shall execute, and the Trustee shall authenticate and deliver to the Holder of such Security without service charge, a new Security or Securities of any authorized denomination as requested by such Holder, in aggregate principal amount equal to and in exchange for the unredeemed portion of the principal of the Security so surrendered, except that if a Global Security is so surrendered, the Company shall execute, and the Trustee shall authenticate and deliver to the Depositary for such Global Security, without service charge, a new Global Security in denomination equal to and in exchange for the unredeemed portion of the principal of the Global Security so surrendered. -30- ARTICLE IV COVENANTS SECTION 4.1 Payment of Securities. The Company shall promptly pay the principal of and interest on the Securities on the dates and in the manner provided in the Securities and in this Indenture. Principal and interest shall be considered paid on the date due if on such date the Trustee or the Paying Agent holds in accordance with this Indenture money sufficient to pay all principal and interest then due. The Company shall pay interest on overdue principal at the rate specified therefor in the Securities, and it shall pay interest on overdue installments of interest at the same rate to the extent lawful. SECTION 4.2 SEC Reports. The Company shall file with the Trustee and provide Securityholders, as their names appear in the Security Register, within 15 days after it files them with the SEC, copies of the annual reports and the information, documents and other reports which it is required to file with the SEC pursuant to Section 13 or 15(d) of the Exchange Act. Notwithstanding that the Company may not be required to be or remain subject to the reporting requirements of Section 13 or 15(d) of the Exchange Act, the Company shall continue to file with the SEC and provide the Trustee and Securityholders with the annual reports and the information, documents and other reports which are specified in Sections 13 and 15(d) of the Exchange Act. The Company also shall comply with the other provisions of TIA 314(a). Delivery of such reports, information and documents to the Trustee is for informational purposes only and the Trustee's receipt of such shall not constitute constructive notice of any information contained therein or determinable from information contained therein, including the Company's compliance with any of its covenants hereunder (as to which the Trustee is entitled to rely exclusively on Officers' Certificates). SECTION 4.3 Limitation on Indebtedness. (a) The Company will not Incur, and will not permit any Restricted Subsidiary to Incur, any Indebtedness; provided, however, that the Company, any Guarantor and any Foreign Restricted Subsidiary may Incur Indebtedness (including Acquired Indebtedness) if on the date thereof the Consolidated Coverage Ratio would be equal to or greater than 2.5 to 1.0. (b) Notwithstanding Section 4.3(a), the Company and any Restricted Subsidiaries (to the extent set forth below) may Incur the following Indebtedness ("Permitted Indebtedness"): (i) Indebtedness and letters of credit (with letters of credit being deemed to have a principal amount equal to the maximum face amount -31- (thereunder) of the Company, Aaron Brothers, Inc. (in the form of a guarantee of the Company's obligations) as long as it is a Restricted Subsidiary that is not a Significant Subsidiary or any Restricted Subsidiary which is a Guarantor of the Notes under the Credit Agreement, Letter of Credit Facility and any Refinancing Indebtedness in respect thereof in an aggregate principal amount outstanding at any time not to exceed the greater of (x) an amount equal to 50% of the book value of the inventory of the Company and its Restricted Subsidiaries as of any date of Incurrence calculated on a consolidated basis in accordance with GAAP and (y) $325 million; provided that if Aaron Brothers, Inc. is at any time a Restricted Subsidiary that is a Significant Subsidiary and an obligor (including as a guarantor) under the Credit Agreement, Letter of Credit Facility or Refinancing Indebtedness in respect thereof, such event will be deemed to constitute the incurrence of Indebtedness guaranteed by Aaron Brothers, Inc. under the Credit Agreement, Letter of Credit Facility or Refinancing Indebtedness in respect thereof, as the case may be; (ii) Indebtedness of the Company owing to and held by any Wholly Owned Subsidiary or Indebtedness of a Restricted Subsidiary owing to and held by the Company or any Wholly Owned Subsidiary; provided, however, that any subsequent issuance or transfer of any Capital Stock or any other event which results in any such Wholly Owned Subsidiary ceasing to be a Wholly Owned Subsidiary or any subsequent transfer of any such Indebtedness (except to the Company or a Wholly Owned Subsidiary) will be deemed, in each case, to constitute the Incurrence of such Indebtedness by the issuer thereof; (iii) (x) Indebtedness represented by the Securities and any Guarantees of the Securities by any of the Company's Subsidiaries in an amount not to exceed the amount outstanding on the initial Issue Date (y) any Indebtedness of the Company or any Restricted Subsidiary (other than the Indebtedness described in Sections 4.3(b)(i)-(ii)) outstanding on the Issue Date, provided that the 10 7/8% Senior Notes shall only be deemed Permitted Indebtedness until 60 days after the Issue Date and (z) any Refinancing Indebtedness Incurred in respect of any Indebtedness described in this Section 4.3(b)(iii) other than the 10 7/8% Senior Notes or Section 4.3(a); (iv) (A) Acquired Indebtedness of the Company or a Restricted Subsidiary; provided, however, that at the time such Restricted Subsidiary or assets is acquired by the Company or a Restricted Subsidiary, the Company would have been able to Incur $1.00 of additional Indebtedness pursuant to Section 4.3(a) after giving effect to the Incurrence of such Indebtedness pursuant to this Section 4.3(b)(iv) and such transaction or series of related transactions and (B) Refinancing Indebtedness Incurred by a Restricted Subsidiary in respect of Indebtedness Incurred by such Restricted Subsidiary pursuant to this Section 4.3(b)(iv); -32- (v) Indebtedness (A) in respect of performance bonds, bankers' acceptances, letters of credit and surety or appeal bonds provided by the Company or any Restricted Subsidiary in the ordinary course of its business and which do not secure other Indebtedness and (B) under Currency Agreements, Interest Rate Agreements and Commodity Price Protection Agreements Incurred which, at the time of Incurrence, is in the ordinary course of business; provided, however, that, in the case of Currency Agreements, Interest Rate Agreements and Commodity Price Protection Agreements, such Currency Agreements, Interest Rate Agreements and Commodity Price Protection Agreements do not increase the Indebtedness of the Company outstanding at any time other than as a result of fluctuations in foreign currency exchange rates, interest rates or commodity prices or by reason of fees, indemnities and compensation payable thereunder; (vi) Indebtedness (A) represented by Guarantees by the Company of Indebtedness otherwise permitted to be Incurred pursuant to this Section 4.3 and (B) represented by Guarantees by a Restricted Subsidiary of Indebtedness of the Company or another Restricted Subsidiary otherwise permitted to be Incurred pursuant to this Section 4.3; provided that, in the case of clause (B), if a Restricted Subsidiary Guarantees any such Indebtedness other than any Guarantee by Aaron Brothers, Inc. of Indebtedness under the Credit Agreement, Letter of Credit Facility and any Refinancing Indebtedness in respect thereof, such Restricted Subsidiary executes and delivers to the Trustee a supplemental indenture in form satisfactory to the Trustee providing for the Guarantee on an equal basis of the Securities; provided, however, if Aaron Brothers , Inc is at any time a Restricted Subsidiary that is a Significant Subsidiary while it has Guaranteed the Credit Agreement, Letter of Credit Facility, or Refinancing Indebtedness in respect thereof, Aaron Brothers, Inc. shall Guarantee the Securities on an equal basis as set forth in this clause (vi); (vii) Indebtedness of the Company or any Restricted Subsidiary represented by Capitalized Lease Obligations, mortgage financings or purchase money obligations, in each case Incurred for the purpose of financing or refinancing all or any part of the purchase price or cost of construction, repairs, renovation, remodeling, expansion or other improvement of property, plant and equipment, including services and equipment supporting such items, used in the Company's or any Restricted Subsidiary's business or a Related Business (collectively, "Purchase Money Debt") in an aggregate principal amount outstanding not to exceed 10% of Total Assets at the time of any Incurrence thereof; (viii) Indebtedness of the Company or any Restricted Subsidiary represented by Capitalized Lease Obligations Incurred from time to time for point-of-sale equipment and store systems, including services and equipment supporting such equipment and systems, with the aggregate capitalized amount of -33- such obligation determined in accordance with GAAP outstanding at any one time not to exceed $50 million; (ix) Indebtedness of the Company or any Restricted Subsidiary Incurred with respect to acquisitions of assets or a Person or consisting of Guarantees of such Indebtedness, so long as such Indebtedness was not created in anticipation of such acquisition and does not exceed, in the aggregate, $10 million; and (x) Other Indebtedness of the Company or any Restricted Subsidiary in an aggregate principal amount outstanding at any time not to exceed $50 million, of which no more than $10 million may be borrowed by non-Guarantor Restricted Subsidiaries. (c) Notwithstanding the foregoing, the Company shall not Incur any Indebtedness pursuant to the foregoing Section 4.3(b) if the proceeds thereof are used, directly or indirectly, to Refinance any Subordinated Obligations unless such new Indebtedness shall be subordinated to the Securities to at least the same extent as such Subordinated Obligations being Refinanced. In addition, notwithstanding any other provision of this Section 4.3, the Company will not, and will not permit any Restricted Subsidiary to, Incur any Guarantee of Indebtedness of any Unrestricted Subsidiary. (d) Notwithstanding the foregoing, any Guarantee by a Restricted Subsidiary of the Securities may be released (i) upon the sale, transfer or other disposition of all of the Capital Stock of such Restricted Subsidiary held by the Company or any Subsidiary to a Person other than the Company or a Subsidiary, (ii) if such Restricted Subsidiary no longer guarantees any Indebtedness of the Company or has outstanding any Indebtedness which it would not be able to incur without guaranteeing the Securities pursuant to Section 4.3(b) if such Indebtedness was incurred on the date of such release, or (iii) if such Subsidiary is designated an Unrestricted Subsidiary in compliance with Section 4.4. (e) For purposes of determining compliance with the foregoing covenant, (i) in the event that an item of Indebtedness meets the criteria of more than one of the types of Indebtedness described above, the Company may classify or later reclassify such item of Indebtedness or any portion thereof and only be required to include the amount and type of such Indebtedness in one of the above clauses and (ii) an item of Indebtedness may be divided and classified in more than one of the types of Indebtedness described above. SECTION 4.4 Limitation on Restricted Payments. (a) The Company will not, and will not permit any Restricted Subsidiary to, directly or indirectly, (i) declare or pay any dividend or make any distribution on or in respect of its Capital Stock (including any payment in connection with any merger or consolidation involving the Company), except (1) dividends or distributions payable solely in its Capital Stock (other than Disqualified Stock) or in options, warrants or other rights to purchase such Capital Stock and (2) dividends or distributions payable to the Company or another Restricted -34- Subsidiary (and, if such Restricted Subsidiary making such dividend or distribution is not wholly owned, to its other shareholders on a pro rata basis), (ii) purchase, redeem, retire or otherwise acquire for value any Capital Stock of the Company held by Persons other than the Company or another Restricted Subsidiary, (iii) purchase, repurchase, redeem, defease or otherwise acquire or retire for value, prior to scheduled maturity, scheduled repayment or scheduled sinking fund payment any Subordinated Obligations (other than (A) the purchase, repurchase or other acquisition of Subordinated Obligations in anticipation of satisfying a sinking fund obligation, principal installment or final maturity, in each case due within one year of the date of such purchase, repurchase or acquisition or (B) the repayment, redemption or retirement for value of the Company's obligations owed to 5931, Inc. or 5931 Business Trust or successors thereto so long as it remains a Wholly Owned Subsidiary) or (iv) make any Investment (other than a Permitted Investment) in any Person (any such dividend, distribution, purchase, redemption, repurchase, defeasance, other acquisition, retirement, Investment or payment being herein referred to as a "Restricted Payment") if at the time the Company or such Restricted Subsidiary makes such Restricted Payment: (1) a Default or Event of Default will have occurred and be continuing (or would result therefrom); (2) the Company could not Incur at least $1.00 of additional Indebtedness under Section 4.3(a); or (3) the aggregate amount of such Restricted Payment and all other Restricted Payments (the amount so expended, if other than in cash, to be determined in good faith by the Board of Directors of the Company, whose determination will be evidenced by a resolution of such Board of Directors certified in an Officers' Certificate to the Trustee) declared or made subsequent to the Issue Date would exceed the sum of: (A) 50% of the Consolidated Net Income with respect to the period (treated as one accounting period) from the end of the most recent fiscal quarter ending prior to the Issue Date to the end of the most recent fiscal quarter for which financial statements are available to the Trustee (or, in case such Consolidated Net Income will be a deficit, minus 100% of such deficit) plus $100 million; (B) the aggregate Net Cash Proceeds received by the Company from the issue or sale of Capital Stock (other than Disqualified Stock) subsequent to the Issue Date (other than an issuance or sale to a Subsidiary); (C) the amount by which Indebtedness of the Company is reduced on the Company's balance sheet upon the conversion or exchange (other than by a Restricted Subsidiary) subsequent to the Issue Date of any Indebtedness of the Company convertible or exchangeable for Capital Stock (other than Disqualified Stock) of the Company (less the amount of any cash or other property distributed by the Company upon such conversion or exchange); -35- (D) in the case of designation of an Unrestricted Subsidiary as a Restricted Subsidiary (as long as the designation of such Subsidiary as an Unrestricted Subsidiary was deemed a Restricted Payment) the value (as provided in the definition of "Investment") of the Company's interest in such Subsidiary provided that such amount shall not in any case exceed the aggregate amount of the Restricted Payments deemed made at the time or after the Subsidiary was designated as an Unrestricted Subsidiary; and (E) in the case of the disposition, return, dividend or repayment of any Investment constituting a Restricted Payment made after the date of the Indenture an amount (to the extent not included in Consolidated Net Income) equal to the lesser of payments made to the Company or a Restricted Subsidiary with respect to such Investment and the initial amount of such Investment, in either case, less the cost of disposition of such Investment and net of taxes (to the extent not reflected in Consolidated Net Income). (b) The provisions of Section 4.4(a) will not prohibit: (i) any purchase, redemption, defeasance or other acquisition of Capital Stock of the Company or Subordinated Obligations made by exchange for, or out of the Net Cash Proceeds of the substantially concurrent sale of, Capital Stock of the Company (other than Disqualified Stock and other than Capital Stock issued or sold to a Subsidiary); provided, however, that (A) such purchase, redemption, defeasance or other acquisition will be excluded in the calculation of the amount of Restricted Payments and (B) the Net Cash Proceeds from such sale will be excluded from Section 4.4(a)(3)(B); (ii) any purchase, redemption, defeasance or other acquisition of Subordinated Obligations made by exchange for, or out of the net proceeds of the substantially concurrent sale of, Subordinated Obligations of the Company; provided, however, that (A) the principal amount of such new Indebtedness does not exceed the principal amount of the Subordinated Obligations being so redeemed, purchased, defeased, acquired or retired for value (plus the amount of any premium required to be paid under the terms of the instrument governing the Subordinated Obligations being so redeemed, purchased, defeased, acquired or retired), (B) such new Indebtedness is subordinated to the Securities at least to the same extent as such Subordinated Obligations so redeemed, purchased, exchanged, defeased, acquired or retired for value, (C) such new Indebtedness has a final scheduled maturity date later than the final scheduled maturity date of the Securities and (D) such new Indebtedness has an Average Life equal to or greater than the Average Life of the Securities; provided further, however, that such purchase, redemption, defeasance or other acquisition will be excluded in the calculation of the amount of Restricted Payments; -36- (iii) any purchase, redemption, defeasance or other acquisition of Subordinated Obligations (1) from Net Available Cash to the extent permitted by Section 4.6; provided, however, that such purchase or redemption will be excluded in the calculation of the amount of Restricted Payments, or (2) pursuant to an offer to purchase which is then required to be made upon a change of control of the Company pursuant to the terms of the instrument governing such Subordinated Obligation; provided, however, that such purchase will be included in the calculation of the amount of Restricted Payments; (iv) dividends paid within 60 days after the date of declaration thereof if at such date of declaration such dividend would have complied with this Section 4.4; provided, however, that the amount of such dividend will be included in the calculation of the amount of Restricted Payments; or (v) repurchase, acquisitions or retirements of shares of Capital Stock of the Company deemed to occur upon the exercise of stock options or similar rights issued under employee benefit plans of the Company if such shares represent all or a portion of the exercise price or are surrendered in connection with satisfying any federal or state income tax obligation or are repurchased or acquired to fulfill obligations of the Company or any Restricted Subsidiary under employee compensation or other benefit arrangements entered into or provided for in the ordinary course of business; provided that cash payments pursuant to this Section 4.4(b)(v) shall not exceed $2 million in any fiscal year. SECTION 4.5 Limitation on Restrictions on Distributions from Restricted Subsidiaries. The Company will not, and will not permit any Restricted Subsidiary to, create or otherwise cause or permit to exist or become effective any consensual encumbrance or restriction on the ability of any Restricted Subsidiary to (i) pay dividends or make any other distributions on its Capital Stock or pay any Indebtedness or other obligation owed to the Company, (ii) make any Investments in the Company or (iii) transfer any of its property or assets to the Company or any Restricted Subsidiary, except: (1) any encumbrance or restriction pursuant to an agreement in effect at or entered into on the Issue Date; (2) any encumbrance or restriction with respect to a Restricted Subsidiary pursuant to an agreement in effect on or prior to the date on which such Restricted Subsidiary was acquired by the Company or a Restricted Subsidiary (other than encumbrances or restrictions Incurred in connection with, or in contemplation of, the transaction or series of related transactions pursuant to -37- which such Restricted Subsidiary became a Subsidiary or was acquired by the Company or a Restricted Subsidiary) and outstanding on such date; (3) any encumbrance or restriction pursuant to an agreement effecting a refinancing of Indebtedness Incurred pursuant to an agreement referred to in clause (1) or (2) of this Section 4.5 or contained in any amendment, waiver, modification or renewal of an agreement referred to in clause (1) or (2) of this Section 4.5; provided, however, that the encumbrances and restrictions contained in any such refinancing agreement or amendment, waiver, modification or renewal are no less favorable to the Securityholders than the encumbrances and restrictions contained in such agreements as determined in good faith by the Company; (4) in the case of clause (iii), any encumbrance or restriction (A) that restricts in a customary manner the subletting, assignment or transfer of any property or asset that is subject to a lease, license or similar contract, (B) by virtue of any transfer of, agreement to transfer, option or right with respect to, or Lien on, any property or assets of the Company or any Restricted Subsidiary not otherwise prohibited by the Indenture, (C) arising or agreed to in the ordinary course of business and that does not individually or in the aggregate, detract from the value of property or assets of the Company or any Restricted Subsidiary in any manner material to the Company or such Restricted Subsidiary or (D) contained in security agreements securing Indebtedness of a Restricted Subsidiary to the extent such encumbrance or restrictions restrict the transfer of the property subject to such security agreements; (5) any restriction with respect to a Restricted Subsidiary imposed pursuant to an agreement entered into for the sale or disposition of all or substantially all the Capital Stock or assets of such Restricted Subsidiary pending the closing of such sale or disposition; and (6) encumbrances or restrictions contained in any financing agreement of a Foreign Restricted Subsidiary or arising or existing by reason of applicable law, including any legal limitations restricting the ability of Foreign Restricted Subsidiaries to pay as dividends or distribute or otherwise pay or repatriate funds to the Company or its Subsidiaries. SECTION 4.6 Limitation on Sales of Assets and Subsidiary Stock. (a) The Company will not, and will not permit any Restricted Subsidiary to, make any Asset Disposition unless (i) the Company or such Restricted Subsidiary receives consideration at the time of such Asset Disposition at least equal to the fair market value, as determined in good faith by the Board of Directors of the Company (including as to the value of all non-cash consideration), of the shares and assets subject to such Asset Disposition, (ii) at least 75% of the consideration thereof received by the Company or such Restricted Subsidiary (other than Asset Swaps) is in the form of cash or Temporary Cash Investments and (iii) an amount -38- equal to 100% of the Net Available Cash from such Asset Disposition is applied by the Company or such Restricted Subsidiary, as the case may be (A) FIRST, to the extent the Company or any Restricted Subsidiary, as the case may be, elects (or is required by the terms of any Senior Indebtedness), to prepay, repay or purchase Senior Indebtedness or Indebtedness (other than Disqualified Stock) of a Wholly Owned Subsidiary (in each case other than Indebtedness owed to the Company or an Affiliate of the Company) within 180 days from the later of the date of such Asset Disposition or the receipt of such Net Available Cash; (B) SECOND, to the extent of the balance of Net Available Cash after application in accordance with clause (A), to the extent the Company or such Restricted Subsidiary, as the case may be, elects, to the investment by the Company or any Restricted Subsidiary in Additional Assets within one year from the later of the date of such Asset Disposition or the receipt of such Net Available Cash; (C) THIRD, to the extent of the balance of such Net Available Cash after application in accordance with clauses (A) and (B), to make an Offer (as defined below) to purchase Securities pursuant to and subject to the conditions set forth in Section 4.6(b) within 45 days after the date that is one year from the receipt of such Net Available Cash; and (D) FOURTH, to the extent of the balance of such Net Available Cash after application in accordance with clauses (A), (B) and (C), to (x) the acquisition by the Company or any Wholly Owned Subsidiary of Additional Assets, (y) the prepayment, repayment, purchase or other acquisition of Indebtedness of the Company (other than Indebtedness owed to an Affiliate of the Company and other than Disqualified Stock of the Company) or Indebtedness of any Restricted Subsidiary (other than Indebtedness owed to the Company or an Affiliate of the Company) or (z) to general corporate purposes (other than to the payment of dividends or distributions in respect of, or repurchases of, Capital Stock), in each case within 45 days after the later of one year from the receipt of such Net Available Cash and the date the Offer described in paragraph (b) below is consummated; provided, however, that in connection with any prepayment, repayment, purchase or other acquisition of Indebtedness pursuant to clause (A), (C) or (D) above, the Company or such Restricted Subsidiary will, to the extent such Indebtedness is not revolving Indebtedness, retire such Indebtedness and, except as to Indebtedness described in Section 4.3(b)(i), will cause any related loan commitment or availability (if any) to be permanently reduced in an amount equal to the principal amount so prepaid, repaid or purchased. For the purposes of this Section 4.6, the following are deemed to be cash: (x) the assumption by the transferee of Indebtedness of the Company (other than Disqualified Stock of the Company) or any Restricted Subsidiary and the release of the Company or such Restricted Subsidiary from all liability on such Indebtedness in connection with such Asset Disposition, (y) any Designated Noncash Consideration received by the Company or any of its Restricted Subsidiaries in the Asset Sale and (z) securities received by the Company or any Restricted Subsidiary from the transferee that are promptly converted by the Company or such Restricted Subsidiary into cash. The aggregate fair market value of the Designated Noncash Consideration, taken together with the fair market value at the time of receipt of all other Designated Noncash Consideration then held by the Company or any Restricted Subsidiary, may not exceed 5% of the Company's Consolidated Tangible Net Worth, at the time of the receipt of the Designated -39- Noncash Consideration (with fair market value being measured at the time received and without giving effect to subsequent changes in value). With respect to an Asset Swap constituting an Asset Disposition, the Company or any Restricted Subsidiary shall be required to receive in cash (as such term is deemed to be defined for purposes of this paragraph (a)) or Temporary Cash Investments in an amount equal to 75% of the proceeds of the Asset Disposition which do not consist of in-kind assets acquired with the Asset Swap. (b) In the event of an Asset Disposition that requires the purchase of Securities pursuant to Section 4.6(a)(iii)(C), the Company will be required to purchase Securities tendered pursuant to an offer by the Company for the Securities (the "Offer") at a purchase price of 100% of their principal amount plus accrued interest to the date of purchase in accordance with the procedures (including prorating in the event of oversubscription) set forth in Section 4.6(c). If the aggregate purchase price of Securities tendered pursuant to the offer is less than the Net Available Cash allotted to the purchase of the Securities, the Company will apply the remaining Net Available Cash in accordance with Section 4.6(a)(iii)(D) above. The Company and its Restricted Subsidiaries shall not be required to apply any Net Available Cash in accordance herewith except to the extent that the aggregate Net Available Cash from all Asset Dispositions which are not applied in accordance with this Section exceeds $10,000,000. The Company shall not be required to make an Offer for Securities pursuant to this Section if the Net Available Cash available therefor (after application of the proceeds as provided in clauses (A) and (B)) is less than $15,000,000 for any particular Asset Disposition (which lesser amounts shall be carried forward for purposes of determining whether an Offer is required with respect to the Net Available Cash from any subsequent Asset Disposition). (c) (1) Promptly, and in any event within 30 days after the Company becomes obligated to make an Offer, the Company shall be obligated to deliver to the Trustee and send, by first-class mail to each Holder, at the address appearing in the Security Register, a written notice stating that the Holder may elect to have his Securities purchased by the Company either in whole or in part (subject to prorationing as hereinafter described in the event the Offer is oversubscribed) in integral multiples of $1,000 of principal amount, at the applicable purchase price. The notice shall specify a purchase date not less than 30 days nor more than 60 days after the date of such notice (the "Purchase Date") and shall contain (i) the most recently filed Annual Report on Form 10-K (including audited consolidated financial statements) of the Company, the most recent subsequently filed Quarterly Report on Form 10-Q of the Company and any Current Report on Form 8-K of any the Company filed subsequent to such Quarterly Report, other than Current Reports describing Asset Dispositions otherwise described in the offering materials (or corresponding successor reports), (ii) a description of material developments in the Company's business subsequent to the date of the latest of such Reports, and (iii) if material, appropriate pro forma financial information and all instructions and materials necessary to tender Securities pursuant to the Offer, together with the information contained in clause (3). (2) Not later than the date upon which written notice of an Offer is delivered to the Trustee as provided below, the Company shall deliver to the Trustee an Officers' Certificate as to (i) the amount of the Offer (the "Offer Amount"), (ii) the -40- allocation of the Net Available Cash from the Asset Dispositions pursuant to which such Offer is being made and (iii) the compliance of such allocation with the provisions of Section 4.6(a). Upon the expiration of the period for which the Offer remains open (the "Offer Period"), the Company shall deliver to the Trustee for cancellation the Securities or portions thereof which have been properly tendered to and are to be accepted by the Company. Not later than 11:00 a.m. (New York City time) on the Purchase Date, the Company shall irrevocably deposit with the Trustee or with a paying agent (or, if the Company is acting as Paying Agent, segregate and hold in trust) an amount in cash sufficient to pay the Offer Amount for all Securities properly tendered to and accepted by the Company. The Trustee shall, on the Purchase Date, mail or deliver payment to each tendering Holder in the amount of the purchase price. (3) Holders electing to have a Security purchased will be required to surrender the Security, together with all necessary endorsements and other appropriate materials duly completed, to the Company at the address specified in the notice at least three Business Days prior to the Purchase Date. Holders will be entitled to withdraw their election in whole or in part if the Trustee or the Company receives not later than one Business Day prior to the Purchase Date, a facsimile transmission or letter setting forth the name of the Holder, the principal amount of the Security (which shall be $1,000 or an integral multiple thereof) which was delivered for purchase by the Holder, the aggregate principal amount of such Security (if any) that remains subject to the original notice of the offer and that has been or will be delivered for purchase by the Company and a statement that such Holder is withdrawing his election to have such Security purchased. If at the expiration of the Offer Period the aggregate principal amount of Securities surrendered by Holders exceeds the Offer Amount, the Company shall select the Securities to be purchased on a pro rata basis (with such adjustments as may be deemed appropriate by the Company so that only securities in denominations of $1,000, or integral multiples thereof, shall be purchased). Holders whose Securities are purchased only in part will be issued new Securities equal in principal amount to the unpurchased portion of the Securities surrendered. (4) A Security shall be deemed to have been accepted for purchase at the time the Trustee, directly or through an agent, mails or delivers payment therefor to the surrendering Holder. (d) The Company shall comply, to the extent applicable, with the requirements of Section 14(e) of the Exchange Act and any other securities laws or regulations in connection with the repurchase of Securities pursuant to this Section. To the extent that the provisions of any securities laws or regulations conflict with provisions of this Section, the Company shall comply with the applicable securities laws and regulations and shall not be deemed to have breached its obligations under this Section by virtue thereof. SECTION 4.7 Limitation on Transactions with Affiliates. (a) The Company will not, and will not permit any Restricted Subsidiary to, directly or indirectly, enter into any agreement or conduct any transaction or series of related -41- transactions (including the purchase, sale, lease or exchange of any property, or rendering of any service) with any Affiliate of the Company (an "Affiliate Transaction") unless (i) the terms of such transaction or agreement are no less favorable to the Company or such Restricted Subsidiary, as the case may be, than those that could be obtained at the time of such transaction in arm's-length dealings with a Person who is not such an Affiliate; and (ii) in the event such Affiliate Transaction involves an aggregate amount in excess of $5,000,000, the terms of such transaction or agreement shall have been approved by a majority of the members of the Board of Directors having no personal stake in such Affiliate Transaction (and such majority determines that such Affiliate Transaction satisfies the criteria in clause (i) above). (b) The foregoing provisions of Section 4.7(a) shall not apply to (i) any Restricted Payment permitted to be made pursuant to Section 4.4, (ii) any issuance of securities, or other payments, awards or grants in cash, securities or otherwise pursuant to, or the funding of, employment arrangements, stock options and stock ownership plans approved by the Board of Directors or the payment of fees and indemnities to directors of the Company and its Restricted Subsidiaries in the ordinary course of business, (iii) loans or advances to employees in the ordinary course of business, (iv) any transaction between the Company and a Wholly Owned Subsidiary or between Wholly Owned Subsidiaries, (v) transactions pursuant to written agreements in existence on the Issue Date, (vi) repurchases, acquisitions or retirements of shares of Capital Stock of the Company deemed to occur upon the exercise of stock options or similar rights issued under employee benefit plans of the Company if such shares represent all or a portion of the exercise price or are surrendered in connection with satisfying any federal or state income tax obligation or repurchased or acquired to fulfill obligations of the Company or any Restricted Subsidiary under employee compensation or other benefit arrangements entered into or provided for in the ordinary course of business; provided that cash payments pursuant to this clause (vi) shall not exceed $2 million in any fiscal year, or (vii) any transaction between the Company or any Wholly Owned Subsidiary, on the one hand, and a Restricted Subsidiary, on the other hand, in the ordinary course of business on terms that are customary in the industry or consistent with past practice. SECTION 4.8 Change of Control. (a) Upon a Change of Control, each Holder shall have the right to require that the Company repurchase all or any part of such Holder's Securities at a purchase price in cash equal to 101% of the principal amount thereof, plus accrued and unpaid interest, if any, to the date of repurchase (subject to the right of Holders of record on the relevant record date to receive interest due on the related interest payment date), in accordance with the terms contemplated in Section 4.8(b). (b) Within 30 days following any Change of Control, or at the Company's option, prior to any Change of Control but after the public announcement thereof, the Company shall mail a notice to each Holder with a copy to the Trustee stating: (1) that a Change of Control has or may have occurred and that such Holder has the right to require the Company to purchase such Holder's Securities at a purchase price in cash equal to 101% of the principal amount thereof, plus -42- accrued and unpaid interest, if any, to the date of repurchase (subject to the right of Holders of record on a record date to receive interest on the relevant interest payment date); (2) the circumstances and relevant facts and pro forma financial information regarding such Change of Control; (3) the repurchase date (which shall be no earlier than the consummation of the Change of Control and no earlier than 30 days nor later than 60 days from the date such notice is mailed); (4) that the Change of Control offer is conditioned on the Change of Control occurring if the notice is mailed prior to the Change of Control; and (5) the instructions determined by the Company, consistent with this Section, that a Holder must follow in order to have its Securities purchased. (c) Holders electing to have a Security purchased will be required to surrender the Security, together with all necessary endorsements and other appropriate materials duly completed, to the Company at the address specified in the notice at least three Business Days prior to the purchase date. Holders will be entitled to withdraw their election if the Trustee or the Company receives not later than one Business Day prior to the purchase date, a facsimile transmission or letter setting forth the name of the Holder, the principal amount of the Security which was delivered for purchase by the Holder as to which such notice of withdrawal is being submitted and a statement that such Holder is withdrawing his election to have such Security purchased. (d) On the purchase date, all Securities purchased by the Company under this Section shall be delivered to the Trustee for cancellation, and the Company shall pay the purchase price plus accrued and unpaid interest, if any, to the Holders entitled thereto. (e) The Company shall comply, to the extent applicable, with the requirements of Section 14(e) of the Exchange Act and any other securities laws or regulations in connection with the repurchase of Securities pursuant to this Section. To the extent that the provisions of any securities laws or regulations conflict with provisions of this Section, the Company shall comply with the applicable securities laws and regulations and shall not be deemed to have breached its obligations under this Section by virtue thereof. (f) Notwithstanding the occurrence of a Change of Control, the Company shall not be obligated (i) to repurchase the Securities or make the offer described above upon a Change of Control if the Company has irrevocably elected to redeem all the Securities in accordance with Article Three; provided that the Company does not default in its redemption obligations pursuant to such election or (ii) to make a Change of Control offer upon a Change of Control if a third party makes the Change of Control offer in the manner, at the times and otherwise in compliance with the requirements described in the Indenture applicable to a Change -43- of Control offer made by the Company and purchases all Securities validly tendered and not withdrawn under such Change of Control offer. SECTION 4.9 Compliance Certificate. The Company shall deliver to the Trustee within 120 days after the end of each fiscal year of the Company an Officers' Certificate, one of the signers of which shall be the principal executive, financial or accounting officer of the Company, stating that in the course of the performance by the signers of their duties as officers of the Company they would normally have knowledge of any Default and whether or not the signers know of any Default that occurred during such period. If they do, the certificate shall describe the Default, its status and what action the Company is taking or proposes to take with respect thereto. The Company also shall comply with TIA 314(a)(4). SECTION 4.10 Further Instruments and Acts. Upon request of the Trustee or as otherwise necessary, the Company will execute and deliver such further instruments and do such further acts as may be reasonably necessary or proper to carry out more effectively the purpose of this Indenture. SECTION 4.11 Limitation on Liens. The Company will not, and will not permit any Restricted Subsidiary to, directly or indirectly, create or permit to exist any Lien on any of its property or assets (including Capital Stock), whether owned on the Issue Date or thereafter acquired, securing any obligation other than Permitted Liens, unless contemporaneously therewith effective provision is made to secure the Securities equally and ratably with (or on a senior basis to, in the case of Subordinated Obligations) such obligation for so long as such obligation is so secured. SECTION 4.12 Limitation on Sale/Leaseback Transactions. The Company will not, and will not permit any Restricted Subsidiary to, enter into any Sale/Leaseback Transaction with respect to any property unless (i) the Company or such Restricted Subsidiary would be entitled to (A) Incur Indebtedness in an amount equal to the Attributable Indebtedness with respect to such Sale/Leaseback Transaction pursuant to Section 4.3 and (B) create a Lien, if any, on such property securing such Attributable Indebtedness without equally and ratably securing the Securities pursuant to Section 4.11, (ii) the Net Cash Proceeds received by the Company or any Restricted Subsidiary in connection with such Sale/Leaseback Transaction are at least equal to the fair value (as determined in good faith and certified in an Officer's Certificate to the Trustee) of such property and (iii) the transfer of such property is permitted by, and the Company or such Restricted Subsidiary applies the proceeds of such transaction in compliance with, Section 4.6. -44- SECTION 4.13 Limitation on Sale of Subsidiary Preferred Stock. The Company (i) will not, and will not permit any Restricted Subsidiary of the Company to, transfer, convey, sell, lease or otherwise dispose of any Preferred Stock of any Restricted Subsidiary to any Person (other than to the Company or a Wholly Owned Subsidiary), unless (a) such transfer, conveyance, sale, lease or other disposition is of all the Capital Stock of such Restricted Subsidiary (or, in the case of a non-wholly owned Restricted Subsidiary, all of the Capital Stock held by the Company or its Restricted Subsidiary) and (b) the Net Cash Proceeds from such transfer, conveyance, sale, lease or other disposition are applied in accordance with the terms of Section 4.6 and (ii) will not permit any Restricted Subsidiary to issue any of its Preferred Stock to any Person other than to the Company or a Wholly Owned Subsidiary. SECTION 4.14 Corporate Existence Subject to Article V, the Company shall do or cause to be done all things necessary to preserve and keep in full force and effect the corporate existence and related rights and franchises (charter and statutory) of the Company. SECTION 4.15 Fall Away Event. (a) In the event of the occurrence of a Fall Away Event, the covenants and provisions described above under Sections 4.3, 4.4, 4.5, 4.6, 4.7, 4.8 and 4.13 shall each no longer be in effect for the remaining term of the Securities, subject to the next paragraph; provided that after a Fall Away Event, so long as the Securities retain an Investment Grade status the Company will be subject to the following covenant without any further action of the Company or the Trustee: From and after the occurrence of a Fall Away Event the non-Guarantor Subsidiaries of the Company (other than Foreign Restricted Subsidiaries, and except that Aaron Brothers, Inc. may guarantee the Credit Agreement, Letter of Credit Facility or Refinancing Indebtedness, so long as it is not a Significant Subsidiary) may not guarantee Indebtedness of the Company or otherwise incur Indebtedness other than Indebtedness of the types described under clauses (ii), (iii)(x) and (iii)(y) of Section 4.3 as in effect on the date of the occurrence of the Fall Away Event, with respect to Indebtedness outstanding on the date of the occurrence of the Fall Away Event, clause (iii)(z) of Section 4.3 as in effect on the date of the occurrence of the Fall Away Event, with respect to Indebtedness outstanding on the date of the occurrence of the Fall Away Event, clause (iv) of Section 4.3 (except that the proviso contained therein shall not be applicable); clauses (v), (vii) and (viii) of Section 4.3 and Indebtedness in an aggregate principal amount not to exceed 5% of the Company's Consolidated Tangible Net Worth at any one time outstanding. Any guarantee by a Subsidiary may be released at the option of the Company (a) upon the sale, transfer or other disposition of all of the Capital Stock of such Subsidiary held by the Company or any Subsidiary to a Person other than the Company or a Subsidiary or (b) if such Subsidiary no longer guarantees any Indebtedness of the Company or has any Indebtedness outstanding which it would not be able to incur without guaranteeing the Securities pursuant to this covenant if such Indebtedness was incurred on the date of the release. -45- (b) If, at any time, after the occurrence of a Fall Away Event, the Company fails to maintain Investment Grade status or a Default or Event of Default has occurred and is continuing, then Sections 4.3, 4.4, 4.5, 4.6. 4.7, 4.8 and 4.13 will be immediately reinstated and be applicable to the Company and its Restricted Subsidiaries and the covenant set forth in Section 4.15 shall be terminated although any actions taken during the pendency of the Fall Away Event shall not be deemed a Default or Event of Default under the Indenture whether or not they would have been permitted or prohibited if the provisions of Section 4.15(a) had not become applicable. -46- ARTICLE V SUCCESSOR COMPANY SECTION 5.1 When the Company May Merge or Transfer Assets. Except as otherwise provided in Section 4.13, the Company will not consolidate with or merge with or into, or convey, transfer or lease all or substantially all its assets to, any Person, unless: (i) the resulting, surviving or transferee Person (the "Successor Company") will be a corporation organized and existing under the laws of the United States of America, any State thereof or the District of Columbia and the Successor Company (if not the Company) will expressly assume, by supplemental indenture, executed and delivered to the Trustee, in form satisfactory to the Trustee, all the obligations of the Company under the Securities and this Indenture; (ii) immediately after giving effect to such transaction (and treating any Indebtedness which becomes an obligation of the Successor Company or any Restricted Subsidiary as a result of such transaction as having been Incurred by the Successor Company or such Restricted Subsidiary at the time of such transaction), no Default or Event of Default will have occurred and be continuing; (iii) immediately after giving effect to such transaction, the Successor Company would be able to Incur an additional $1.00 of Indebtedness under Section 4.3(a); and (iv) the Company will have delivered to the Trustee an Officers' Certificate and an Opinion of Counsel, each stating that such consolidation, merger or transfer and such supplemental indenture (if any) comply with this Indenture. The Successor Company will succeed to, and be substituted for, and may exercise every right and power of, the Company under this Indenture, but the predecessor Company in the case of a lease of all its assets or a conveyance, transfer or lease of substantially all its assets will not be released from the obligation to pay the principal of and interest on the Securities. Notwithstanding the foregoing clauses (ii) and (iii), any Wholly Owned Subsidiary may consolidate with, merge into or transfer all or part of its properties and assets to the Company and the Company will not be required to take any action under clause (iv) in connection therewith. -47- ARTICLE VI DEFAULTS AND REMEDIES SECTION 6.1 Events of Default. An "Event of Default" occurs if: (1) the Company defaults in any payment of interest on any Security when the same becomes due and payable, and such default continues for a period of 30 days; (2) the Company (i) defaults in the payment of the principal or premium, if any, of any Security when the same becomes due and payable at its Stated Maturity, upon optional redemption, upon required repurchase, upon declaration or otherwise or (ii) fails to redeem or purchase Securities when required pursuant to this Indenture or the Securities; (3) the Company fails to comply with Section 4.6, 4.8 or 5.1; (4) the Company fails to comply with any of its agreements in the Securities or this Indenture (other than those referred to in (1), (2) or (3) above) and such failure continues for 60 days after the notice specified below; (5) the Company or any Significant Subsidiary of the Company fails to pay any Indebtedness within any applicable grace period after final maturity or the acceleration of any such Indebtedness by the holders thereof because of a default and the total amount of such Indebtedness unpaid or accelerated exceeds $10,000,000 or its foreign currency equivalent at the time (the "cross acceleration provision"); (6) the Company or any Significant Subsidiary of the Company pursuant to or within the meaning of any Bankruptcy Law: (A) commences a voluntary case; (B) consents to the entry of an order for relief against it in an involuntary case in which it is the debtor; (C) files a petition on answer or consent seeking reorganization or relief under Bankruptcy law; (D) consents to the filing of a petition or the appointment of, or taking possession by, a Custodian of it or for any substantial part of its property; (E) makes a general assignment for the benefit of its creditors; or takes any comparable action under any foreign laws relating to insolvency; or (F) admits in writing its inability to pay its debts generally as they become due. -48- (7) a court of competent jurisdiction enters an order or decree under any Bankruptcy Law that: (A) is for relief against the Company or any Significant Subsidiary of the Company in an involuntary case; (B) appoints a Custodian of the Company or any Significant Subsidiary of the Company or for any substantial part of the property of the Company or Significant Subsidiary; or (C) orders the winding up or liquidation of the Company or any Significant Subsidiary of the Company; (or any similar relief is granted under any foreign laws) and the order or decree remains unstayed and in effect for 60 days; or (8) any final, non-appealable judgment or decree for the payment of money in excess of $10,000,000 or its foreign currency equivalent at the time is entered against the Company or any Significant Subsidiary of the Company and either: (A) an enforcement proceeding has been commenced by any creditor upon such judgment or decree; or (B) such judgment or decree remains unpaid and outstanding for a period of 60 days following such judgment and is not discharged, waived or stayed (the "judgment default provision"). The foregoing will constitute Events of Default whatever the reason for any such Event of Default and whether it is voluntary or involuntary or is effected by operation of law or pursuant to any judgment, decree or order of any court or any order, rule or regulation of any administrative or governmental body. The term "Bankruptcy Law" means Title 11, United States Bankruptcy Code of 1978, as amended, or any similar federal or state law or foreign law relating to bankruptcy, insolvency, receivership, winding up, liquidation, reorganization or other law for the relief of debtors or any amendment to, succession to or change in any such law. The term "Custodian" means any receiver, trustee, assignee, liquidator, custodian or similar official under any Bankruptcy Law. A Default under clause (4) or (5) is not an Event of Default until the Trustee or the Holders of at least 25% in aggregate principal amount of the outstanding Securities notify the Company of the Default and the Company does not cure such Default within the time specified after receipt of such notice. Such notice must specify the Default, demand that it be remedied and state that such notice is a "Notice of Default". The Company shall deliver to the Trustee, within 30 days after the occurrence thereof, written notice in the form of an Officers' Certificate of any Event of Default under clause -49- (5) and (8) and any event which with the giving of notice or the lapse of time would become an Event of Default under clause (4), its status and what action the Company is taking or proposes to take with respect thereto. SECTION 6.2 Acceleration. If an Event of Default (other than an Event of Default specified in Section 6.1(6) or (7) with respect to the Company) occurs and is continuing, the Trustee by notice to the Company, or the Holders of at least 25% in aggregate principal amount of the outstanding Securities by notice to the Company and the Trustee, may declare the principal of and accrued interest on all the Securities to be due and payable. Upon such a declaration, such principal and interest shall be due and payable immediately. If an Event of Default specified in section 6.1(6) or (7) with respect to the Company occurs and is continuing, the principal of and accrued interest on all the Securities shall ipso facto become and be immediately due and payable without any declaration or other act on the part of the Trustee or any Holders. The Holders of a majority in aggregate principal amount of the outstanding Securities by notice to the Trustee may rescind an acceleration and its consequences if the rescission would not conflict with any judgment or decree and if all existing Events of Default have been cured or waived except nonpayment of principal or interest that has become due solely because of acceleration. No such rescission shall affect any subsequent Default or impair any right consequent thereto. SECTION 6.3 Other Remedies. If an Event of Default occurs and is continuing, the Trustee may pursue any available remedy to collect the payment of principal of or interest on the Securities or to enforce the performance of any provision of the Securities or this Indenture. The Trustee may maintain a proceeding even if it does not possess any of the Securities or does not produce any of them in the proceeding. Any such proceeding instituted by the Trustee may be brought in its own name and as trustee of an express trust, and any recovery of judgment shall, after provision for the payment of the reasonable compensation, expenses, disbursements and advances of the Trustee, its agents and counsel, be for the ratable benefit of the Holders of the Securities in respect of which such judgment has been recovered. A delay or omission by the Trustee or any Securityholder in exercising any right or remedy accruing upon an Event of Default shall not impair the right or remedy or constitute a waiver of or acquiescence in the Event of Default. No remedy is exclusive of any other remedy. All available remedies are, to the extent permitted by law, cumulative. SECTION 6.4 Waiver of Past Defaults. The Holders of a majority in aggregate principal amount of the Securities then outstanding by notice to the Trustee may waive any past or existing Default and its consequences except (i) a Default in the payment of the principal of or interest on a Security or (ii) a Default in respect of a provision that under Section 9.2 cannot be amended without the consent of each Securityholder affected. When a Default is waived, it is deemed cured, and any Event of Default -50- arising therefrom shall be deemed to have been cured, but no such waiver shall extend to any subsequent or other Default or impair any consequent right. SECTION 6.5 Control by Majority. The Holders of a majority in aggregate principal amount of the Securities then outstanding may direct the time, method and place of conducting any proceeding for any remedy available to the Trustee or of exercising any trust or power conferred on the Trustee. However, the Trustee may refuse to follow any direction that conflicts with law or this Indenture or, subject to Section 7.1, that the Trustee determines is unduly prejudicial to the rights of other Securityholders or would involve the Trustee in personal liability; provided, however, that the Trustee may take any other action deemed proper by the Trustee that is not inconsistent with such direction. Prior to taking any action hereunder, the Trustee shall be entitled to indemnification from the Securityholders satisfactory to it in its sole discretion against all losses and expenses caused by taking or not taking such action. SECTION 6.6 Limitation on Suits. A Securityholder may not pursue any remedy with respect to this Indenture or the Securities unless: (1) the Holder gives to the Trustee written notice stating that an Event of Default is continuing; (2) the Holders of at least 25% in aggregate principal amount of the Securities then outstanding make a written request to the Trustee to pursue the remedy; (3) such Holder or Holders offer to the Trustee reasonable security or indemnity reasonably satisfactory to it against any loss, liability or expense; (4) the Trustee does not comply with the request within 60 days after receipt of the request and the offer of security or indemnity; and (5) the Holders of a majority in aggregate principal amount of the Securities then outstanding do not give the Trustee a direction inconsistent with the request during such 60-day period. A Securityholder may not use this Indenture to prejudice the rights of another Securityholder or to obtain a preference or priority over another Securityholder. SECTION 6.7 Rights of Holders To Receive Payment. Notwithstanding any other provision of this Indenture, the right of any Holder to receive payment of principal of and interest on the Securities held by such Holder, on or after the respective due dates expressed in the Securities, or to bring suit for the enforcement of any such payment on or after such respective dates, shall not be impaired or affected without the consent of such Holder. -51- SECTION 6.8 Collection Suit by Trustee. If an Event of Default specified in Section 6.1(1) or (2) occurs and is continuing, the Trustee may recover judgment in its own name and as trustee of an express trust against the Company for the whole amount then due and owing (together with interest on any unpaid interest to the extent lawful) and the amounts provided for in Section 7.7. SECTION 6.9 Trustee May File Proofs of Claim. The Trustee may file such proofs of claim and other papers or documents as may be necessary or advisable in order to have the claims of the Trustee and the Securityholders allowed in any judicial proceedings relative to the Company, its creditors or its property and, unless prohibited by law or applicable regulations, may vote on behalf of the Holders in any election of a trustee in bankruptcy or other Person performing similar functions, and any Custodian in any such judicial proceeding is hereby authorized by each Holder to make payments to the Trustee and, in the event that the Trustee shall consent to the making of such payments directly to the Holders, to pay to the Trustee any amount due it for the reasonable compensation, expenses, disbursements and advances of the Trustee, its agents and its counsel, and any other amounts due the Trustee under Section 7.7. Nothing herein contained shall be deemed to authorize the Trustee to authorize or consent to or accept or adopt on behalf of any Holder any plan of reorganization, arrangement, adjustment or composition affecting the Securities or the rights of any Holder thereof, or to authorize the Trustee to vote in respect of the claim of any Holder in any such proceeding. SECTION 6.10 Priorities. If the Trustee collects any money or property pursuant to this Article 6, it shall pay out the money or property in the following order, subject to applicable law: FIRST: to the Trustee for amounts due under Section 7.7; SECOND: to Holders for amounts due and unpaid on the Securities for principal and interest, ratably, without preference or priority of any kind, according to the amounts due and payable on the Securities for principal and interest, respectively; and THIRD: to the Company. The Trustee may, upon prior written notice to the Company, fix a record date and payment date for any payment to Securityholders pursuant to this Section. At least 15 days before such record date, the Company shall mail to each Securityholder and the Trustee a notice that states the record date, the payment date and amount to be paid. SECTION 6.11 Undertaking for Costs. In any suit for the enforcement of any right or remedy under this Indenture or in any suit against the Trustee for any action taken or omitted by it as Trustee, a court in its -52- discretion may require the filing by any party litigant in the suit of an undertaking to pay the costs of the suit, and the court in its discretion may assess reasonable costs, including reasonable attorneys fees and expenses, against any party litigant in the suit, having due regard to the merits and good faith of the claims or defenses made by the party litigant. This Section does not apply to a suit by the Trustee, a suit by a Holder pursuant to Section 6.7 or a suit by Holders of more than 10% in aggregate principal amount of the outstanding Securities. SECTION 6.12 Waiver of Stay or Extension Laws. The Company (to the extent it may lawfully do so) shall not at any time insist upon, or plead, or in any manner whatsoever claim or take the benefit or advantage of, any stay or extension law wherever enacted, now or at any time hereafter in force, which may affect the covenants or the performance of this Indenture; and the Company (to the extent that it may lawfully do so) hereby expressly waives all benefit or advantage of any such law, and shall not hinder, delay or impede the execution of any power herein granted to the Trustee, but shall suffer and permit the execution of every such power as though no such law had been enacted. SECTION 6.13 Restoration of Rights and Remedies. If the Trustee or any Holder has instituted any proceeding to enforce any right or remedy under this Indenture and such proceeding has been discontinued or abandoned for any reason, or has been determined adversely to the Trustee or to such Holder, then and in every such case the Company, any other obligor on the Securities, the Trustee and the Holders shall, subject to any determination in such proceeding, be restored severally and respectively to their former positions hereunder, and thereafter all rights and remedies of the Trustee and the Holders shall continue as though no such proceeding had been instituted. SECTION 6.14 Rights and Remedies Cumulative. No right or remedy herein conferred upon or reserved to the Trustee or to the Holders is intended to be exclusive of any other right or remedy, and every right and remedy shall, to the extent permitted by law, be cumulative and in addition to every other right and remedy given hereunder or now or hereafter existing at law or in equity or otherwise. The assertion or employment of any right or remedy hereunder, or otherwise, shall not prevent the concurrent assertion or employment of any other appropriate right or remedy. SECTION 6.15 Delay or Omission Not Waiver. No delay or omission of the Trustee or of any Holder of any Security to exercise any right or remedy accruing upon any Event of Default shall impair any such right or remedy or constitute a waiver of any such Event of Default or an acquiescence therein. Every right and remedy given by this Article or by law to the Trustee or to the Holders may be exercised from time to time, and as often as may be deemed expedient, by the Trustee or by the Holders, as the case may be. -53- SECTION 6.16 Remedies Subject to Applicable Law. All rights, remedies and powers provided by this Article VI may be exercised only to the extent that the exercise thereof does not violate any applicable provision of law in the premises, and all the provisions of this Indenture are intended to be subject to all applicable mandatory provisions of law which may be controlling in the premises and to be limited to the extent necessary so that they will not render this Indenture invalid, unenforceable or not entitled to be recorded, registered or filed under the provisions of any applicable law. ARTICLE VII TRUSTEE SECTION 7.1 Duties of Trustee. (a) If an Event of Default has occurred and is continuing, the Trustee shall exercise the rights and powers vested in it by this Indenture and use the same degree of care and skill in their exercise as a prudent Person would exercise or use under the circumstances in the conduct of such Persons own affairs. (b) Except during the continuance of an Event of Default: (1) the Trustee undertakes to perform such duties and only such duties as are specifically set forth in this Indenture and no implied covenants or obligations shall be read into this Indenture against the Trustee; and (2) in the absence of bad faith or willful misconduct on its part, the Trustee may conclusively rely, as to the truth of the statements and the correctness of the opinions expressed therein, upon certificates or opinions furnished to the Trustee and conforming to the requirements of this Indenture. However, in the case of any such certificates or opinions which by any provision hereof are specifically required to be furnished to the Trustee, the Trustee shall examine the certificates and opinions to determine whether or not they substantially conform to the requirements of this Indenture. (c) The Trustee may not be relieved from liability for its own negligent action, its own negligent failure to act or its own willful misconduct, except that: (1) this paragraph does not limit the effect of paragraph (b) of this Section; (2) the Trustee shall not be liable for any error of judgment made in good faith by a Trust officer unless it is proved that the Trustee was negligent in ascertaining the pertinent facts; and (3) the Trustee shall not be liable with respect to any action it takes or omits to take in good faith in accordance with a direction received by it pursuant to Section 6.5. -54- (d) Every provision of this Indenture that in any way relates to the Trustee is subject to paragraphs (a), (b) and (c) of this Section. (e) Money held in trust by the Trustee need not be segregated from other funds except to the extent required by law. (f) No provision of this Indenture shall require the Trustee to expend or risk its own funds or otherwise incur financial liability in the performance of any of its duties hereunder or in the exercise of any of its rights or powers, if it shall have reasonable grounds to believe that repayment of such funds or adequate indemnity against such risk or liability is not reasonably assured to it. (g) Every provision of this Indenture relating to the conduct or affecting the liability of or affording protection to the Trustee shall be subject to the provisions of this Section and to the provisions of the TIA. SECTION 7.2 Rights of Trustee. (a) The Trustee may rely on any document believed by it to be genuine and to have been signed or presented by the proper person. The Trustee need not investigate any fact or matter stated in any resolution, certificate, statement, instrument, opinion, report, notice, request, direction, consent, order, approval, appraisal, bond, debenture, note, coupon, security or other paper or document (whether in its original or facsimile form) unless requested in writing to do so by the Holders of not less than a majority in aggregate principal amount of the Securities then outstanding; PROVIDED that, if the payment within a reasonable time to the Trustee of the costs, expenses or liabilities likely to be incurred by it in the making of such investigation is, in the opinion of the Trustee, not reasonably assured to the Trustee by the security afforded to it by the terms of this Indenture, the Trustee may require reasonable indemnity against such expenses or liabilities as a condition to proceeding; the reasonable expenses of every such investigation so requested by the Holders of not less than a majority in aggregate principal amount of the Securities outstanding shall be paid by the Company or, if paid by the Trustee or any predecessor Trustee, shall be repaid by the Company upon demand; PROVIDED, FURTHER, the Trustee in its discretion may make such further inquiry or investigation into such facts or matters as it may deem fit, and, if the Trustee shall determine to make such further inquiry or investigation, it shall be entitled to examine the books, records and premises of the Company, personally or by agent or attorney at the expense of the Company and shall incur no liability or additional liability of any kind by reason of such inquiry or investigation; and (b) Before the Trustee acts or refrains from acting, it may require an Officers' Certificate or an Opinion of Counsel. The Trustee shall not be liable for any action it takes or omits to take in good faith in reliance on the Officers' Certificate or Opinion of Counsel. (c) The Trustee may act through agents and shall not be responsible for the misconduct or negligence of any agent appointed with due care. -55- (d) The Trustee shall not be liable for any action it takes or omits to take in good faith which it reasonably believes to be authorized or within its rights or powers; provided, however, that the Trustee's conduct does not constitute willful misconduct, bad faith or negligence. (e) The Trustee may consult with counsel of its selection, and the advice or opinion of counsel with respect to legal matters relating to this Indenture and the Securities shall be full and complete authorization and protection from liability in respect to any action taken, omitted or suffered by it hereunder in good faith and in accordance with the advice or opinion of such counsel. (f) The Trustee shall be under no obligation to exercise any of the rights or powers vested in it by this Indenture at the request or direction of any of the Holders pursuant to this Indenture, unless such Holders shall have offered to the Trustee reasonable security or indemnity reasonably satisfactory to it against the costs, expenses and liabilities which might be incurred by it in compliance with such request or direction. SECTION 7.3 Individual Rights of Trustee. The Trustee in its individual or any other capacity may become the owner or pledgee of Securities and may otherwise deal with the Company or its respective Affiliates with the same rights it would have if it were not Trustee. Any Paying Agent, Registrar, co-registrar or co-paying agent may do the same with like rights. However, the Trustee must comply with Sections 7.10 and 7.11. SECTION 7.4 Trustee's Disclaimer. The Trustee shall not be responsible for and makes no representation as to the validity or adequacy of this Indenture or the Securities, it shall not be accountable for the Company's use of the proceeds from the Securities, and it shall not be responsible for any statement of the Company in this Indenture or in any document issued in connection with the sale of the Securities or in the Securities except that the Trustee represents that it is duly authorized to execute and deliver this Indenture, authenticate the Securities and perform its obligations hereunder and that the statements made by it in any Statement of Eligibility and Qualification on Form T-1 to be supplied to the Company will be true and accurate subject to the qualifications set forth therein. SECTION 7.5 Notice of Defaults. If a Default occurs and is continuing and if it is known to a Trust Officer the Trustee, the Trustee shall mail to each Securityholder notice of the Default within the earlier of 90 days after it occurs or 30 days after it is known by a Trust Officer or written notice of it is received by a Trust Officer or the Trustee. Except in the case of a Default in payment of principal of, premium, if any, or interest on any Security (including payments pursuant to the mandatory redemption provisions of such Security, if any), the Trustee may withhold the notice -56- if and so long as a committee of its Trust Officers in good faith determines that withholding the notice is in the interests of Securityholders. SECTION 7.6 Reports by Trustee to Holders. As promptly as practicable after each May 15 beginning with the May 15 following the date of this Indenture, and in any event prior to July 15 in each year, the Trustee shall mail to each Securityholder a brief report dated as of May 15 that complies with TIA 313(a). The Trustee also shall comply with TIA 313(b). The Trustee shall promptly deliver to the Company a copy of any report it delivers to Holders pursuant to Section 7.6. A copy of each report at the time of its mailing to Securityholders shall be filed with the SEC and each stock exchange (if any) on which the Securities are listed. The Company agrees to notify promptly the Trustee whenever the Securities become listed on any stock exchange and of any delisting thereof. SECTION 7.7 Compensation and Indemnity. The Company shall pay to the Trustee from time to time such compensation for its services as the Company and the Trustee shall from time to time agree in writing. The Trustee's compensation shall not be limited by any law on compensation of a trustee of an express trust. The Company shall reimburse the Trustee upon request for all out-of-pocket expenses incurred or made by it, including costs of collection, in addition to such compensation for its services, except any such expense, disbursement or advance as shall be determined by a court of competent jurisdiction to have been caused by its own negligence, willful misconduct or bad faith. Such expenses shall include the reasonable compensation and expenses, disbursements and advances of the Trustee's agents, counsel, accountants and experts. The Trustee shall provide the Company reasonable notice of any expenditure not in the ordinary course of business; provided that prior approval by the Company of any such expenditure shall not be a requirement for the making of such expenditure nor for reimbursement by the Company thereof. The Company shall fully indemnify each of the Trustee and any predecessor Trustees against any and all loss, damage, claim, liability or expense (including attorneys' fees and expenses) (other than taxes applicable to the Trustee's compensation hereunder) incurred by it in connection with the acceptance or administration of this trust and the performance of its duties hereunder. The Trustee shall notify the Company promptly of any claim for which it may seek indemnity. Failure by the Trustee to so notify the Company shall not relieve the Company of its obligations hereunder. The Company shall defend the claim and the Trustee may have separate counsel, which counsel must be reasonably acceptable to the Company and the Company will pay the reasonable fees and expenses of such counsel The Company need not reimburse any expense or indemnify against any loss, liability or expense determined by a court of competent jurisdiction to have been caused by the Trustee through the Trustee's own willful misconduct, negligence or bad faith. To secure the Company's payment obligations in this Section, the Trustee shall have a lien prior to the Securities on all money or property held or collected by the Trustee other than money or property held in trust to pay principal of and interest on particular Securities. -57- The Company's payment obligations pursuant to this Section shall survive the discharge of this Indenture. When the Trustee incurs expenses after the occurrence of a Default specified in Section 6.1(6) or (7) with respect to the Company, the expenses are intended to constitute expenses of administration under the Bankruptcy Law. The Trustee shall comply with the provisions of TIA Section 313(b)(2) to the extent applicable. SECTION 7.8 Replacement of Trustee. The Trustee may resign at any time by so notifying the Company in writing no later than 20 Business Days prior to the date of the proposed resignation. The Holders of a majority in principal amount of the Securities then outstanding, may remove the Trustee by so notifying the Trustee and may appoint a successor Trustee. The Company shall remove the Trustee if: (1) the Trustee fails to comply with Section 7.10; (2) the Trustee is adjudged bankrupt or insolvent; (3) a receiver or other public officer takes charge of the Trustee or its property; or (4) the Trustee otherwise becomes incapable of acting. If the Trustee is removed by the Company or by the Holders of a majority in principal amount of the Securities and such Holders do not reasonably promptly appoint a successor Trustee (but in no event later then 15 business days after such removal by Holders), or if the Trustee resigns or a vacancy exists in the office of Trustee for any reason (the Trustee in such event being referred to herein as the retiring Trustee), the Company shall promptly appoint a successor Trustee. A successor Trustee shall deliver a written acceptance of its appointment to the retiring Trustee and to the Company. Thereupon the resignation or removal of the retiring Trustee shall become effective, and the successor Trustee shall have all the rights, powers and duties of the Trustee under this Indenture. The successor Trustee shall mail a notice of its succession to Securityholders. The retiring Trustee shall promptly transfer all property held by it as Trustee to the successor Trustee, subject to the lien provided for in Section 7.7. If a successor Trustee does not take office within 60 days after the retiring Trustee resigns or is removed, the retiring Trustee or any Holder who has been a bona fide Holder for at least six months may, on behalf of all other Holders, petition at the expense of the Company any court of competent jurisdiction for the appointment of a successor Trustee. -58- The Trustee may be removed at any time for any cause or for no cause by an act of the Holders of not less than a majority in aggregate principal amount of the outstanding Securities, delivered to the Trustee and to the Company. Notwithstanding the replacement of the Trustee pursuant to this Section, the Company's obligations under Section 7.7 shall continue for the benefit of the retiring Trustee. SECTION 7.9 Successor Trustee by Merger. If the Trustee consolidates with, merges or converts into, or transfers all or substantially all its corporate trust business or assets to, another corporation or banking association, the resulting, surviving or transferee corporation without any further act shall be the successor Trustee, provided that such corporation shall be eligible under this Article Seven and TIA Section 3.10(a). In case at the time such successor or successors by merger, conversion or consolidation to the Trustee shall succeed to the trusts created by this Indenture any of the Securities shall have been authenticated but not delivered, any such successor to the Trustee may adopt the certificate of authentication of any predecessor trustee, and deliver such Securities so authenticated; and in case at that time any of the Securities shall not have been authenticated, any successor to the Trustee may authenticate such Securities either in the name of any predecessor hereunder or in the name of the successor to the Trustee; and in all such cases such certificates shall have the full force which it is anywhere in the Securities or in this Indenture provided that the certificate of the Trustee shall have. SECTION 7.10 Eligibility; Disqualification. The Trustee shall at all times satisfy the requirements of TIA 310(a). The Trustee shall have a combined capital and surplus of at least $50,000,000 as set forth in its most recent published annual report of condition. The Trustee shall comply with TIA 310(b); provided, however, that there shall be excluded from the operation of TIA 310(b)(1) any indenture or indentures under which other securities or certificates of interest or participation in other securities of the Company are outstanding if the requirements for such exclusion set forth in TIA 310(b)(1) are met. -59- SECTION 7.11 Preferential Collection of Claims Against Company. The Trustee shall comply with TIA 311(a), excluding any creditor relationship listed in TIA 311(b). A Trustee who has resigned or been removed shall be subject to TIA 311(a) to the extent indicated. ARTICLE VIII DISCHARGE OF INDENTURE; DEFEASANCE SECTION 8.1 Satisfaction and Discharge of Indenture; Defeasance. (a) This Indenture shall be discharged and shall cease to be of further effect (except as to surviving rights of registration of transfer or exchange of the Securities as expressly provided for herein) as to all outstanding Securities hereunder, and the Trustee, upon order of the Company and at the expense of the Company, shall execute proper instruments acknowledging satisfaction and discharge of this Indenture, when (b) either (1) all the Securities theretofore authenticated and delivered (other than (i) lost, stolen or destroyed Securities which have been replaced as provided in Section 2.7 or thereafter repaid or (ii) all Securities for whose payment money has theretofore been deposited in trust or segregated and held in trust by the Company and thereafter repaid to the Company or discharged from such trust as provided in Sections 2.4 and 8.4) have been delivered to the Trustee for cancellation; or (2) all such Securities not theretofore delivered to the Trustee for cancellation (i) have become due and payable, (ii) will become due and payable at their Stated Maturity within 91 days or (iii) are to be called for redemption within 91 days under arrangements satisfactory to the Trustee for the giving of notice of redemption by the Trustee in the name, and at the expense, of the Company; (c) the Company or any other Person has irrevocably deposited or caused to be deposited with the Trustee as trust funds in trust an amount in United States dollars sufficient to pay and discharge the entire Indebtedness on the Securities not theretofore delivered to the Trustee for cancellation, including the principal of, premium, if any, and accrued interest on, such Securities at such maturity, Stated Maturity or redemption date; and (d) the Company or any other Person has paid or caused to be paid all other sums payable hereunder by the Company. Notwithstanding the satisfaction and discharge hereof, the obligations of the Company to the Trustee under Section 7.7 and, if United States dollars shall have been deposited -60- with the Trustee pursuant to subclause (2) of subsection (b) of this Section 8.1, the obligations of the Trustee under Sections 8.3 and 8.4 shall survive such satisfaction and discharge. The Company may request the Trustee to acknowledge the discharge upon delivery to the Trustee of an Officers' Certificate and an Opinion of Counsel each stating that all conditions precedent under the Indenture relating to the satisfaction and discharge of such Indenture have been complied with. (e) Subject to Sections 8.1(f) and 8.2, the Company at any time may terminate (i) all of its obligations under the Securities and this Indenture ("legal defeasance option") or (ii) its obligations under Sections 4.2, 4.3, 4.4, 4.5, 4.6, 4.7, 4.8, 4.9, 4.10, 4.11, 4.12 and 4.13 and the operation of Sections 6.1(4), 6.1(5), 6.1(6) (but only with respect to a Significant Subsidiary), 6.1(7) (but only with respect to a Significant Subsidiary), 6.1(8) and 5.1(ii), 5.1(iii) or 5.1(iv) ("covenant defeasance option"). The Company may exercise its legal defeasance option notwithstanding its prior exercise of its covenant defeasance option. If the Company exercises its legal defeasance option, payment of the Securities may not be accelerated because of an Event of Default. If the Company exercises its covenant defeasance option, payment of the Securities may not be accelerated because of an Event of Default specified in Section 6.1(4), 6.1(5), 6.1(6) (but only with respect to a Significant Subsidiary), 6.1(7) (but only with respect to a Significant Subsidiary), 6.1(8) or because of the failure of the Company to comply with Sections 5.1(ii), 5.1(iii) and 5.1(iv). (f) Notwithstanding Sections 8.1(a) and (e) above, the Company's obligations in Sections 2.3, 2.4, 2.5, 2.6, 2.7, 7.7, 7.8, 8.4, 8.5 and 8.6 shall survive until the Securities have been paid in full. Thereafter, the Company's obligations in Sections 7.7, 8.4 and 8.5 shall survive. SECTION 8.2 Conditions to Defeasance. The Company may exercise its legal defeasance option or its covenant defeasance option only if: (1) the Company irrevocably deposits or causes to be deposited in trust (the "defeasance trust") with the Trustee U.S. dollars or U.S. Government Obligations which through the scheduled payment of principal and interest in respect thereof in accordance with their terms will provide cash at such times and in such amounts as will be sufficient to pay principal and interest when due on all outstanding Securities (except Securities replaced pursuant to Section 2.7) to maturity or redemption, as the case may be; (2) the Company delivers to the Trustee a certificate from a nationally recognized firm of independent accountants or other Person acceptable to the Trustee expressing their opinion that the payments of principal and interest when due and without reinvestment on the deposited U.S. Government Obligations plus any deposited money without investment will provide cash at such times and in such amounts as will be sufficient to pay principal and interest -61- when due on all outstanding Securities (except Securities replaced pursuant to Section 2.7) to maturity or redemption, as the case may be; (3) 91 days pass after the deposit is made and during the 91-day period no Default specified in Section 6.1(6) or (7) with respect to the Company occurs which is continuing at the end of the period; (4) the deposit does not constitute a default under any other material agreement binding on the Company or any Restricted Subsidiary; (5) the Company delivers to the Trustee an opinion of Counsel to the effect that the trust resulting from the deposit does not constitute, or is qualified as, a regulated investment company under the Investment Company Act of 1940; (6) in the case of the legal defeasance option, the Company shall have delivered to the Trustee an opinion of Counsel stating that (i) the Company have received from, or there has been published by, the Internal Revenue Service a ruling, or (ii) since the date of this Indenture there has been a change in the applicable federal income tax law, in either case to the effect that, and based thereon such Opinion of Counsel shall confirm that, the Securityholders will not recognize income, gain or loss for federal income tax purposes as a result of such deposit and defeasance and will be subject to federal income tax on the same amounts, in the same manner and at the same times as would have been the case if such deposit and defeasance had not occurred; (7) in the case of the covenant defeasance option, the Company shall have delivered to the Trustee an Opinion of Counsel to the effect that the Securityholders will not recognize income, gain or loss for federal income tax purposes as a result of such covenant defeasance and will be subject to federal income tax on the same amounts, in the same manner and at the same times as would have been the case if such deposit and covenant defeasance had not occurred; and (8) the Company delivers to the Trustee an Officers Certificate and an Opinion of Counsel, each stating that all conditions precedent to the defeasance and discharge of the Securities as contemplated by this Article 8 have been complied with. Opinions of Counsel required to be delivered under this Section may have qualifications customary for opinions of the type required and counsel delivering such Opinions of Counsel may rely on certificates of the Company or government or other officials customary for opinions of the type required, including certificates certifying as to matters of fact. Before or after a deposit, the Company may make arrangements satisfactory to the Trustee for the redemption of Securities at a future date in accordance with Article 3. -62- SECTION 8.3 Application of Trust Money. The Trustee shall hold in trust U.S. dollars or U.S. Government Obligations deposited with it pursuant to this Article 8. It shall apply the deposited U.S. dollars and the money from U.S. Government Obligations either directly or through the Paying Agent (including the Company acting as its own Paying Agent as the Trustee may determine) and in accordance with this Indenture to the payment of principal of and interest on the Securities. SECTION 8.4 Repayment to Company. Any money deposited with the Trustee or any Paying Agent in trust for the payment of the principal of, premium, if any, or interest on any Security and remaining unclaimed for two years after such principal and premium, if any, or interest has become due and payable shall promptly be paid to the Company upon written request, or (if then held by the Company) shall be discharged from such trust; and the Holder of such Security shall thereafter, as an unsecured general creditor, look only to the Company for payment thereof, PROVIDED, HOWEVER, that the Trustee or such Paying Agent, before being required to make any such repayment, may at the expense of the Company cause to be published once, in the NEW YORK TIMES and THE WALL STREET JOURNAL (national edition), and mail to each such Holder, notice that such money remains unclaimed. SECTION 8.5 Indemnity for Government Obligations. The Company shall pay and shall indemnify the Trustee against any tax, fee or other charge imposed on or assessed against deposited U.S. Government Obligations or the principal and interest received on such U.S. Government Obligations other than any such tax, fee or other charge which by law is for the account of the Holders of the defeased Securities; provided that the Trustee shall be entitled to charge any such reasonable tax, fee or other charge to such Holder's account. SECTION 8.6 Reinstatement. If the Trustee or Paying Agent is unable to apply any U.S. dollars or U.S. Government Obligations in accordance with this Article 8 by reason of any legal proceeding or by reason of any order or judgment of any court or governmental authority enjoining, restraining or otherwise prohibiting such application, the Company's obligations under this Indenture and the Securities shall be revived and reinstated as though no deposit had occurred pursuant to this Article 8 until such time as the Trustee or Paying Agent is permitted to apply all such U.S. dollars or U.S. Government Obligations in accordance with this Article 8; provided, however, that, (a) if the Company has made any payment of interest on or principal of any Securities following the reinstatement of their obligations, the Company shall be subrogated to the rights of the Holders of such Securities to receive such payment from U.S. dollars or U.S. Government Obligations held by the Trustee or Paying Agent and (b) unless otherwise required by any legal proceeding or any order or judgment of any court or governmental authority, the Trustee or Paying Agent shall return all such money and U.S. Government Obligations to the Company -63- promptly after receiving a written request therefor at any time, if such reinstatement of the Company's obligations has occurred and continues to be in effect. ARTICLE IX AMENDMENTS SECTION 9.1 Without Consent of Holders. The Company and the Trustee may amend this Indenture or the Securities without notice to or consent of any Securityholder: (1) to cure any ambiguity, omission, defect or inconsistency; (2) to comply with Article 5; (3) to provide for uncertificated Securities in addition to or in place of certificated Securities; provided, however, that the uncertificated Securities are issued in registered form for purposes of Section 163(f) of the Code or in a manner such that the uncertificated Securities are as described in Section 163(f)(2)(B) of the Code; (4) to add Guarantees with respect to the Securities; (5) to secure the Securities; (6) to add to the covenants of the Company for the benefit of the Holders or to surrender any right or power herein conferred upon the Company; (7) to make any change that does not adversely affect the rights of any Securityholder; or (8) to comply with any requirements of the SEC in connection with qualifying this Indenture under the TIA. After an amendment under this Section becomes effective, the Company shall mail to Securityholders a notice briefly describing such amendment. The failure to give such notice to all Securityholders, or any defect therein, shall not impair or affect the validity of an amendment under this section. SECTION 9.2 With Consent of Holders. The Company and the Trustee may amend this Indenture or the Securities without notice to any Securityholder but with the written consent of the Holders of at least a majority in principal amount of the Securities then outstanding. However, without the consent of each Securityholder affected, an amendment may not: -64- (1) reduce the amount of Securities whose Holders must consent to an amendment; (2) reduce the rate of or extend the time for payment of interest on any Security; (3) reduce the principal of or extend the Stated Maturity of any Security; (4) reduce the premium payable upon the redemption of any Security or change the time at which any Security may be redeemed in accordance with Article 3; (5) make any Security payable in money other than that stated in the Security; (6) impair the right of any Holder to receive payment of principal of and interest on such Holder's Securities on or after the due dates therefor or to institute suit for the enforcement of any payment on or with respect to such Holder's Securities; or (7) make any change in Section 6.4 or 6.7 or the second sentence of this Section. It shall not be necessary for the consent of the Holders under this Section to approve the particular form of any proposed amendment, but it shall be sufficient if such consent approves the substance thereof. After an amendment under this Section becomes effective, the Company shall mail to Securityholders a notice briefly describing such amendment. The failure to give such notice to all Securityholders, or any defect therein, shall not impair or affect the validity of an amendment under this Section. SECTION 9.3 Compliance with Trust Indenture Act. Every amendment to this Indenture or the Securities shall comply with the TIA as then in effect. SECTION 9.4 Revocation and Effect of Consents and Waivers. A consent to an amendment or a waiver by a Holder of a Security shall bind the Holder and every subsequent Holder of that Security or portion of the Security that evidences the same debt as the consenting Holder's Security, even if notation of the consent or waiver is not made on the Security. After an amendment or waiver becomes effective, it shall bind every Securityholder. The Company may, but shall not be obligated to, fix a record date for the purpose of determining the Securityholders entitled to give their consent or take any other action described above or required or permitted to be taken pursuant to this Indenture. If a record date is fixed, then notwithstanding the immediately preceding paragraph, those Persons who were Securityholders at such record date (or their duly designated proxies), and only those Persons, -65- shall be entitled to give such consent or to revoke any consent previously given or to take any such action, whether or not such Persons continue to be Holders after such record date. No such consent shall be valid or effective for more than 120 days after such record date. SECTION 9.5 Notation on or Exchange of Securities. If an amendment changes the terms of a Security, the Trustee may require the Holder of the Security to deliver it to the Trustee. The Trustee may place an appropriate notation on the Security regarding the changed terms and return it to the Holder. Alternatively, if the Company or the Trustee so determine, the Company in exchange for the Security shall issue and the Trustee shall authenticate a new Security that reflects the changed terms. Failure to make the appropriate notation or to issue a new Security shall not affect the validity of such amendment. SECTION 9.6 Trustee To Sign Amendments. The Trustee shall sign any amendment authorized pursuant to this Article 9 if the amendment does not affect the rights, duties, liabilities or immunities of the Trustee. If it does, the Trustee may but need not sign it. In signing such amendment the Trustee shall be entitled to receive indemnity reasonably satisfactory to it and to receive, and (subject to Section 7.1) shall be fully protected in relying upon, an Officers' Certificate and an Opinion of Counsel stating that such amendment complies with the provisions of Article 9 of this Indenture. ARTICLE X MISCELLANEOUS SECTION 10.1 Trust Indenture Act Controls. If any provision hereof limits, qualifies or conflicts with any provision of the TIA or another provision which is required or deemed to be included in this Indenture by any of the provisions of the TIA, then the provision or requirement of the TIA shall control. If any provision of this Indenture modifies or excludes any provision of the TIA that may be so modified or excluded, the latter provision shall be deemed to apply to this Indenture as so modified or to be excluded, as the case may be. SECTION 10.2 Notices. Any notice or communication shall be in writing and delivered in person, by overnight courier or facsimile (if to the Company, with receipt confirmed by an Officer) or mailed by first-class mail addressed as follows: if to the Company: Michaels Stores, Inc. 8000 Bent Branch Drive -66- Irving, TX 75063 Attention: General Counsel if to the Trustee: The Bank of New York 101 Barclay Street, Floor 21 West New York, New York 10286 Attention: Corporate Trust Administration The Company or the Trustee by notice to the other may designate additional or different addresses for subsequent notices or communications. Any notice or communication mailed or sent by overnight courier or facsimile to a Securityholder shall be sent to the Securityholder at the Securityholder's address as it appears on the registration books of the Registrar and shall be sufficiently given if so sent within the time prescribed. Failure to send a notice or communication to a Securityholder or any defect in it shall not affect its sufficiency with respect to other Securityholders. If a notice or communication is sent in the manner provided above, it is duly given, whether or not the addressee receives it. Where this Indenture provides for notice in any manner, such notice may be waived in writing by the Person entitled to receive such notice, either before or after the event, and such waiver shall be the equivalent of such notice. SECTION 10.3 Communication by Holders with Other Holders. Securityholders may communicate pursuant to TIA 312 (b) with other Securityholders with respect to their rights under this Indenture or the Securities. The Company, the Trustee, the Registrar and anyone else shall have the protection of TIA 312 (c) . SECTION 10.4 Certificate and Opinion as to Conditions Precedent. Upon any request or application by the Company to the Trustee to take or refrain from taking any action under this Indenture, each the Company and any other obligor on the Securities (if applicable) shall furnish to the Trustee: (1) an Officers' Certificate stating that, in the opinion of the signers, all conditions precedent, if any, provided for in this Indenture (including any covenant compliance which constitutes a condition precedent) relating to the proposed action have been complied with; and (2) an Opinion of Counsel stating that, in the opinion of such counsel, all such conditions precedent have been complied with. -67- SECTION 10.5 Statements Required in Certificate or Opinion. Each certificate or opinion with respect to compliance with a covenant or condition provided for in this Indenture shall include: (1) a statement that each individual signing such certificate or individual or firm signing such opinion has read such covenant or condition and the definitions herein relating thereto; (2) a brief statement as to the nature and scope of the examination or investigation upon which the statements or opinions contained in such certificate or opinion are based; (3) a statement that, in the opinion of such individual or such firm, he or it has made such examination or investigation as is necessary to enable him or it to express an informed opinion as to whether or not such covenant or condition has been complied with; and (4) a statement as to whether or not, in the opinion of such individual or such firm, such covenant or condition has been complied with. SECTION 10.6 Form of Documents Delivered to Trustee In any case where several matters are required to be certified by, or covered by an opinion of, any specified Person, it is not necessary that all such matters be certified by, or covered by the opinion of, only one such Person, or that they be so certified or covered by only one document, but one such Person may certify or give an opinion with respect to some matters and one or more other such Persons as to other matters, and any such Person may certify or give an opinion as to such matters in one or several documents. Any certificate of an officer of the Company, or other obligor on the Securities may be based, insofar as it relates to legal matters, upon a certificate or opinion of, or representations by, counsel, unless such officer knows, or in the exercise of reasonable care should know, that the certificate or opinion or representations with respect to the matters upon which his certificate or opinion is based are erroneous. Any such certificate or opinion may be based, insofar as it relates to factual matters, upon a certificate or opinion of, or representations by, an officer or officers of the Company, or other obligor on the Securities stating that the information with respect to such factual matters is in the possession of the Company, or other obligor on the Securities, unless such officer or counsel knows, or in the exercise of reasonable care should know, that the certificate or opinion or representations with respect to such matters are erroneous. Any certificate or opinion of an officer of the Company, or other obligor on the Securities may be based, insofar as it relates to accounting matters, upon a certificate or opinion of, or representations by, an accountant or firm of accountants in the employ of the Company, unless such officer knows, or in the exercise of reasonable care should know, that the certificate -68- or opinion or representations with respect to the accounting matters upon which his certificate or opinion may be based are erroneous. Any certificate or opinion of any independent firm of public accountants filed with the Trustee shall contain a statement that such firm is independent with respect to the Company. Where any Person is required to make, give or execute two or more applications, requests, consents, certificates, statements, opinions or other instruments under this Indenture, they may, but need not, be consolidated and form one instrument. SECTION 10.7 Act of Holders. (a) Any request, demand, authorization, direction, notice, consent, waiver or other action provided by this Indenture to be given or taken by Holders may be embodied in and evidenced by one or more instruments of substantially similar tenor signed by such Holders in person or by an agent duly appointed in writing; and, except as herein otherwise expressly provided, such action shall become effective when such instrument or instruments are delivered to the Trustee and, where it is hereby expressly required, to the Company. Such instrument or instruments (and the action embodied therein and evidenced thereby) are herein sometimes referred to as the "Act" of the Holders signing such instrument or instruments. Proof of execution of any such instrument or of a writing appointing any such agent shall be sufficient for any purpose of this Indenture and conclusive in favor of the Trustee and the Company, if made in the manner provided in this Section 10.7. (b) The ownership of Securities shall be proved by the Securities Register. (c) The fact and date of the execution by any Person of any such instrument or writing may be proved by the affidavit of a witness of such execution or by a certificate of a notary public or other officer authorized by law to take acknowledgments of deeds, certifying that the individual signing such instrument or writing acknowledged to him the execution thereof. Where such execution is by a signer acting in a capacity other than his individual capacity, such certificate or affidavit shall also constitute sufficient proof of his authority. The fact and date of the execution of any such instrument or writing, or the authority of the Person executing the same, may also be proved in any other manner which the Trustee deems sufficient. (d) For purposes of this Indenture, any action by the Holders which may be taken in writing may be taken by electronic means or as otherwise reasonably acceptable to the Trustee. SECTION 10.8 When Securities Disregarded. In determining whether the Holders of the required principal amount of Securities have concurred in any direction, waiver or consent, Securities owned by the Company or by any Person directly or indirectly controlling or controlled by or under direct or indirect common control with the Company shall be disregarded and deemed not to be outstanding, except that, for the purpose of determining whether the Trustee shall be protected in relying on any such direction, waiver or consent, only Securities which the Trustee actually knows are so owned shall -69- be so disregarded. Also, subject to the foregoing, only Securities outstanding at the time shall be considered in any such determination. SECTION 10.9 Rules by Trustee, Paying Agent and Registrar. The Trustee may make reasonable rules for action by or a meeting of Securityholders. The Trustee shall provide the Company reasonable notice of such rules; provided that neither prior notice to the Company of such rules nor prior approval by the Company of such rules shall be a requirement for their effectiveness. The Registrar and the Paying Agent may make reasonable rules for their functions. SECTION 10.10 Legal Holidays. A "Legal Holiday" is a Saturday, a Sunday or a day on which banking institutions are not required to be open in the State of New York. If a payment date, redemption date, maturity or stated maturity of any Security is a Legal Holiday, payment shall be made on the next succeeding day that is not a Legal Holiday, and no interest shall accrue for the intervening period. If a regular record date is a Legal Holiday, the record date shall not be affected. SECTION 10.11 Governing Law. This Indenture and the Securities shall be governed by, and construed in accordance with, the laws of the State of New York but without giving effect to applicable principles of conflict of laws to the extent that the application of the laws of another jurisdiction would be required thereby. SECTION 10.12 No Recourse Against Others. A director, officer, employee or stockholder, as such, of the Company shall not have any liability for any obligations of the Company under the Securities or this Indenture or for any claim based on, in respect of or by reason of such obligations or their creation. By accepting a Security, each Securityholder shall waive and release all such liability. The waiver and release shall be part of the consideration for the issue of the Securities. SECTION 10.13 Successors. All agreements of the Company in this Indenture and the Securities shall bind the Company's successors and assigns, whether so expressed or not. All agreements of the Trustee in this Indenture shall bind its successors. SECTION 10.14 Multiple Originals. The parties may sign any number of copies of this Indenture. Each signed copy shall be an original, but all of them together represent the same agreement. One signed copy is enough to prove this Indenture. -70- SECTION 10.15 Table of Contents; Headings. The table of contents, cross-reference sheet and headings of the Articles and Sections of this Indenture have been inserted for convenience of reference only, are not intended to be considered a part hereof and shall not modify or restrict any of the terms or provisions hereof. SECTION 10.16 Severability Clause. In case any provision in this Indenture or in the Securities shall be invalid, illegal or unenforceable, the validity, legality and enforceability of the remaining provisions shall not in any way be affected or impaired thereby. SECTION 10.17 Benefits of the Indentures. Nothing in this Indenture or in the Securities, express or implied, shall give to any Person (other than the parties hereto and their successors hereunder, any Paying Agent and the Holders) any benefit or any legal or equitable right, remedy or claim under this Indenture. SECTION 10.18 Independence of Covenants. All covenants and agreements in this Indenture shall be given independent effect so that if a particular action or condition is not permitted by any such covenant, the fact that it would be permitted by an exception to, or be otherwise within the limitations of, another covenant shall not avoid the occurrence of a Default or an Event of Default if such action is taken or condition exists. For purposes of clarity only, it is hereby agreed that the covenants that fall away during a Fall Away Event cannot result in a Default or Event of Default during the continuance of a Fall Away Event. SECTION 10.19 Schedules and Exhibits. All schedule and exhibits attached hereto are by this reference made a part hereof with the same effect as if herein set forth in full. SECTION 10.20 Counterparts. This Indenture may be executed in any number of counterparts, each of which shall be deemed an original; but all such counterparts shall together constitute but one and the same instrument. SECTION 10.21 Interest and Charges. It is the intention of the Trustee, the Holders and the Company to comply with applicable usury laws (now or hereafter enacted); accordingly, notwithstanding any provision to the contrary in this Indenture, the Securities or any other document related hereto or thereto, in no event shall this Indenture, any Securities or any such other document require the payment or permit the collection of interest in excess of the maximum amount permitted by applicable law. -71- If from any circumstance whatsoever, fulfillment of any provision of this Indenture, any Securities or any such documents shall involve exceeding the limit of validity prescribed by applicable law for the collection or charging of interest, then the obligation to be fulfilled shall be reduced automatically to the limit of such validity. If from any circumstance whatsoever, the Trustee or any Holder ever receives, collects or applies any amount as interest or deemed to be interest by applicable law under this Indenture, the Securities or any other document pertaining hereto or thereto that would exceed the highest rate of interest permitted by applicable law, the amount that would be excessive interest shall be applied to the reduction of the principal amount owing on the Securities, and not to the payment of interest, or if such excessive interest exceeds the unpaid balance of principal of the Securities, such excess shall be refunded to the Company. In determining whether or not the any amount paid or payable, under any specific contingency, exceeds the highest rate permitted by applicable law, the Company, the Trustee and the Holders shall, to the maximum extent permitted by applicable law, (a) characterize any nonprincipal payment as an expense, fee or premium rather than as interest, (b) exclude voluntary prepayments and the effect thereof, (c) amortize, prorate, allocate and spread the total amount of interest throughout the entire contemplated term of the Securities so that the interest thereon does not exceed the maximum amount permitted by applicable law, and (d) allocate interest between portions of the indebtedness evidenced by the Securities, to the end that no such portion shall bear interest at a rate greater than that permitted by applicable law. -72- IN WITNESS WHEREOF, the parties have caused this Indenture to be duly executed as of the date first written above. MICHAELS STORES, INC. By: /s/ BRYAN M. DECORDOVA --------------------------------------- Name: Bryan M. DeCordova Title: Executive Vice President-Chief Financial Officer THE BANK OF NEW YORK, as Trustee By: /s/ REMO J. REALE --------------------------------------- Name: /s/ Remo J. Reale Title: Vice President -73- EXHIBIT A FACE OF SECURITY [Unless and until (i) an Initial Security is sold under an effective Registration Statement or (ii) an Initial Security is exchanged for a Series B Security in connection with an effective Registration Statement, in such case pursuant to the Registration Rights Agreement, than such Initial Security shall bear the legend set forth in the following paragraph.] THE SECURITIES HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), OR ANY STATE SECURITIES LAWS. NEITHER THIS SECURITY NOR ANY INTEREST OR PARTICIPATION HEREIN MAY BE REOFFERED, SOLD, ASSIGNED, TRANSFERRED, PLEDGED, ENCUMBERED OR OTHERWISE DISPOSED OF IN THE ABSENCE OF SUCH REGISTRATION OR UNLESS SUCH TRANSACTION IS EXEMPT FROM, OR NOT SUBJECT TO, REGISTRATION AS SET FORTH BELOW. BY ITS ACQUISITION HEREOF, THE HOLDER (1) REPRESENTS THAT IT IS A "QUALIFIED INSTITUTIONAL BUYER" (AS DEFINED IN RULE 144A UNDER THE SECURITIES ACT ("RULE 144A")), (2) AGREES TO OFFER, SELL OR OTHERWISE TRANSFER SUCH SECURITY PRIOR TO THE DATE WHICH IS TWO YEARS AFTER THE LATER OF THE ORIGINAL ISSUE DATE HEREOF AND THE LAST DATE ON WHICH THE COMPANY OR ANY AFFILIATE OF THE COMPANY WAS THE OWNER OF THIS NOTE (OR ANY PREDECESSOR OF THIS NOTE) ONLY (A) TO THE COMPANY, (B) PURSUANT TO A REGISTRATION STATEMENT WHICH HAS BEEN DECLARED EFFECTIVE UNDER THE SECURITIES ACT, (C) FOR SO LONG AS THE SECURITIES ARE ELIGIBLE FOR RESALE PURSUANT TO RULE 144A INSIDE THE UNITED STATES, TO A PERSON IT REASONABLY BELIEVES IS A "QUALIFIED INSTITUTIONAL BUYER" AS DEFINED IN RULE 144A THAT PURCHASES FOR ITS OWN ACCOUNT OR FOR THE ACCOUNT OF A QUALIFIED INSTITUTIONAL BUYER TO WHOM NOTICE IS GIVEN THAT THE TRANSFER IS BEING MADE IN RELIANCE ON RULE 144A, OR (D) PURSUANT TO ANOTHER AVAILABLE EXEMPTION FROM THE REGISTRATION REQUIREMENTS OF THE SECURITIES ACT, SUBJECT TO THE COMPANY'S AND THE TRUSTEE'S RIGHT PRIOR TO ANY SUCH OFFER, SALE OR TRANSFER (I) PURSUANT TO CLAUSE (D) TO REQUIRE THE DELIVERY OF AN OPINION OF COUNSEL, CERTIFICATION AND/OR OTHER INFORMATION SATISFACTORY TO EACH OF THEM AND (II) IN THE FOREGOING CASE, TO REQUIRE THAT A CERTIFICATE OF TRANSFER IN THE FORM APPEARING ON THE OTHER SIDE OF THIS SECURITY BE COMPLETED AND DELIVERED BY THE TRANSFEROR TO THE TRUSTEE. UNLESS THIS CERTIFICATE IS PRESENTED BY AN AUTHORIZED REPRESENTATIVE OF THE DEPOSITORY TRUST COMPANY, A NEW YORK CORPORATION ("DTC"), TO THE COMPANY OR ITS AGENT FOR REGISTRATION OF TRANSFER, EXCHANGE, OR PAYMENT AND ANY CERTIFICATE ISSUED IS REGISTERED IN THE NAME OF CEDE & CO. OR IN SUCH OTHER NAME AS IS REQUESTED BY AN AUTHORIZED REPRESENTATIVE OF DTC (AND ANY PAYMENT IS MADE TO CEDE & CO. OR TO SUCH OTHER ENTITY AS IS REQUESTED BY AN AUTHORIZED A-1 REPRESENTATIVE OF DTC), ANY TRANSFER, PLEDGE, OR OTHER USE HEREOF FOR VALUE OR OTHERWISE BY OR TO ANY PERSON IS WRONGFUL INASMUCH AS THE REGISTERED OWNER HEREOF, CEDE & CO., HAS AN INTEREST HEREIN. TRANSFERS OF THIS GLOBAL SECURITY SHALL BE LIMITED TO TRANSFERS IN WHOLE, BUT NOT IN PART, TO NOMINEES OF DTC OR TO A SUCCESSOR THEREOF OR SUCH SUCCESSOR'S NOMINEE AND LIMITED TO TRANSFERS MADE IN ACCORDANCE WITH THE RESTRICTIONS SET FORTH IN THE INDENTURE REFERRED TO ON THE REVERSE HEREOF. No. ____ $______________ 9 1/4% Senior Notes Due 2009 CUSIP No. 594087 AE 8 MICHAELS STORES, INC., a Delaware corporation, promises to pay to _____________, or registered assigns, the principal sum of ____________ United States dollars on _____________, 2009. Interest Payment Dates: January 1 and July 1. Record Dates: December 15 and June 15. Additional provisions of this Security are set forth on the other side of this Security. A-2 MICHAELS STORES, INC. By:________________________________________ Name:__________________________________ Title:_________________________________ Dated: _____________, 200_ TRUSTEE'S CERTIFICATE OF AUTHENTICATION THE BANK OF NEW YORK, as Trustee, certifies that this is one of the Securities referred to in the within-mentioned Indenture. By:___________________________________ Authorized Signatory A-3 REVERSE OF SECURITY 9 1/4% Senior Notes Due 2009 1. Interest MICHAELS STORES, INC., a Delaware corporation (such entity, and its successors and assigns under the Indenture hereinafter referred to, being herein called the "Company"), promises to pay interest on the principal amount of this Security at the rate per annum shown above. The Company will pay interest semiannually on January 1 and July 1 of each year commencing January 1, 2002. Interest on the Securities will accrue from the most recent date to which interest has been paid or, if no interest has been paid, from July 6, 2001. Interest will be computed on the basis of a 360-day year of twelve 30-day months. The Company shall pay interest on overdue principal at the rate borne by the Securities plus 1% per annum, and it shall pay interest on overdue installments of interest at the same rate to the extent lawful. 2. Method of Payment The Company will pay interest on the Securities (except defaulted interest) to the Persons who are registered holders of Securities at the close of business on the December 15 or June 15 next preceding the interest payment date even if Securities are canceled after the record date and on or before the interest payment date. Holders must surrender Securities to a Paying Agent to collect principal payments. The Company will pay principal and interest in money of the United States that at the time of payment is legal tender for payment of public and private debts. However, the Company may pay principal and interest by check payable in such money and may mail an interest check to a Holder's registered address. All payments of principal of, premium, if any, and interest on the Securities will be made by the Company in immediately available funds. 3. Registration Rights The Holder of this Series A Security is entitled to the benefits of the Registration Rights Agreement among the Company and the Initial Purchasers, dated July 6, 2001, pursuant to which, subject to the terms and conditions thereof, the Company is obligated to consummate the Exchange Offer pursuant to which the Holder of this Security shall have the right to exchange this Security for 9 1/4% Senior Notes due 2009 (herein called the "Series B Securities") in like principal amount as provided therein. In addition, the Company has agreed to file a Shelf Registration Statement in the event that the Exchange Offer is not consummated within 165 days of the date of original issue of the Securities or under certain other circumstances. The Series A Securities and the Series B Securities, and Additional Securities, if issued, are together referred to as the "Securities." The Series A Securities rank PARI PASSU in right of payment with the Series B Securities. In the event that (a) the Exchange Offer Registration Statement is not filed with the Commission on or prior to the 75th calendar day following the date of original issue of the A-4 Series A Securities, (b) the Exchange Offer Registration Statement has not been declared effective on or prior to the 135th calendar day following the date of original issue of the Series A Securities, (c) the Exchange Offer is not consummated on or prior to the 165th calendar day following the date of original issue of the Series A Securities, (d) a Shelf Registration Statement required to be filed is not declared effective on or prior to the 165th day after the date of original issue of the Series A Securities, or (e) the Shelf Registration Statement is declared effective but shall thereafter become unusable for more than 30 consecutive days (each such event referred to in clauses (a) through (e) above, a "Registration Default"), the interest rate borne by the Series A Securities shall be increased by one-quarter of one percent per annum upon the occurrence of any Registration Default, which rate (as increased as aforesaid) will increase by an additional one-quarter of one percent each 90-day period that such additional interest continues to accrue under any such circumstance, provided that the aggregate maximum increase in the interest rate will in no event exceed one percent (1%) per annum. Following the earlier of (a) the cure of all Registration Defaults or (b) the Securities become freely tradeable without registration under the Securities Act of 1933 the accrual of additional interest with respect to that particular Registration Default will cease and the interest rate will revert to the original rate. 4. Paying Agent and Registrar Initially, The Bank of New York, a New York banking corporation ("Trustee"), will act as Paying Agent and Registrar. The Company may appoint and change any Paying Agent, Registrar or co-registrar without notice. The Company or any of its domestically incorporated Wholly Owned Subsidiaries may act as Paying Agent, Registrar or co-registrar. 5. Indenture The Company issued the Securities under an Indenture dated as of July 6, 2001 (the "Indenture"), by and between the Company and the Trustee. The terms of the Securities include those stated in the Indenture and those made part of the Indenture by reference to the Trust Indenture Act of 1939, as amended, or any successor statute (the "TIA"). Terms defined in the Indenture and not defined herein have the meanings ascribed thereto in the Indenture. The Securities are subject to all such terms, and Securityholders are referred to the Indenture and the TIA for a statement of those terms. Any conflict between this Note and the Indenture will be governed by the Indenture. The Securities are general unsecured obligations of the Company limited (except as otherwise provided in the Indenture) in aggregate principal amount to $250.0 million (of which $200.0 million may be Initial Securities and Series B Securities exchanged therefor, and up to $50.0 million may be issued as Additional Securities) issued under and subject to the terms of the Indenture. The Indenture imposes certain limitations on the Incurrence of Indebtedness by the Company and its Restricted Subsidiaries, the existence of liens, the payment of dividends on, and redemption of, the Capital Stock of the Company and its Subsidiaries and the redemption of certain subordinated obligations of the Company and its Subsidiaries, restricted payments, the sale or transfer of assets and Subsidiary stock, the issuance or sale of Preferred Stock of Restricted Subsidiaries, sale and leaseback transactions, the investments of the Company and its Restricted Subsidiaries, consolidations, mergers and transfers of all or substantially all the assets A-5 of the Company, and transactions with Affiliates. In addition, the Indenture limits the ability of the Company and certain of its Subsidiaries to restrict distributions and dividends from Subsidiaries. 6. Optional Redemption Except as set forth in the next paragraph, the Securities may not be redeemed prior to July 1, 2005. On and after that date, the Company may redeem as provided in, and subject to the terms of, the Indenture the Securities in whole at any time or in part from time to time at the following redemption prices (expressed in percentages of principal amount), plus accrued interest to the redemption date (subject to the right of Holders of record on the relevant record date to receive interest due on the related interest payment date): if redeemed during the 12-month period beginning July 1,
Period Percentage 2005......................................104.625% 2006......................................102.313% 2007 and thereafter.......................100.000%
In addition, at any time and from time to time prior to July 1, 2004, the Company may redeem in the aggregate up to 35% of the aggregate principal amount of the Securities with the proceeds of one or more Equity Offerings so long as there is a Public Market at the time of such redemption at a redemption price (expressed as a percentage of principal amount) of 109.25% plus accrued interest, if any, to the redemption date (subject to the right of Holders of record on the relevant record date to receive interest due on the relevant interest payment date) as provided in, and subject to the terms of, the Indenture; provided, however, that at least 65% of the initial aggregate principal amount of the Securities must remain outstanding after each such redemption. 7. Notice of Redemption Notice of redemption will be mailed by first-class mail at least 30 days but not more than 60 days before the redemption date to each Holder of Securities to be redeemed at his registered address. Securities in denominations larger than $1,000 may be redeemed in part but only in whole multiples of $1,000. If money sufficient to pay the redemption price of and accrued interest on all Securities (or portions thereof) to be redeemed on the redemption date is deposited with the Paying Agent on or before the redemption date and certain other conditions are satisfied, on and after such date interest ceases to accrue on such Securities (or such portions thereof) called for redemption. If a notice or communication is sent in the manner provided in the Indenture, it is duly given, whether or not the addressee receives it. Failure to send a notice or communication to a Securityholder or any defect in it shall not affect its sufficiency with respect to other Securityholders. A-6 In addition, in the event of certain Asset Dispositions, the Company will be required to make an offer to purchase Securities at a purchase price of 100% of their principal amount plus accrued interest to the date of purchase (subject to the rights of Holders of record on the relevant record date to receive interest due on the relevant interest payment date) as provided in, and subject to the terms of, the Indenture. 8. Put Provisions Upon a Change of Control, any Holder of Securities will have the right to require the Company to repurchase all or any part of the Securities of such Holder at a repurchase price in cash equal to 101% of the principal amount of the Securities to be repurchased plus accrued interest to the date of repurchase (subject to the right of Holders of record on the relevant record date to receive interest due on the related interest payment date) as provided in, and subject to the terms of, the Indenture. 9. Denominations; Transfer; Exchange The Securities are in registered form without coupons in denominations of $1,000 and whole multiples of $1,000. A Holder may transfer or exchange securities in accordance with the Indenture. The Registrar may require a Holder, among other things, to furnish appropriate endorsements or transfer documents and to pay any taxes and fees required by law or permitted by the Indenture, including any transfer tax or other similar governmental charge payable in connection therewith. The Registrar need not register the transfer of or exchange any Securities selected for redemption (except, in the case of a Security to be redeemed in part, the portion of the Security not to be redeemed) or any Securities for a period of 15 days before a selection of Securities to be redeemed or 15 days before an interest payment date. 10. Persons Deemed Owners The registered Holder of this Security may be treated as the owner of it for all purposes. 11. Unclaimed Money If money for the payment of principal or interest remains unclaimed for two years, the Trustee or Paying Agent shall pay the money back to the Company at its written request unless an abandoned property law designates another Person. After any such payment, Holders entitled to the money must look only to the Company and not to the Trustee for payment. 12. Discharge and Defeasance Subject to certain conditions, the Company at any time may terminate some or all of its obligations under the Securities and the Indenture if the Company deposits with the Trustee U.S. dollars or U.S. Government Obligations for the payment of principal and interest on the Securities to redemption or maturity, as the case may be. A-7 13. Amendment, Waiver Subject to certain exceptions set forth in the Indenture, (i) the Indenture or the Securities may be amended with the written consent of the Holders of at least a majority in principal amount outstanding of the Securities and (ii) any default or noncompliance with any provision may be waived with the written consent of the Holders of a majority in principal amount outstanding of the Securities. Subject to certain exceptions set forth in the Indenture, without the consent of any Securityholder, the Company and the Trustee may amend the Indenture or the Securities to cure any ambiguity, omission, defect or inconsistency, or to comply with Article 5 of the Indenture, or to provide for uncertificated Securities in addition to or in place of certificated Securities, or to add guarantees with respect to the Securities, or to secure the Securities, or to add additional covenants or surrender rights and powers conferred on the Company, or to make any change that does not adversely affect the rights of any Securityholder or to comply with any request of the SEC in connection with qualifying the Indenture under the TIA. 14. Defaults and Remedies Under the Indenture, Events of Default include (i) default for 30 days in payment of interest on the Securities; (ii) default in payment of principal on the Securities at maturity, upon redemption pursuant to paragraphs 5 or 6 above, upon acceleration or otherwise, or failure by the Company to redeem or purchase Securities when required; (iii) failure by the Company to comply with other agreements in the Indenture or the Securities, in certain cases subject to notice and lapse of time; (iv) certain accelerations (including failure to pay within any grace period after final maturity) of other Indebtedness of the Company and any Significant Subsidiary if the amount accelerated (or so unpaid) exceeds $10 million; (v) certain events of bankruptcy or insolvency with respect to the Company and its Significant Subsidiaries; and (vi) certain judgments or decrees for the payment of money is in excess of $10 million. If an Event of Default occurs and is continuing, the Trustee or the Holders of at least 25% in principal amount of the Securities then outstanding may declare all the Securities to be due and payable. Certain events of bankruptcy or insolvency are Events of Default which will result in the Securities being due and payable immediately upon the occurrence of such Events of Default. Securityholders may not enforce the Indenture or the Securities except as provided in the Indenture. The Trustee may refuse to enforce the Indenture or the Securities unless it receives reasonable indemnity or security. Subject to certain limitations, Holders of a majority in principal amount of the Securities may direct the Trustee in its exercise of any trust or power. The Trustee may withhold from Securityholders notice of any continuing Default (except a Default in payment of principal or interest) if it determines that withholding notice is in the interest of the Holders. A-8 15. Trustee Dealings with the Company Subject to certain limitations imposed by the TIA, the Trustee under the Indenture, in its individual or any other capacity, may become the owner or pledgee of Securities and may otherwise deal with and collect obligations owed to it by the Company or any of its Affiliates and may otherwise deal with the Company or any of its Affiliates with the same rights it would have if it were not Trustee. 16. No Recourse Against Others A director, officer, employee or stockholder, as such, of the Company or the Trustee shall not have any liability for any obligations of the Company under the Securities or the Indenture or for any claim based on, in respect of or by reason of such obligations or their creation. By accepting a Security, each Securityholder waives and releases all such liability. The waiver and release are part of the consideration for the issue of the Securities. 17. Governing Law The Indenture and the Securities shall be governed by, and construed in accordance with, the laws of the State of New York but without giving effect to applicable principles of conflict of laws to the extent that the application of the laws of another jurisdiction would be required thereby. 18. Authentication This Security shall not be valid until an authorized signatory of the Trustee (or an authenticating agent) manually signs the certificate of authentication on the other side of this Security. 19. Abbreviations Customary abbreviations may be used in the name of a Securityholder or an assignee, such as TEN COM (=tenants in common), TEN ENT (=tenants by the entireties), JT TEN (=joint tenants with rights of survivorship and not as tenants in common), CUST (=custodian), and U/G/M/A (=Uniform Gift to Minors Act). 20. CUSIP Numbers Pursuant to a recommendation promulgated by the Committee on Uniform Security Identification Procedures, the Company has caused CUSIP numbers to be printed on the Securities and have directed the Trustee to use CUSIP numbers in notices of redemption as a convenience to Securityholders. No representation is made as to the accuracy of such numbers either as printed on the Securities or as contained in any notice of redemption, and reliance may be placed only on the other identification numbers placed thereon. A-9 The Company will furnish to any Securityholder upon written request and without charge to the Securityholder a copy of the Indenture which has in it the text of this Security in larger type. Requests may be made as follows: Michaels Stores, Inc. 8000 Bent Branch Drive Irving, TX 75063 Attention: General Counsel A-10 ASSIGNMENT FORM To assign this Security, fill in the form below: I or we assign and transfer this Security to ---------------------------------- (Print or type assignee's name, address and zip code) ---------------------------------- (Insert assignee's soc. sec. or tax I.D. No.) and irrevocably appoint ______________________________ agent to transfer this Security on the books of the Company. The agent may substitute another to act for him. Date: Your Signature: ------------------ ---------------------------------- (Sign exactly as your name appears on the other side of the Security) Signature Guarantee: ------------------------------ (Signature must be guaranteed) A-11 OPTION OF HOLDER TO ELECT PURCHASE If you want to elect to have this Security purchased by the Company pursuant to Section 4.6 or 4.8 of the Indenture, check the box: |_| If you want to elect to have only part of this Security purchased by the Company pursuant to Section 4.6 or 4.8 of the Indenture, state the amount: $ Date: Your Signature: ------------------ ---------------------------------- (Sign exactly as your name appears on the other side of the Security) Signature Guarantee: ------------------------------ (Signature must be guaranteed) A-12 EXHIBIT B FACE OF SECURITY UNLESS THIS CERTIFICATE IS PRESENTED BY AN AUTHORIZED REPRESENTATIVE OF THE DEPOSITORY TRUST COMPANY, A NEW YORK CORPORATION ("DTC"), TO THE COMPANY OR ITS AGENT FOR REGISTRATION OF TRANSFER, EXCHANGE, OR PAYMENT AND ANY CERTIFICATE ISSUED IS REGISTERED IN THE NAME OF CEDE & CO. OR IN SUCH OTHER NAME AS IS REQUESTED BY AN AUTHORIZED REPRESENTATIVE OF DTC (AND ANY PAYMENT IS MADE TO CEDE & CO. OR TO SUCH OTHER ENTITY AS IS REQUESTED BY AN AUTHORIZED REPRESENTATIVE OF DTC), ANY TRANSFER, PLEDGE, OR OTHER USE HEREOF FOR VALUE OR OTHERWISE BY OR TO ANY PERSON IS WRONGFUL INASMUCH AS THE REGISTERED OWNER HEREOF, CEDE & CO., HAS AN INTEREST HEREIN. TRANSFERS OF THIS GLOBAL SECURITY SHALL BE LIMITED TO TRANSFERS IN WHOLE, BUT NOT IN PART, TO NOMINEES OF DTC OR TO A SUCCESSOR THEREOF OR SUCH SUCCESSOR'S NOMINEE AND LIMITED TO TRANSFERS MADE IN ACCORDANCE WITH THE RESTRICTIONS SET FORTH IN THE INDENTURE REFERRED TO ON THE REVERSE HEREOF. No. ____ $______________ 9 1/4% Senior Notes Due 2009 CUSIP No. 594087 AF 5 MICHAELS STORES, INC., a Delaware corporation, promises to pay to _________________, or registered assigns, the principal sum of ________________ United States dollars on _________________, 2009. Interest Payment Dates: January 1 and July 1. Record Dates: December 15 and June 15. Additional provisions of this Security are set forth on the other side of this Security. B-1 MICHAELS STORES, INC. By: ------------------------------------- Name: -------------------------------- Title: ------------------------------- Dated: , 200 ------------- -- TRUSTEE'S CERTIFICATE OF AUTHENTICATION THE BANK OF NEW YORK, as Trustee, certifies that this is one of the Securities referred to in the within-mentioned Indenture. By: ------------------------------------- Authorized Signatory B-2 REVERSE OF SECURITY 9 1/4% Senior Notes Due 2009 1. Interest MICHAELS STORES, INC., a Delaware corporation (such entity, and its successors and assigns under the Indenture hereinafter referred to, being herein called the "Company"), promises to pay interest on the principal amount of this Security at the rate per annum shown above. The Company will pay interest semiannually on January 1 and July 1 of each year commencing January 1, 2002. Interest on the Securities will accrue from the most recent date to which interest has been paid (which shall include any interest paid on any Series A Securities (defined below) which was exchanged for this Series B Security) or, if no interest has been paid, from July 6, 2001. Interest will be computed on the basis of a 360-day year of twelve 30-day months. The Company shall pay interest on overdue principal at the rate borne by the Securities plus 1% per annum, and it shall pay interest on overdue installments of interest at the same rate to the extent lawful. 2. Method of Payment The Company will pay interest on the Securities (except defaulted interest) to the Persons who are registered holders of Securities at the close of business on the December 15 or June 15 next preceding the interest payment date even if Securities are canceled after the record date and on or before the interest payment date. Holders must surrender Securities to a Paying Agent to collect principal payments. The Company will pay principal and interest in money of the United States that at the time of payment is legal tender for payment of public and private debts. However, the Company may pay principal and interest by check payable in such money and may mail an interest check to a Holder's registered address. All payments of principal of, premium, if any, and interest on the Securities will be made by the Company in immediately available funds. 3. PARI PASSU With Series A Security [Only include if security is issued pursuant to the Exchange Offer described below.] [The Series B Security was issued pursuant to an Exchange Offer pursuant to which this Security was exchanged for 9 1/4% Senior Notes due 2009 (herein called the "Series A Securities") in like principal amount as provided therein.] The Series A Securities and the Series B Securities, and Additional Securities, if issued, are together referred to as the "Securities." The Series A Securities rank PARI PASSU in right of payment with the Series B Securities. Any interest or other payments owing on the Series A Security at the time of the consummation of the Exchange Offer shall be paid with respect to the Series B Security issued in exchange therefor unless all such interest and other payments are paid in full in connection with the Exchange Offer. B-3 4. Paying Agent and Registrar Initially, The Bank of New York, a New York banking corporation ("Trustee"), will act as Paying Agent and Registrar. The Company may appoint and change any Paying Agent, Registrar or co-registrar without notice. The Company or any of its domestically incorporated Wholly Owned Subsidiaries may act as Paying Agent, Registrar or co-registrar. 5. Indenture The Company issued the Securities under an Indenture dated as of July 6, 2001 (the "Indenture"), by and between the Company and the Trustee. The terms of the Securities include those stated in the Indenture and those made part of the Indenture by reference to the Trust Indenture Act of 1939, as amended, or any successor statute (the "TIA"). Terms defined in the Indenture and not defined herein have the meanings ascribed thereto in the Indenture. The Securities are subject to all such terms, and Securityholders are referred to the Indenture and the TIA for a statement of those terms. Any conflict between this Note and the Indenture will be governed by the Indenture. The Securities are general unsecured obligations of the Company limited (except as otherwise provided in the Indenture) in aggregate principal amount to $250.0 million (of which $200.0 million may be Initial Securities and Series B Securities exchanged therefor, and up to $50.0 million may be issued as Additional Securities) issued under and subject to the terms of the Indenture. The Indenture imposes certain limitations on the Incurrence of Indebtedness by the Company and its Restricted Subsidiaries, the existence of liens, the payment of dividends on, and redemption of, the Capital Stock of the Company and its Subsidiaries and the redemption of certain subordinated obligations of the Company and its Subsidiaries, restricted payments, the sale or transfer of assets and Subsidiary stock, the issuance or sale of Preferred Stock of Restricted Subsidiaries, sale and leaseback transactions, the investments of the Company and its Restricted Subsidiaries, consolidations, mergers and transfers of all or substantially all the assets of the Company, and transactions with Affiliates. In addition, the Indenture limits the ability of the Company and certain of its Subsidiaries to restrict distributions and dividends from Subsidiaries. 6. Optional Redemption Except as set forth in the next paragraph, the Securities may not be redeemed prior to July 1, 2005. On and after that date, the Company may redeem as provided in, and subject to the terms of, the Indenture the Securities in whole at any time or in part from time to time at the following redemption prices (expressed in percentages of principal amount), plus accrued interest to the redemption date (subject to the right of Holders of record on the relevant record date to receive interest due on the related interest payment date): B-4 if redeemed during the 12-month period beginning July 1,
Period Percentage 2005.......................................104.625% 2006.......................................102.313% 2007 and thereafter........................100.000%
In addition, at any time and from time to time prior to July 1, 2004, the Company may redeem in the aggregate up to 35% of the aggregate principal amount of the Securities with the proceeds of one or more Equity Offerings so long as there is a Public Market at the time of such redemption at a redemption price (expressed as a percentage of principal amount) of 109.25% plus accrued interest, if any, to the redemption date (subject to the right of Holders of record on the relevant record date to receive interest due on the relevant interest payment date) as provided in, and subject to the terms of, the Indenture; provided, however, that at least 65% of the initial aggregate principal amount of the Securities must remain outstanding after each such redemption. 7. Notice of Redemption Notice of redemption will be mailed by first-class mail at least 30 days but not more than 60 days before the redemption date to each Holder of Securities to be redeemed at his registered address. Securities in denominations larger than $1,000 may be redeemed in part but only in whole multiples of $1,000. If money sufficient to pay the redemption price of and accrued interest on all Securities (or portions thereof) to be redeemed on the redemption date is deposited with the Paying Agent on or before the redemption date and certain other conditions are satisfied, on and after such date interest ceases to accrue on such Securities (or such portions thereof) called for redemption. If a notice or communication is sent in the manner provided in the Indenture, it is duly given, whether or not the addressee receives it. Failure to send a notice or communication to a Securityholder or any defect in it shall not affect its sufficiency with respect to other Securityholders. In addition, in the event of certain Asset Dispositions, the Company will be required to make an offer to purchase Securities at a purchase price of 100% of their principal amount plus accrued interest to the date of purchase (subject to the rights of Holders of record on the relevant record date to receive interest due on the relevant interest payment date) as provided in, and subject to the terms of, the Indenture. 8. Put Provisions Upon a Change of Control, any Holder of Securities will have the right to require the Company to repurchase all or any part of the Securities of such Holder at a repurchase price in cash equal to 101% of the principal amount of the Securities to be repurchased plus accrued interest to the date of repurchase (subject to the right of Holders of record on the relevant record date to receive interest due on the related interest payment date) as provided in, and subject to the terms of, the Indenture. B-5 9. Denominations; Transfer; Exchange The Securities are in registered form without coupons in denominations of $1,000 and whole multiples of $1,000. A Holder may transfer or exchange securities in accordance with the Indenture. The Registrar may require a Holder, among other things, to furnish appropriate endorsements or transfer documents and to pay any taxes and fees required by law or permitted by the Indenture, including any transfer tax or other similar governmental charge payable in connection therewith. The Registrar need not register the transfer of or exchange any Securities selected for redemption (except, in the case of a Security to be redeemed in part, the portion of the Security not to be redeemed) or any Securities for a period of 15 days before a selection of Securities to be redeemed or 15 days before an interest payment date. 10. Persons Deemed Owners The registered Holder of this Security may be treated as the owner of it for all purposes. 11. Unclaimed Money If money for the payment of principal or interest remains unclaimed for two years, the Trustee or Paying Agent shall pay the money back to the Company at its written request unless an abandoned property law designates another Person. After any such payment, Holders entitled to the money must look only to the Company and not to the Trustee for payment. 12. Discharge and Defeasance Subject to certain conditions, the Company at any time may terminate some or all of its obligations under the Securities and the Indenture if the Company deposits with the Trustee U.S. dollars or U.S. Government Obligations for the payment of principal and interest on the Securities to redemption or maturity, as the case may be. 13. Amendment, Waiver Subject to certain exceptions set forth in the Indenture, (i) the Indenture or the Securities may be amended with the written consent of the Holders of at least a majority in principal amount outstanding of the Securities and (ii) any default or noncompliance with any provision may be waived with the written consent of the Holders of a majority in principal amount outstanding of the Securities. Subject to certain exceptions set forth in the Indenture, without the consent of any Securityholder, the Company and the Trustee may amend the Indenture or the Securities to cure any ambiguity, omission, defect or inconsistency, or to comply with Article 5 of the Indenture, or to provide for uncertificated Securities in addition to or in place of certificated Securities, or to add guarantees with respect to the Securities, or to secure the Securities, or to add additional covenants or surrender rights and powers conferred on the Company, or to make any change that does not adversely affect the rights of any Securityholder or to comply with any request of the SEC in connection with qualifying the Indenture under the TIA. B-6 14. Defaults and Remedies Under the Indenture, Events of Default include (i) default for 30 days in payment of interest on the Securities; (ii) default in payment of principal on the Securities at maturity, upon redemption pursuant to paragraphs 5 or 6 above, upon acceleration or otherwise, or failure by the Company to redeem or purchase Securities when required; (iii) failure by the Company to comply with other agreements in the Indenture or the Securities, in certain cases subject to notice and lapse of time; (iv) certain accelerations (including failure to pay within any grace period after final maturity) of other Indebtedness of the Company and any Significant Subsidiary if the amount accelerated (or so unpaid) exceeds $10 million; (v) certain events of bankruptcy or insolvency with respect to the Company and its Significant Subsidiaries; and (vi) certain judgments or decrees for the payment of money is in excess of $10 million. If an Event of Default occurs and is continuing, the Trustee or the Holders of at least 25% in principal amount of the Securities then outstanding may declare all the Securities to be due and payable. Certain events of bankruptcy or insolvency are Events of Default which will result in the Securities being due and payable immediately upon the occurrence of such Events of Default. Securityholders may not enforce the Indenture or the Securities except as provided in the Indenture. The Trustee may refuse to enforce the Indenture or the Securities unless it receives reasonable indemnity or security. Subject to certain limitations, Holders of a majority in principal amount of the Securities may direct the Trustee in its exercise of any trust or power. The Trustee may withhold from Securityholders notice of any continuing Default (except a Default in payment of principal or interest) if it determines that withholding notice is in the interest of the Holders. 15. Trustee Dealings with the Company Subject to certain limitations imposed by the TIA, the Trustee under the Indenture, in its individual or any other capacity, may become the owner or pledgee of Securities and may otherwise deal with and collect obligations owed to it by the Company or any of its Affiliates and may otherwise deal with the Company or any of its Affiliates with the same rights it would have if it were not Trustee. 16. No Recourse Against Others A director, officer, employee or stockholder, as such, of the Company or the Trustee shall not have any liability for any obligations of the Company under the Securities or the Indenture or for any claim based on, in respect of or by reason of such obligations or their creation. By accepting a Security, each Securityholder waives and releases all such liability. The waiver and release are part of the consideration for the issue of the Securities. B-7 17. Governing Law The Indenture and the Securities shall be governed by, and construed in accordance with, the laws of the State of New York but without giving effect to applicable principles of conflict of laws to the extent that the application of the laws of another jurisdiction would be required thereby. 18. Authentication This Security shall not be valid until an authorized signatory of the Trustee (or an authenticating agent) manually signs the certificate of authentication on the other side of this Security. 19. Abbreviations Customary abbreviations may be used in the name of a Securityholder or an assignee, such as TEN COM (=tenants in common), TEN ENT (=tenants by the entireties), JT TEN (=joint tenants with rights of survivorship and not as tenants in common), CUST (=custodian), and U/G/M/A (=Uniform Gift to Minors Act). 20. CUSIP Numbers Pursuant to a recommendation promulgated by the Committee on Uniform Security Identification Procedures, the Company has caused CUSIP numbers to be printed on the Securities and have directed the Trustee to use CUSIP numbers in notices of redemption as a convenience to Securityholders. No representation is made as to the accuracy of such numbers either as printed on the Securities or as contained in any notice of redemption, and reliance may be placed only on the other identification numbers placed thereon. The Company will furnish to any Securityholder upon written request and without charge to the Securityholder a copy of the Indenture which has in it the text of this Security in larger type. Requests may be made as follows: Michaels Stores, Inc. 8000 Bent Branch Drive Irving, TX 75063 Attention: General Counsel B-8 ASSIGNMENT FORM To assign this Security, fill in the form below: I or we assign and transfer this Security to ---------------------------------- (Print or type assignee's name, address and zip code) ---------------------------------- (Insert assignee's soc. sec. or tax I.D. No.) and irrevocably appoint ______________________________ agent to transfer this Security on the books of the Company. The agent may substitute another to act for him. Date: Your Signature: ------------------- --------------------------------- (Sign exactly as your name appears on the other side of the Security) Signature Guarantee: --------------------------------- (Signature must be guaranteed) B-9 OPTION OF HOLDER TO ELECT PURCHASE If you want to elect to have this Security purchased by the Company pursuant to Section 4.6 or 4.8 of the Indenture, check the box: |_| If you want to elect to have only part of this Security purchased by the Company pursuant to Section 4.6 or 4.8 of the Indenture, state the amount: $ Date: Your Signature: ------------------- --------------------------------- (Sign exactly as your name appears on the other side of the Security) Signature Guarantee: --------------------------------- (Signature must be guaranteed) B-10 EX-4.4 5 a2055355zex-4_4.txt EXHIBIT 4.4 Exhibit 4.4 ------------------------- REGISTRATION RIGHTS AGREEMENT DATED AS OF JULY 6, 2001 AMONG MICHAELS STORES, INC. AND MERRILL LYNCH, PIERCE, FENNER & SMITH INCORPORATED, CREDIT SUISSE FIRST BOSTON CORPORATION, DEUTSCHE BANC ALEX. BROWN INC., FLEET SECURITIES, INC. AND WELLS FARGO BROKERAGE SERVICES, LLC ------------------------- TABLE OF CONTENTS
PAGE 1. DEFINITIONS......................................................... 1 2. REGISTRATION UNDER THE 1933 ACT..................................... 5 2.1. Exchange Offer............................................. 5 2.2. Shelf Registration......................................... 8 2.3. Expenses................................................... 10 2.4. Effectiveness.............................................. 10 2.5. Interest................................................... 10 3. REGISTRATION PROCEDURES............................................. 12 4. INDEMNIFICATION; CONTRIBUTION....................................... 19 5. MISCELLANEOUS....................................................... 24 5.1. Rule 144 and Rule 144A..................................... 24 5.2. No Inconsistent Agreements................................. 24 5.3. Amendments and Waivers..................................... 24 5.4. Notices.................................................... 24 5.5. Successor and Assigns...................................... 26 5.6. Third Party Beneficiaries.................................. 26 5.7. Specific Enforcement....................................... 26 5.8. Restriction on Resales..................................... 26 5.9. Counterparts............................................... 26 5.10. Headings................................................... 27 5.11. Governing Law.............................................. 27 5.12. Severability............................................... 27
i REGISTRATION RIGHTS AGREEMENT This Registration Rights Agreement (the "Agreement") is made and entered into this 6th day of July 2001, among Michaels Stores, Inc., a Delaware corporation (the "Company"), and Merrill Lynch, Pierce, Fenner & Smith Incorporated, Credit Suisse First Boston Corporation, Deutsche Banc Alex. Brown Inc., Fleet Securities, Inc. and Wells Fargo Brokerage Services, LLC (collectively, the "Initial Purchasers"). This Agreement is made pursuant to the Purchase Agreement, dated June 29, 2001, among the Company and the Initial Purchasers (the "Purchase Agreement"), which provides for the sale by the Company to the Initial Purchasers of an aggregate of $150.0 million principal amount of the Company's 9 1/4% Senior Notes due 2009, (the "Securities"). In order to induce the Initial Purchasers to enter into the Purchase Agreement, the Company has agreed to provide to the Initial Purchasers and their direct and indirect transferees the registration rights set forth in this Agreement. The execution of this Agreement is a condition to the closing under the Purchase Agreement. In consideration of the foregoing, the parties hereto agree as follows: 1. DEFINITIONS. As used in this Agreement, the following capitalized defined terms shall have the following meanings: "1933 Act" shall mean the Securities Act of 1933, as amended from time to time. "1934 Act" shall mean the Securities Exchange Act of l934, as amended from time to time. "Closing Date" shall mean the Closing Time as defined in the Purchase Agreement. "Company" shall have the meaning set forth in the preamble and shall also include the Company's successors. "Depositary" shall mean The Depository Trust Company, or any other depositary appointed by the Company, PROVIDED, HOWEVER, that such depositary must have an address in the Borough of Manhattan, in the City of New York. "Exchange Offer" shall mean the exchange offer by the Company of Exchange Securities for Securities pursuant to Section 2.1 hereof. "Exchange Offer Registration" shall mean a registration under the 1933 Act effected pursuant to Section 2.1 hereof. "Exchange Offer Registration Statement" shall mean an exchange offer registration statement on Form S-4 (or, if applicable, on another appropriate form or on any successor form used for substantially the same transactions), and all amendments and supplements to such registration statement, including the Prospectus contained therein, all exhibits thereto and all documents incorporated by reference therein. "Exchange Period" shall have the meaning set forth in Section 2.1 hereof. "Exchange Securities" shall mean the 9 1/4% Senior Notes due 2009 issued by the Company under the Indenture containing terms identical to the Securities in all material respects (except for references to certain interest rate provisions, restrictions on transfers and restrictive legends), to be offered to Holders of Securities in exchange for Securities pursuant to the Exchange Offer. "Holder" shall mean an Initial Purchaser, for so long as it owns any Registrable Securities, and each of its successors, assigns and direct and indirect transferees who become registered owners of Registrable Securities under the Indenture and each Participating Broker-Dealer that holds Exchange Securities for so long as such Participating Broker-Dealer is required to deliver a prospectus meeting the requirements of the 1933 Act in connection with any resale of such Exchange Securities. "Indenture" shall mean the Indenture relating to the Securities, dated as of _____________ , 2001, between the Company and The Bank of New York, as trustee, as the same may be amended, supplemented, waived or otherwise modified from time to time in accordance with the terms thereof. "Initial Purchaser" or "Initial Purchasers" shall have the meaning set forth in the preamble. 2 "Majority Holders" shall mean the Holders of a majority of the aggregate principal amount of Outstanding (as defined in the Indenture) Registrable Securities; provided that whenever the consent or approval of Holders of a specified percentage of Registrable Securities is required hereunder, Registrable Securities held by the Company and other obligors on the Securities or any Affiliate (as defined in the Indenture) of the Company shall be disregarded in determining whether such consent or approval was given by the Holders of such required percentage amount. "Participating Broker-Dealer" shall mean any of Merrill Lynch, Pierce, Fenner & Smith Incorporated, Credit Suisse First Boston Corporation, Deutsche Banc Alex. Brown Inc., Fleet Securities, Inc. Wells Fargo Brokerage Services, LLC and any other broker-dealer which makes a market in the Securities and exchanges Securities in the Exchange Offer for Exchange Securities. "Person" shall mean an individual, partnership (general or limited), corporation, limited liability company, trust or unincorporated organization, or a government or agency or political subdivision thereof. "Private Exchange" shall have the meaning set forth in Section 2.1 hereof. "Private Exchange Securities" shall have the meaning set forth in Section 2.1 hereof. "Prospectus" shall mean the prospectus included in a Registration Statement, including any preliminary prospectus, and any such prospectus as amended or supplemented by any prospectus supplement, including any such prospectus supplement with respect to the terms of the offering of any portion of the Registrable Securities covered by a Shelf Registration Statement, and by all other amendments and supplements to a prospectus, including post-effective amendments, and in each case including all material incorporated by reference therein. "Purchase Agreement" shall have the meaning set forth in the preamble. "Registrable Securities" shall mean the Securities and, if issued, the Private Exchange Securities; PROVIDED, HOWEVER, that Securities and, if issued, the Private Exchange Securities, shall cease to be Registrable Securities when (i) a Registration Statement with respect to such Securities shall have been declared effective under the 1933 Act and such Securities shall have been disposed of pursuant to such Registration Statement, (ii) such Securities have been sold or are 3 permitted to be sold to the public pursuant to Rule l44 (or any similar provision then in force, but not Rule 144A) under the 1933 Act, (iii) such Securities shall have ceased to be outstanding or (iv) the Exchange Offer is consummated, except in any such case with respect to Securities as to which the Company is required to file a Shelf Registration. "Registration Expenses" shall mean any and all expenses incident to performance of or compliance by the Company with this Agreement, including without limitation: (i) all SEC, stock exchange or National Association of Securities Dealers, Inc. (the "NASD") registration and filing fees, including, if applicable, the fees and expenses of any "qualified independent underwriter" (and its counsel) that is required to be retained by any holder of Registrable Securities in accordance with the rules and regulations of the NASD, (ii) all fees and expenses incurred in connection with compliance with state securities or blue sky laws and compliance with the rules of the NASD (including reasonable fees and disbursements not to exceed $5,000 of counsel for any underwriters or Holders in connection with blue sky qualification of any of the Exchange Securities or Registrable Securities and any filings with the NASD), (iii) all expenses of any Persons in preparing or assisting in preparing, word processing, printing and distributing any Registration Statement, any Prospectus, any amendments or supplements thereto, any underwriting agreements, securities sales agreements and other documents relating to the performance of and compliance with this Agreement, (iv) all fees and expenses incurred in connection with the listing, if any, of any of the Registrable Securities on any securities exchange or exchanges, (v) all rating agency fees, (vi) the fees and disbursements of counsel for the Company and of the independent public accountants of the Company, including the expenses of any special audits or "cold comfort" letters required by or incident to such performance and compliance, (vii) the fees and expenses of the Trustee, and any escrow agent or custodian, (viii) in the case of a Shelf Registration Statement, the reasonable fees and disbursements of one counsel representing the Holders of Registrable Securities but excluding fees and expenses of counsel to the underwriters (other than fees and expenses set forth in clause (ii) above) or the Holders' underwriting discounts and commissions and transfer taxes, if any, relating to the sale or disposition of Registrable Securities by a Holder. "Registration Statement" shall mean any registration statement of the Company which covers any of the Exchange Securities or Registrable Securities pursuant to the provisions of this Agreement, and all amendments and supplements to any such Registration Statement, including post-effective amendments, in each case including the Prospectus contained therein, all exhibits thereto and all material incorporated by reference therein. 4 "SEC" shall mean the Securities and Exchange Commission. "Shelf Registration" shall mean a registration effected pursuant to Section 2.2 hereof. "Shelf Registration Statement" shall mean a "shelf" registration statement of the Company pursuant to the provisions of Section 2.2 of this Agreement which covers all of the Registrable Securities or all of the Private Exchange Securities on an appropriate form under Rule 415 under the 1933 Act, or any successor or similar rule that may be adopted by the SEC, and all amendments and supplements to such registration statement, including post-effective amendments, in each case including the Prospectus contained therein, all exhibits thereto and all material incorporated by reference therein. "Trustee" shall mean the trustee with respect to the Securities under the Indenture. 2. REGISTRATION UNDER THE 1933 ACT. 2.1. EXCHANGE OFFER. The Company shall, for the benefit of the Holders, at the Company's cost, (A) prepare and, as soon as practicable but not later than 75 days following the Closing Date, file with the SEC an Exchange Offer Registration Statement on an appropriate form under the 1933 Act with respect to a proposed Exchange Offer and the issuance and delivery to the Holders, in exchange for the Registrable Securities (other than Private Exchange Securities), of a like principal amount of Exchange Securities, (B) use its commercially reasonable efforts to cause the Exchange Offer Registration Statement to be declared effective under the 1933 Act within 135 days of the Closing Date, (C) use its commercially reasonable efforts to keep the Exchange Offer Registration Statement effective until the closing of the Exchange Offer and (D) use its commercially reasonable efforts to cause the Exchange Offer to be consummated not later than 165 days following the Closing Date. Upon the effectiveness of the Exchange Offer Registration Statement, the Company shall promptly commence the Exchange Offer, it being the objective of such Exchange Offer to enable each Holder eligible and electing to exchange Registrable Securities for Exchange Securities (assuming that such Holder (a) is not an affiliate of the Company within the meaning of Rule 405 under the 1933 Act, (b) is not a broker-dealer tendering Registrable Securities acquired directly from the Company for its own account, (c) acquired or will acquire the Exchange Securities in the ordinary course of such Holder's business and (d) is not engaged in, and does not intend to engage in, and has no arrangements or understandings with any Person to participate in the Exchange Offer for the purpose of distributing the Exchange Securities) to transfer such Exchange 5 Securities from and after their receipt without any limitations or restrictions under the 1933 Act and under state securities or blue sky laws. In connection with the Exchange Offer, the Company shall: (a) mail as promptly as practicable to each Holder a copy of the Prospectus forming part of the Exchange Offer Registration Statement, together with an appropriate letter of transmittal and related documents; (b) keep the Exchange Offer open for acceptance for a period of not less than 30 calendar days after the date notice thereof is mailed to the Holders (or longer if required by applicable law) (such period referred to herein as the "Exchange Period"); (c) utilize the services of the Depositary for the Exchange Offer; (d) permit Holders to withdraw tendered Registrable Securities at any time prior to 5:00 p.m. (Eastern Time), on the last business day of the Exchange Period, by sending to the institution specified in the notice, a telegram, telex, facsimile transmission or letter setting forth the name of such Holder, the principal amount of Registrable Securities delivered for exchange, and a statement that such Holder is withdrawing such Holder's election to have such Securities exchanged; (e) notify each Holder that any Registrable Security not tendered will remain outstanding and continue to accrue interest, but will not retain any rights under this Agreement (except in the case of the Initial Purchasers and Participating Broker-Dealers as provided herein); and (f) otherwise comply in all respects with all applicable laws relating to the Exchange Offer. If, prior to consummation of the Exchange Offer, the Initial Purchasers hold any Securities acquired by them and having the status of an unsold allotment in the initial distribution, the Company upon the request of any Initial Purchaser shall, simultaneously with the delivery of the Exchange Securities in the Exchange Offer, issue and deliver to such Initial Purchaser in exchange (the "Private Exchange") for the Securities held by such Initial Purchaser, a like principal amount of debt securities of the Company on a senior basis, that are identical (except that such securities shall bear appropriate transfer restrictions) to the Exchange Securities (the "Private Exchange Securities") but will not have been registered under the Exchange Offer. 6 The Exchange Securities and the Private Exchange Securities shall be issued under (i) the Indenture or (ii) an indenture identical in all material respects to the Indenture and which, in either case, has been qualified under the Trust Indenture Act of 1939, as amended (the "TIA"), or is exempt from such qualification and shall provide that the Exchange Securities shall not be subject to the transfer restrictions set forth in the Indenture but that the Private Exchange Securities shall be subject to such transfer restrictions and shall not be subject to Section 2.5 hereof. The Indenture or such indenture shall provide that the Exchange Securities, the Private Exchange Securities and the Securities shall vote and consent together on all matters as one class and that none of the Exchange Securities, the Private Exchange Securities or the Securities will have the right to vote or consent as a separate class on any matter. The Private Exchange Securities shall be of the same series as the Exchange Securities and the Company shall use all commercially reasonable efforts to have the Private Exchange Securities bear the same CUSIP number as the Exchange Securities. As soon as practicable after the close of the Exchange Offer and/or the Private Exchange, as the case may be, the Company shall: (i) accept for exchange all Securities duly tendered and not validly withdrawn pursuant to the Exchange Offer in accordance with the terms of the Exchange Offer Registration Statement and the letter of transmittal which shall be an exhibit thereto; (ii) accept for exchange all Securities properly tendered pursuant to the Private Exchange; (iii) deliver to the Trustee for cancellation all Securities so accepted for exchange; and (iv) cause the Trustee promptly to authenticate and deliver Exchange Securities or Private Exchange Securities, as the case may be, to each Holder of Securities so accepted for exchange in a principal amount equal to the principal amount of the Securities of such Holder so accepted for exchange. The Exchange Offer and the Private Exchange shall not be subject to any conditions, other than (i) that the Exchange Offer or the Private Exchange, or the making of any exchange by a Holder, does not violate applicable law or any applicable interpretation of the staff of the SEC, (ii) the due tendering of Registrable Securities in accordance with the Exchange Offer and the Private Exchange, (iii) that each Holder of Securities exchanged in the Exchange Offer shall have represented that it is not an affiliate of the 7 Company or a broker-dealer tendering Securities acquired directly from the Company for its account and all Exchange Securities to be received by it shall be acquired in the ordinary course of its business and that at the time of the consummation of the Exchange Offer it is not engaged in, and does not intend to engage in and shall have no arrangement or understanding with any person to participate in the distribution (within the meaning of the 1933 Act) of the Exchange Securities and shall have made such other representations as may be reasonably necessary under applicable SEC rules, regulations or interpretations to render the use of Form S-4 or other appropriate form under the 1933 Act available and (iv) that no action or proceeding shall have been instituted or threatened in any court or by or before any governmental agency with respect to the Exchange Offer or the Private Exchange which, in the Company's judgment, would reasonably be expected to impair the ability of the Company to proceed with the Exchange Offer or the Private Exchange. The Company shall inform the Initial Purchasers of the names and addresses of the Holders to whom the Exchange Offer is made, and the Initial Purchasers shall have the right to contact such Holders and otherwise facilitate the tender of Registrable Securities in the Exchange Offer. 2.2. SHELF REGISTRATION. (i) If, because of any changes in law, SEC rules or regulations or applicable interpretations thereof by the staff of the SEC, the Company is not permitted to effect the Exchange Offer as contemplated by Section 2.1 hereof, (ii) if for any other reason the Exchange Offer Registration Statement is not declared effective within 135 days following the original issue of the Securities or the Exchange Offer is not consummated within 165 days after the original issue of the Securities, or (iii) if a Holder is not permitted by applicable law to participate in the Exchange Offer or elects to participate in the Exchange Offer but does not receive fully tradeable Exchange Securities pursuant to the Exchange Offer, then in case of each of clauses (i) through (iii) the Company shall, at its cost: (a) As promptly as reasonably practicable, file with the SEC, and thereafter shall use its commercially reasonable efforts to cause to be declared effective as promptly as practicable but no later than 165 days after the original issue of the Securities or as promptly as practical thereafter, a Shelf Registration Statement relating to the offer and sale of the Registrable Securities by the Holders from time to time in accordance with the methods of distribution elected by the Majority Holders participating in the Shelf Registration and set forth in such Shelf Registration Statement. (b) Use its commercially reasonable efforts to keep the Shelf Registration Statement continuously effective in order to permit the Prospectus forming part thereof to be usable by Holders for a period of two 8 years from the date hereof or for such shorter period that will terminate when all Registrable Securities covered by the Shelf Registration Statement have been sold pursuant to the Shelf Registration Statement or cease to be outstanding or otherwise to be Registrable Securities (the "Effectiveness Period"); PROVIDED, HOWEVER, that the Effectiveness Period in respect of the Shelf Registration Statement shall be extended to the extent required to permit dealers to comply with the applicable prospectus delivery requirements under the 1933 Act and as otherwise provided herein. (c) Notwithstanding any other provisions hereof, use its commercially reasonable efforts to ensure that (i) any Shelf Registration Statement and any amendment thereto and any Prospectus forming part thereof and any supplement thereto complies in all material respects with the 1933 Act and the rules and regulations thereunder, (ii) any Shelf Registration Statement and any amendment thereto does not, when it becomes effective, contain an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading and (iii) any Prospectus forming part of any Shelf Registration Statement, and any supplement to such Prospectus (as amended or supplemented from time to time), does not include an untrue statement of a material fact or omit to state a material fact necessary in order to make the statements, in light of the circumstances under which they were made, not misleading; provided, however, that the Company shall not be responsible for any untrue statement of a material fact or omission to state a material fact necessary in order to make the statements in light of the circumstances under which they were made, not misleading, if any such statement or omission was in connection with or related to information provided by a Holder in writing for use in such Shelf Registration Statement or Prospectus, as the case may be. In addition, in the event that the Initial Purchasers shall not have resold all of the Securities initially purchased by them from the Company pursuant to the Purchase Agreement prior to the consummation of the Exchange Offer and the Initial Purchasers exchange those Securities for Private Exchange Securities, the Company shall use its commercially reasonable efforts to file under the Securities Act as soon as practicable after request therefor by the Initial Purchasers a Shelf Registration Statement. The foregoing provisions will apply to this Shelf Registration for the Initial Purchasers except that the Company will use its commercially reasonable efforts to have the Shelf Registration Statement declared effective as promptly as practicable (however, in no event later than 30 days after filing if such registration statement is not reviewed by the SEC or 90 days if such registration statement is reviewed by the SEC) and to keep the 9 Shelf Registration Statement continuously effective for one year from the date hereof or for such shorter period that will terminate when those Private Exchange Securities have been sold or cease to be outstanding or otherwise to be Registrable Securities. The Company shall not permit any securities other than Registrable Securities to be included in the Shelf Registration Statement, other than any additional Securities issued under the Indenture. The Company further agrees, if necessary, to supplement or amend the Shelf Registration Statement, as required by Section 3(b) below, and to furnish to the Holders of Registrable Securities copies of any such supplement or amendment promptly after its being used or filed with the SEC. 2.3. EXPENSES. The Company shall pay all Registration Expenses in connection with the registration pursuant to Section 2.1 or 2.2. Each Holder shall pay all underwriting discounts and commissions and transfer taxes, if any, relating to the sale or disposition of such Holder's Registrable Securities pursuant to the Shelf Registration Statement. 2.4. EFFECTIVENESS. (a) If, after the Company has filed an Exchange Offer Registration Statement that satisfies the requirements of Section 2.1 above, the Company is required to file a Shelf Registration Statement solely because the Exchange Offer is not permitted because of any change in law or applicable interpretations thereof by the staff of the SEC, then the filing of the Exchange Offer Registration Statement shall be deemed to satisfy the requirements of Section 2.2(b); provided that, in such event, the Company shall remain obligated to meet the effectiveness deadline set forth in Section 2.2(a) above. (b) An Exchange Offer Registration Statement pursuant to Section 2.1 hereof or a Shelf Registration Statement pursuant to Section 2.2 hereof will not be deemed to have become effective unless it has been declared effective by the SEC; PROVIDED, HOWEVER, that if, after it has been declared effective, the offering of Registrable Securities pursuant to an Exchange Offer Registration Statement or a Shelf Registration Statement is interfered with by any stop order, injunction or other order or requirement of the SEC or any other governmental agency or court, such Registration Statement will be deemed not to have become effective during the period of such interference, until the offering of Registrable Securities pursuant to such Registration Statement may legally resume. 2.5. INTEREST. The Indenture executed in connection with the Securities will provide that in the event that either (a) the Exchange Offer Registration Statement is not filed with the SEC on or prior to the 75th calendar day following the date of original issue of the Securities, (b) the Exchange Offer Registration Statement has not been declared effective on or prior to the 135th calendar day following the date of original 10 issue of the Securities or (c) the Exchange Offer is not consummated or a Shelf Registration Statement is not declared effective, in either case, on or prior to the 165th calendar day (or in the case of an unsold allotment held by the Initial Purchasers, the time periods for effectiveness set forth in the penultimate paragraph of Section 2.2) following the date of original issue of the Securities (each such event referred to in clauses (a) through (c) above, a "Registration Default"), the interest rate borne by the Securities shall be increased ("Additional Interest") by one-quarter of one percent per annum upon the occurrence of each Registration Default, which rate will increase by one quarter of one percent each 90-day period that such Additional Interest continues to accrue under any such circumstance, provided that the maximum aggregate increase in the interest rate will in no event exceed one percent (1%) per annum. Following the earlier of (a) the cure of all Registration Defaults or (b) the Securities become fully tradeable without registration under the 1933 Act, the accrual of Additional Interest will cease and the interest rate will revert to the original rate. If the Shelf Registration Statement is unusable by the Holders for any reason, and the consecutive number of days in any consecutive twelve-month period for which the Shelf Registration Statement shall not be usable exceeds 30 days in the aggregate, then the interest rate borne by the Securities will be increased by 0.25% per annum of the principal amount of the Securities for the first 90-day period (or portion thereof) beginning on the 31st such date that such Shelf Registration Statement ceases to be usable, which rate shall be increased by an additional 0.25% per annum of the principal amount of the Securities at the beginning of each subsequent 90-day period, provided that the maximum aggregate increase in the interest rate will in no event exceed one percent (1%) per annum. Any amounts payable under this paragraph shall also be deemed "Additional Interest" for purposes of this Agreement. Upon the earlier of (a) the Shelf Registration Statement once again becoming usable, or (b) the Securities become fully tradeable without registration under the 1933 Act, the interest rate borne by the Securities will be reduced to the original interest rate if the Company is otherwise in compliance with this Agreement at such time. Additional Interest shall be computed based on the actual number of days elapsed in each 90-day period in which the Shelf Registration Statement is unusable. The Company shall notify the Trustee within three business days after each and every date on which an event occurs in respect of which Additional Interest is required to be paid (an "Event Date"). Additional Interest shall be paid by depositing with the Trustee, in trust, for the benefit of the Holders of Registrable Securities, on or before the applicable semiannual interest payment date, immediately available funds in sums sufficient to pay the Additional Interest then due. The Additional Interest due shall be payable on each interest payment date to the record Holder of Securities entitled to receive the interest payment to be paid on such date as set forth in the Indenture. 11 Each obligation to pay Additional Interest shall be deemed to accrue from and including the day following the applicable Event Date. 3. REGISTRATION PROCEDURES. In connection with the obligations of the Company with respect to Registration Statements pursuant to Sections 2.1 and 2.2 hereof, the Company shall: (a) prepare and file with the SEC a Registration Statement, within the relevant time period specified in Section 2, on the appropriate form under the 1933 Act, which form (i) shall be selected by the Company, (ii) shall, in the case of a Shelf Registration, be available for the sale of the Registrable Securities by the selling Holders thereof, (iii) shall comply as to form in all material respects with the requirements of the applicable form and include or incorporate by reference all financial statements required by the SEC to be filed therewith or incorporated by reference therein, and (iv) shall comply in all respects with the requirements of Regulation S-T under the 1933 Act, and use its commercially reasonable efforts to cause such Registration Statement to become effective and remain effective in accordance with Section 2 hereof; (b) prepare and file with the SEC such amendments and post-effective amendments to each Registration Statement as may be necessary under applicable law to keep such Registration Statement effective for the applicable period; and cause each Prospectus to be supplemented by any required prospectus supplement, and as so supplemented to be filed pursuant to Rule 424 (or any similar provision then in force) under the 1933 Act and comply with the provisions of the 1933 Act, the 1934 Act and the rules and regulations thereunder applicable to them with respect to the disposition of all securities covered by each Registration Statement during the applicable period in accordance with the intended method or methods of distribution by the selling Holders thereof (including sales by any Participating Broker-Dealer); (c) in the case of a Shelf Registration, (i) notify each Holder of Registrable Securities, at least five business days prior to filing, that a Shelf Registration Statement with respect to the Registrable Securities is being filed and advising such Holders that the distribution of Registrable Securities will be made in accordance with the method selected by the Majority Holders participating in the Shelf Registration; (ii) furnish to each Holder of Registrable Securities and to each underwriter of an underwritten offering of Registrable Securities, if any, without charge, as many copies of each Prospectus, including each preliminary Prospectus, and any amendment or supplement thereto and such other documents as such Holder or underwriter may reasonably request, including financial statements and schedules and, if the Holder so requests, all exhibits in order to facilitate the public sale or other disposition of the 12 Registrable Securities; and (iii) hereby consent to the use of the Prospectus, as amended or supplemented, in accordance with the terms and conditions of this Agreement by each of the selling Holders of Registrable Securities in connection with the offering and sale of the Registrable Securities covered by the Prospectus, as amended or supplemented; (d) use its commercially reasonable efforts to register or qualify the Registrable Securities under all applicable state securities or "blue sky" laws of such jurisdictions as any Holder of Registrable Securities covered by a Registration Statement and each underwriter of an underwritten offering of Registrable Securities shall reasonably request in writing by the time the applicable Registration Statement is declared effective by the SEC, and do any and all other acts and things which may be reasonably necessary or advisable to enable each such Holder and underwriter to consummate the disposition in each such jurisdiction of such Registrable Securities owned by such Holder; PROVIDED, HOWEVER, that the Company shall not be required to (i) qualify as a foreign corporation or as a dealer in securities in any jurisdiction where it would not otherwise be required to qualify but for this Section 3(d), or (ii) take any action which would subject it to general service of process or taxation in any such jurisdiction where it is not then so subject; (e) in the case of a Shelf Registration Statement, notify promptly each Holder of Registrable Securities or any Participating Broker-Dealer who has notified the Company that it is utilizing the Exchange Offer Registration Statement as provided in paragraph (f) below and, if requested by such Holder or Participating Broker-Dealer, confirm such advice in writing promptly (i) when a Registration Statement has become effective and when any post-effective amendments and supplements thereto become effective, (ii) of any request by the SEC or any state securities authority for post-effective amendments and supplements to a Registration Statement and Prospectus or for additional information after the Registration Statement has become effective, (iii) of the issuance by the SEC or any state securities authority of any stop order suspending the effectiveness of a Registration Statement or the initiation of any proceedings for that purpose, (iv) if, between the effective date of a Registration Statement and the closing of any sale of Registrable Securities covered thereby, the representations and warranties of the Company contained in any underwriting agreement, securities sales agreement or other similar agreement, if any, relating to the offering cease to be true and correct in all material respects, (v) of the happening of any event or the discovery of any facts during the period a Shelf Registration Statement is effective which makes any statement made in such Registration Statement or the related Prospectus untrue in any material respect or which requires the making of any changes in such Registration Statement or Prospectus in order to make the statements therein not misleading, (vi) of the receipt by the Company of any notification with respect to the suspension of the qualification of 13 the Registrable Securities or the Exchange Securities, as the case may be, for sale in any jurisdiction or the initiation or threatening of any proceeding for such purpose and (vii) of any determination by the Company that a post-effective amendment to such Registration Statement would be appropriate; (f) in the case of the Exchange Offer Registration Statement (i) include in the Exchange Offer Registration Statement a section entitled "Plan of Distribution" or similarly titled Section, which section shall be acceptable to Merrill Lynch on behalf of the Participating Broker-Dealers, and which shall contain a summary statement of the positions taken or policies made by the staff of the SEC with respect to the potential "underwriter" status of any broker-dealer that holds Registrable Securities acquired for its own account as a result of market-making activities or other trading activities and that will be the beneficial owner (as defined in Rule 13d-3 under the Exchange Act) of Exchange Securities to be received by such broker-dealer in the Exchange Offer, including a statement that any such broker-dealer who receives Exchange Securities for Securities pursuant to the Exchange Offer may be deemed a statutory underwriter and must deliver a prospectus meeting the requirements of the 1933 Act in connection with any resale of such Exchange Securities, (ii) furnish to each Participating Broker-Dealer who has delivered to the Company the notice referred to in Section 3(e), without charge, as many copies of each Prospectus included in the Exchange Offer Registration Statement, including any preliminary prospectus, and any amendment or supplement thereto, as such Participating Broker-Dealer may reasonably request, (iii) hereby consent to the use of the Prospectus, as amended or supplemented, in accordance with the terms and conditions of this Agreement by any Person subject to the prospectus delivery requirements of the SEC, including all Participating Broker-Dealers, in connection with the sale or transfer of the Exchange Securities covered by the Prospectus, as amended or supplemented, and (iv) include in the transmittal letter or similar documentation to be executed by an exchange offeree in order to participate in the Exchange Offer (x) the following provision (or any other provision requested by Merrill Lynch on behalf of the Participating Broker-Dealers with respect to similar matters): "If the exchange offeree is a broker-dealer holding Registrable Securities acquired for its own account as a result of market-making activities or other trading activities, it will deliver a prospectus meeting the requirements of the 1933 Act in connection with any resale of Exchange Securities received in respect of such Registrable Securities pursuant to the Exchange Offer;" and (y) a statement to the effect that by a broker-dealer making the acknowledgment described in clause (x) and by delivering a Prospectus in connection with the exchange 14 of Registrable Securities, the broker-dealer will not be deemed to admit that it is an underwriter within the meaning of the 1933 Act; (g) (i) in the case of an Exchange Offer, furnish counsel for the Initial Purchasers and (ii) in the case of a Shelf Registration, furnish counsel for the Holders of Registrable Securities copies of any comment letters received from the SEC or any other request by the SEC or any state securities authority for amendments or supplements to a Registration Statement and Prospectus or for additional information; (h) make reasonable efforts to obtain the withdrawal of any order suspending the effectiveness of a Registration Statement at the earliest possible moment; (i) in the case of a Shelf Registration, furnish upon request to each Holder of Registrable Securities, and each underwriter, if any, without charge, at least one conformed copy of each Registration Statement and any post-effective amendment thereto (without documents incorporated therein by reference and all exhibits thereto, unless requested); (j) in the case of a Shelf Registration, cooperate with the selling Holders of Registrable Securities to facilitate the timely preparation and delivery of a global certificate representing Registrable Securities to be sold and not bearing any restrictive legend; and if consistent with market practice enable such Registrable Securities to be in such denominations (consistent with the provisions of the Indenture) and registered in such names as the selling Holders or the underwriters, if any, may reasonably request at least three business days prior to the closing of any sale of Registrable Securities; (k) in the case of a Shelf Registration, upon the occurrence of any event or the discovery of any facts, each as contemplated by Sections 3(e)(v) and 3(e)(vi) hereof, as promptly as practicable after the occurrence of such an event, use its commercially reasonable efforts to prepare a supplement or post-effective amendment to the Registration Statement or the related Prospectus or any document incorporated therein by reference or file any other required document so that, as thereafter delivered to the purchasers of the Registrable Securities or Participating Broker-Dealers, such Prospectus will not contain at the time of such delivery any untrue statement of a material fact or omit to state a material fact necessary to make the statements therein, in light of the circumstances under which they were made, not misleading or will remain so qualified. At such time as such public disclosure is otherwise made or the Company determines that such disclosure is not necessary, in each case to correct any misstatement of a material fact or to include any omitted material fact, the Company agrees promptly to notify each Holder of such determination and to furnish each Holder 15 such number of copies of the Prospectus as amended or supplemented, as such Holder may reasonably request; (l) in the case of a Shelf Registration, a reasonable time prior to the filing of any Registration Statement, any Prospectus, any amendment to a Registration Statement or amendment or supplement to a Prospectus or any document which is to be incorporated by reference into a Registration Statement or a Prospectus after initial filing of a Registration Statement, provide copies of such document to the Initial Purchasers on behalf of such Holders; and make representatives of the Company as shall be reasonably requested by the Holders of Registrable Securities, or the Initial Purchasers on behalf of such Holders, available for discussion of such document; (m) obtain a CUSIP number for all Exchange Securities, Private Exchange Securities or Registrable Securities, as the case may be, not later than the effective date of a Registration Statement, and provide the Trustee with printed certificates for the Exchange Securities, Private Exchange Securities or the Registrable Securities, as the case may be, in a form eligible for deposit with the Depositary; (n) (i) cause the Indenture to be qualified under the Trust Indenture Act of 1939 (the "TIA") in connection with the registration of the Exchange Securities or Registrable Securities, as the case may be, (ii) cooperate with the Trustee and the Holders to effect such changes to the Indenture as may be required for the Indenture to be so qualified in accordance with the terms of the TIA and (iii) execute, and use its commercially reasonable efforts to cause the Trustee to execute, all documents as may be required to effect such changes, and all other forms and documents required to be filed with the SEC to enable the Indenture to be so qualified in a timely manner; (o) in the case of a Shelf Registration Statement for an underwritten offering, enter into customary agreements (including underwriting agreements) and take all other customary and appropriate actions in order to expedite or facilitate the disposition of such Registrable Securities and in such connection: (i) to the extent possible, make such representations and warranties to the Holders of such Registrable Securities and the underwriters, if any, in form, substance and scope as are customarily made by issuers to such holders and underwriters, as the case may be, in similar underwritten offerings as may be reasonably requested by them; (ii) obtain opinions of counsel to the Company and updates thereof (which counsel and opinions (in form, scope and substance) shall be reasonably satisfactory to the managing underwriters, addressed to each 16 selling Holder and the underwriters, if any, covering the matters customarily covered in opinions to such holders and underwriters, as the case may be, requested in sales of securities or underwritten offerings and such other matters as may be reasonably requested by such Holders and underwriters; (iii) obtain "cold comfort" letters and updates thereof from the Company's independent certified public accountants (and, if necessary, any other independent certified public accountants of any subsidiary of the Company or of any business acquired by the Company for which financial statements are, or are required to be, included in the Registration Statement) addressed to the underwriters, (to the extent consistent with Statement on Auditing Standards No. 72 of the American Institute of Certified Public Accounts), such letters to be in customary form and covering matters of the type customarily covered in "cold comfort" letters to underwriters in connection with similar underwritten offerings; (iv) if an underwriting agreement is entered into, cause the same to set forth indemnification provisions and procedures substantially equivalent to the indemnification provisions and procedures set forth in Section 4 hereof with respect to the underwriters and all other parties to be indemnified pursuant to said Section or, at the request of any underwriters, in the form customarily provided to such underwriters in similar types of transactions; and (v) deliver such documents and certificates as may be reasonably requested and as are customarily delivered in similar offerings to the Holders of a majority in principal amount of the Registrable Securities being sold and the managing underwriters, if any. The above shall be done at (i) the pricing of any underwritten offering or (ii) each closing under any underwriting or similar agreement as and to the extent required thereunder; (p) in the case of a Shelf Registration Statement for an underwritten offering or if a Prospectus is required to be delivered by any Participating Broker-Dealer in the case of an Exchange Offer, make available for inspection by representatives of the Holders of the Registrable Securities, any underwriters participating in any disposition pursuant to a Shelf Registration Statement, any Participating Broker-Dealer and any counsel or accountant retained by any of the foregoing, all financial and other records, pertinent corporate documents and properties of the Company reasonably requested by 17 any such persons, and cause the respective officers, directors, employees, and any other agents of the Company to supply all information reasonably requested by any such representative, underwriter, special counsel or accountant in connection with a Registration Statement, and make such representatives of the Company available for discussion of such documents as shall be reasonably requested by the Holders or their representatives; (q) in the case of a Shelf Registration, a reasonable time prior to filing any Shelf Registration Statement, any Prospectus forming a part thereof, any amendment to such Shelf Registration Statement or amendment or supplement to such Prospectus, provide copies of such document to counsel for the Holders and to the underwriter or underwriters of an underwritten offering of Registrable Securities, if any, make such changes in any such document prior to the filing thereof as the counsel to the Holders or the underwriter or underwriters reasonably request and not file any such document in a form to which the Majority Holders, counsel for the Holders of Registrable Securities or any underwriter shall not have previously been advised and furnished a copy of or to which the Majority Holders, the Initial Purchasers of behalf of the Holders of Registrable Securities, counsel to the Holders of Registrable Securities or any underwriter shall reasonably object, and make the representatives of the Company available for discussion of such document as shall be reasonably requested by the Holders of Registrable Securities, counsel for the Holders of Registrable Securities or any underwriter. (r) in the case of a Shelf Registration, use its commercially reasonable efforts to cause all Registrable Securities to be listed on any securities exchange on which similar debt securities issued by the Company are then listed if requested by the underwriter or underwriters of an underwritten offering of Registrable Securities, if any; (s) in the case of a Shelf Registration, use its commercially reasonable efforts to cause the Registrable Securities to be rated by the appropriate rating agencies, if requested by the underwriter or underwriters of an underwritten offering of Registrable Securities, if any; (t) otherwise comply with all applicable rules and regulations of the SEC and make available to its security holders, as soon as reasonably practicable, an earnings statement covering at least 12 months which shall satisfy the provisions of Section 11(a) of the 1933 Act and Rule 158 thereunder; and (u) cooperate and assist in any filings required to be made with the NASD and, in the case of a Shelf Registration, in the performance of any due diligence investigation by any underwriter and its counsel (including any "qualified independent 18 underwriter" that is required to be retained in accordance with the rules and regulations of the NASD). In the case of a Shelf Registration Statement, the Company may (as a condition to such Holder's participation in the Shelf Registration) require each Holder of Registrable Securities to furnish to the Company such information regarding the Holder and the proposed distribution by such Holder of such Registrable Securities as the Company may from time to time reasonably request in writing. In the case of a Shelf Registration Statement, each Holder agrees that, upon receipt of any notice from the Company of the happening of any event or the discovery of any facts, each of the kind described in Section 3(e)(v) hereof, such Holder will forthwith discontinue disposition of Registrable Securities pursuant to a Registration Statement until such Holder's receipt of the copies of the supplemented or amended Prospectus contemplated by Section 3(k) hereof, and, if so directed by the Company, such Holder will deliver to the Company (at its expense) all copies in such Holder's possession, other than permanent file copies then in such Holder's possession, of the Prospectus covering such Registrable Securities current at the time of receipt of such notice. If any of the Registrable Securities covered by any Shelf Registration Statement are to be sold in an underwritten offering, the underwriter or underwriters and manager or managers that will manage such offering will be selected by the Majority Holders of such Registrable Securities included in such offering and shall be acceptable to the Company. No Holder of Registrable Securities may participate in any underwritten registration hereunder unless such Holder (a) agrees to sell such Holder's Registrable Securities on the basis provided in any underwriting arrangements approved by the persons entitled hereunder to approve such arrangements and (b) completes and executes all questionnaires, powers of attorney, indemnities, underwriting agreements and other documents required under the terms of such underwriting arrangements. The Holders, as a group, will be permitted to effect two underwritten offerings pursuant to this Agreement; provided that, the first such underwritten offering must include at least $50.0 million of Registrable Securities and the second such underwritten offering must include at least $25.0 million of Registrable Securities and the Company must provide reasonable notice of such offerings to all Holders to enable them to participate in such offerings. 4. INDEMNIFICATION; CONTRIBUTION. (a) The Company agrees to indemnify and hold harmless the Initial Purchasers, each Holder, each Participating Broker-Dealer, each Person who participates 19 as an underwriter (any such Person being an "Underwriter") and each Person, if any, who controls any Holder or Underwriter within the meaning of Section 15 of the 1933 Act or Section 20 of the 1934 Act as follows: (i) against any and all loss, liability, claim, damage and expense whatsoever, as incurred, arising out of any untrue statement or alleged untrue statement of a material fact contained in any Registration Statement (or any amendment or supplement thereto) pursuant to which Exchange Securities or Registrable Securities were registered under the 1933 Act, including all documents incorporated therein by reference, or the omission or alleged omission therefrom of a material fact required to be stated therein or necessary to make the statements therein not misleading, or arising out of any untrue statement or alleged untrue statement of a material fact contained in any Prospectus (or any amendment or supplement thereto) or the omission or alleged omission therefrom of a material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading other than with respect to such untrue statements or alleged untrue statements of a material fact or the omission or alleged omission therefrom of a material fact necessary in order to make such statements therein, in light of the circumstances under which they were made not misleading, in the Registration Statement or Prospectus, as the case may be, furnished in writing by any Initial Purchaser, Holder of Participating Broker-Dealer to the Company in writing, for use in such Registration Statement or Prospectus, as the case may be; (ii) against any and all loss, liability, claim, damage and expense whatsoever, as incurred, to the extent of the aggregate amount paid in settlement of any litigation, or any investigation or proceeding by any governmental agency or body, commenced or threatened, or of any claim whatsoever based upon any such untrue statement or omission, or any such alleged untrue statement or omission; provided that (subject to Section 4(d) below) any such settlement is effected with the written consent of the Company; and (iii) against any and all expense whatsoever, as incurred (including the fees and disbursements of counsel chosen by any indemnified party), reasonably incurred in investigating, preparing or defending against any litigation, or any investigation or proceeding by any governmental agency or body, commenced or threatened, or any claim whatsoever based upon any such untrue statement or omission, or any such alleged untrue statement or omission, to the extent that any such expense is not paid under subparagraph (i) or (ii) above; 20 provided, however, that this indemnity agreement shall not apply to any loss, liability, claim, damage or expense to the extent arising out of any untrue statement or omission or alleged untrue statement or omission made in reliance upon and in conformity with written information furnished to the Company by any of the Holders or Underwriters expressly for use in a Registration Statement (or any amendment thereto) or any Prospectus (or any amendment or supplement thereto) and with respect to any Shelf Registration Statement, the indemnity contained herein this Section 4(a) shall not inure to the benefit of any Initial Purchaser, Holder or Participating Broker-Dealer from whom the person asserting any such losses, claims, damages or liabilities purchased the Securities concerned, to the extent that a Prospectus relating to such Securities was required to be delivered by such Initial Purchaser, Holder or Participating Broker-Dealer under the 1933 Act in connection with such purchase and any such loss, claim, damage or liability of such Initial Purchaser, Holder or Participating Broker-Dealer results solely from the fact that there was not sent or given to such person, at or prior to the written confirmation of the sale of such Securities to such person, a copy of the Prospectus which had been made available on a timely basis to the Initial Purchaser, Holder or Participating Broker-Dealer. (b) Each Holder severally, but not jointly, agrees to indemnify and hold harmless the Company, the Initial Purchasers, each Underwriter and the other selling Holders, and each of their respective directors and officers, and each Person, if any, who controls the Company, the Initial Purchasers, any Underwriter or any other selling Holder within the meaning of Section 15 of the 1933 Act or Section 20 of the 1934 Act, against any and all loss, liability, claim, damage and expense described in the indemnity contained in Section 4(a) hereof, as incurred, but only with respect to untrue statements or omissions, or alleged untrue statements or omissions, made in the Shelf Registration Statement (or any amendment thereto) or any Prospectus included therein (or any amendment or supplement thereto) in reliance upon and in conformity with written information with respect to such Holder furnished to the Company by such Holder expressly for use in the Shelf Registration Statement (or any amendment thereto) or such Prospectus (or any amendment or supplement thereto); PROVIDED, HOWEVER, that no such Holder shall be liable for any claims hereunder in excess of the amount of net proceeds received by such Holder from the sale of Registrable Securities pursuant to such Shelf Registration Statement. (c) Each indemnified party shall give notice in writing as promptly as reasonably practicable to each indemnifying party of any action or proceeding commenced against it in respect of which indemnity may be sought hereunder, but failure so to notify an indemnifying party shall not relieve such indemnifying party from any liability hereunder to the extent it is not materially prejudiced as a result thereof and in any event shall not relieve it from any liability which it may have otherwise than on 21 account of this indemnity agreement. An indemnifying party may participate at its own expense in the defense of such action; provided, however, that counsel to the indemnifying party shall not (except with the consent of the indemnified party) also be counsel to the indemnified party. In no event shall the indemnifying party or parties be liable for the fees and expenses of more than one counsel (in addition to any local counsel) separate from their own counsel for all indemnified parties in connection with any one action or separate but similar or related actions in the same jurisdiction arising out of the same general allegations or circumstances. No indemnifying party shall, without the prior written consent of the indemnified parties, settle or compromise or consent to the entry of any judgment with respect to any litigation, or any investigation or proceeding by any governmental agency or body, commenced or threatened, or any claim whatsoever in respect of which indemnification or contribution could be sought under this Section 4 (whether or not the indemnified parties are actual or potential parties thereto), unless such settlement, compromise or consent (i) includes an unconditional release of each indemnified party from all liability arising out of such litigation, investigation, proceeding or claim and (ii) does not include a statement as to or an admission of fault, culpability or a failure to act by or on behalf of any indemnified party. (d) If at any time an indemnified party shall have requested an indemnifying party to reimburse the indemnified party for fees and expenses of counsel, such indemnifying party agrees that it shall be liable for any settlement of the nature contemplated by Section 4(a)(ii) effected without its written consent if (i) such settlement is entered into more than 45 days after receipt by such indemnifying party of the aforesaid request, (ii) such indemnifying party shall have received notice of the terms of such settlement at least 30 days prior to such settlement being entered into and (iii) such indemnifying party shall not have reimbursed such indemnified party in accordance with such request prior to the date of such settlement; provided, that an indemnifying party shall not be liable for any such settlement effected without its consent if such indemnifying party (1) reimburses such indemnified party in accordance with such request to the extent it considers such request to be reasonable and (2) provides written notice to the indemnified party describing any unpaid balance it believes is unreasonable and the reasons therefore, in each case prior to the date of such settlement. (e) If the indemnification provided for in this Section 4 is for any reason unavailable to or insufficient to hold harmless an indemnified party in respect of any losses, liabilities, claims, damages or expenses referred to therein, then each indemnifying party shall contribute to the aggregate amount of such losses, liabilities, claims, damages and expenses incurred by such indemnified party, as incurred, in such proportion as is appropriate to reflect the relative fault of the Company on the one hand, the Initial Purchasers on a second hand and the Holders and Participating Broker-Dealers on a third 22 hand in connection with 82 the statements or omissions which resulted in such losses, liabilities, claims, damages or expenses, as well as any other relevant equitable considerations. The relative fault of the Company on the one hand and the Holders and the Initial Purchasers on the other hand shall be determined by reference to, among other things, whether any such untrue or alleged untrue statement of a material fact or omission or alleged omission to state a material fact relates to information supplied by the Company, the Holders or the Initial Purchasers and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. The Holders' obligations to contribute pursuant to this Section 4 are several in proportion to the aggregate principal amount at maturity of Registrable Securities of such Holder that were registered pursuant to the Registration Statement. The Company, the Holders and the Initial Purchasers agree that it would not be just and equitable if contribution pursuant to this Section 4 were determined by pro rata allocation (even if the Initial Purchasers were treated as one entity for such purpose) or by any other method of allocation which does not take account of the equitable considerations referred to above in this Section 4. The aggregate amount of losses, liabilities, claims, damages and expenses incurred by an indemnified party and referred to above in this Section 4 shall be deemed to include any legal or other expenses reasonably incurred by such indemnified party in investigating, preparing or defending against any litigation, or any investigation or proceeding by any governmental agency or body, commenced or threatened, or any claim whatsoever based upon any such untrue or alleged untrue statement or omission or alleged omission. Notwithstanding the provisions of this Section 4, no Initial Purchaser shall be required to contribute any amount in excess of the amount by which the total price at which the Securities sold by it were offered exceeds the amount of any damages which such Initial Purchaser has otherwise been required to pay by reason of such untrue or alleged untrue statement or omission or alleged omission. No Person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the 1933 Act) shall be entitled to contribution from any Person who was not guilty of such fraudulent misrepresentation. For purposes of this Section 4, each Person, if any, who controls an Initial Purchaser or Holder within the meaning of Section 15 of the 1933 Act or Section 20 of the 1934 Act shall have the same rights to contribution as such Initial Purchaser or Holder, and each director of the Company, and each Person, if any, who controls the Company within the meaning of Section 15 of the 1933 Act or Section 20 of the 1934 Act shall have the same rights to contribution as the Company. The Initial Purchasers' 23 respective obligations to contribute pursuant to this Section 7 are several in proportion to the principal amount of Securities set forth opposite their respective names in Schedule A to the Purchase Agreement and not joint. 5. MISCELLANEOUS. 5.1. RULE 144 AND RULE 144A. For so long as the Company is subject to the reporting requirements of Section 13 or 15 of the 1934 Act, the Company covenants that it will file the reports required to be filed by it under the 1933 Act and Section 13(a) or 15(d) of the 1934 Act and the rules and regulations adopted by the SEC thereunder. If the Company ceases to be so required to file such reports, the Company covenants that it will upon the request of any Holder of Registrable Securities (a) make publicly available such information as is necessary to permit sales pursuant to Rule 144 under the 1933 Act, (b) deliver such information to a prospective purchaser as is necessary to permit sales pursuant to Rule 144A under the 1933 Act and it will take such further action as any Holder of Registrable Securities may reasonably request, and (c) take such further action that is reasonable in the circumstances, in each case, to the extent required from time to time to enable such Holder to sell its Registrable Securities without registration under the 1933 Act within the limitation of the exemptions provided by (i) Rule 144 under the 1933 Act, as such Rule may be amended from time to time, (ii) Rule 144A under the 1933 Act, as such Rule may be amended from time to time, or (iii) any similar rules or regulations hereafter adopted by the SEC. Upon the request of any Holder of Registrable Securities, the Company will deliver to such Holder a written statement as to whether it has complied with such requirements. 5.2. NO INCONSISTENT AGREEMENTS. The Company has not entered into and the Company will not after the date of this Agreement enter into any agreement which is inconsistent with the rights granted to the Holders of Registrable Securities in this Agreement or otherwise conflicts with the provisions hereof. The rights granted to the Holders hereunder do not and will not for the term of this Agreement in any way conflict with the rights granted to the holders of the Company's other issued and outstanding securities under any such agreements. 5.3. AMENDMENTS AND WAIVERS. The provisions of this Agreement, including the provisions of this sentence, may not be amended, modified or supplemented, and waivers or consents to departures from the provisions hereof may not be given unless the Company has obtained the written consent of Holders of at least a majority in aggregate principal amount of the outstanding Registrable Securities affected by such amendment, modification, supplement, waiver or departure. 5.4. NOTICES. All notices and other communications provided for or permitted hereunder shall be made in writing by hand delivery, registered first-class 24 mail, telex, telecopier, or any courier guaranteeing overnight delivery (a) if to a Holder, at the most current address given by such Holder to the Company by means of a notice given in accordance with the provisions of this Section 5.4, which address initially is the address set forth in the Purchase Agreement with respect to the Initial Purchasers; and (b) if to the Company, initially at the Company's address set forth in the Purchase Agreement, and thereafter at such other address of which notice is given in accordance with the provisions of this Section 5.4. All such notices and communications shall be deemed to have been duly given: at the time delivered by hand, if personally delivered; two business days after being deposited in the mail, postage prepaid, if mailed; when answered back, if telexed; when receipt is acknowledged, if telecopied; and on the next business day if timely delivered to an air courier guaranteeing overnight delivery. Copies of all such notices, demands, or other communications shall be concurrently delivered by the person giving the same to the Trustee under the Indenture, at the address specified in such Indenture. 25 5.5. SUCCESSOR AND ASSIGNS. This Agreement shall inure to the benefit of and be binding upon the successors, assigns and transferees of each of the parties, including, without limitation and without the need for an express assignment, subsequent Holders; provided that nothing herein shall be deemed to permit any assignment, transfer or other disposition of Registrable Securities in violation of the terms of the Purchase Agreement or the Indenture. If any transferee of any Holder shall acquire Registrable Securities, in any manner, whether by operation of law or otherwise, such Registrable Securities shall be held subject to all of the terms of this Agreement, and by taking and holding such Registrable Securities such person shall be conclusively deemed to have agreed to be bound by and to perform all of the terms and provisions of this Agreement, including the restrictions on resale set forth in this Agreement and, if applicable, the Purchase Agreement, and such person shall be entitled to receive the benefits hereof. 5.6. THIRD PARTY BENEFICIARIES. The Initial Purchasers (even if the Initial Purchasers are not Holders of Registrable Securities) shall be third party beneficiaries to the agreements made hereunder between the Company, on the one hand, and the Holders, on the other hand, and shall have the right to enforce such agreements directly to the extent they deem such enforcement necessary or advisable to protect their rights or the rights of Holders hereunder. Each Holder of Registrable Securities shall be a third party beneficiary to the agreements made hereunder between the Company, on the one hand, and the Initial Purchasers, on the other hand, and shall have the right to enforce such agreements directly to the extent it deems such enforcement necessary or advisable to protect its rights hereunder. 5.7. SPECIFIC ENFORCEMENT. Without limiting the remedies available to the Initial Purchasers and the Holders, the Company acknowledges that any failure by the Company to comply with its obligations under Sections 2.1 through 2.4 hereof may result in material irreparable injury to the Initial Purchasers or the Holders for which there is no adequate remedy at law, that it would not be possible to measure damages for such injuries precisely and that, in the event of any such failure, the Initial Purchasers or any Holder may obtain such relief as may be required to specifically enforce the Company's obligations under Sections 2.1 through 2.4 hereof. 5.8. RESTRICTION ON RESALES. Until the expiration of two years after the original issuance of the Securities, the Company will not, and will cause its "affiliates" (as such term is defined in Rule 144(a)(1) under the 1933 Act) not to, resell any Securities which are "restricted securities" (as such term is defined under Rule 144(a)(3) under the 1933 Act) that have been reacquired by any of them. 5.9. COUNTERPARTS. This Agreement may be executed in any number of counterparts and by the parties hereto in separate counterparts, each of which when 26 so executed shall be deemed to be an original and all of which taken together shall constitute one and the same agreement. 5.10. HEADINGS. The headings in this Agreement are for convenience of reference only and shall not limit or otherwise affect the meaning hereof. 5.11. GOVERNING LAW. THIS AGREEMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAW OF THE STATE OF NEW YORK WITHOUT REGARD TO THE PRINCIPLES OF CONFLICT OF LAWS THEREOF. 5.12. SEVERABILITY. In the event that any one or more of the provisions contained herein, or the application thereof in any circumstance, is held invalid, illegal or unenforceable, the validity, legality and enforceability of any such provision in every other respect and of the remaining provisions contained herein shall not be affected or impaired thereby. 27 IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first written above. MICHAELS STORES, INC. By: /s/ Bryan M. DeCordova ----------------------------------- Name: Bryan M. DeCordova Title: Executive Vice President- Chief Financial Officer Confirmed and accepted as of the date first above written: MERRILL LYNCH, PIERCE, FENNER & SMITH INCORPORATED CREDIT SUISSE FIRST BOSTON CORPORATION DEUTSCHE BANC ALEX. BROWN INC. FLEET SECURITIES, INC. WELLS FARGO BROKERAGE SERVICES, LLC BY: MERRILL LYNCH, PIERCE, FENNER & SMITH INCORPORATED By: /s/ Barry Price --------------------------------------- Name: Barry Price Title: Director 28 EX-5.1 6 a2055355zex-5_1.txt EXHIBIT 5.1 EXHIBIT 5.1 JONES, DAY, REAVIS & POGUE 2727 NORTH HARWOOD STREET DALLAS, TEXAS 75201-1515 TELEPHONE: 214-220-3939 August 1, 2001 Michaels Stores, Inc. 8000 Bent Branch Drive Irving, Texas 75063 Ladies and Gentlemen: We are acting as counsel to Michaels Stores, Inc. (the "Company"), a corporation organized under the laws of the State of Delaware, in connection with (i) the offer to exchange (the "Senior Note Exchange Offer") $1,000 principal amount at maturity of the Company's 9 1/4% Senior Notes due 2009 (the "Exchange Notes") for each $1,000 principal amount at maturity of the Company's outstanding 9 1/4% Senior Notes due 2009 (the "Private Notes") and (ii) the preparation of the prospectus (the "Prospectus") contained in the registration statement on Form S-4 (the "Registration Statement") filed on this date with the Securities and Exchange Commission by the Company for the purpose of registering the Exchange Notes under the Securities Act of 1933 (the "Act"). The Private Notes have been, and the Exchange Notes will be, issued pursuant to an Indenture, dated as of July 6, 2001 (the "Indenture"), between the Company and The Bank of New York, as Trustee. We have examined originals or copies, certified or otherwise identified to our satisfaction, of such corporate records, agreements, documents, and other instruments and such certificates or comparable documents of public officials and representatives of the Company and have made such other and further investigations as we have deemed relevant and necessary as a basis for the opinions hereinafter set forth. In such examination, we have assumed the genuineness of all signatures, the legal capacity of natural persons, the authenticity of all documents submitted to us as originals, the conformity to original documents of all documents submitted to us as certified or photostatic copies and the authenticity of the originals of such latter documents. Based on the foregoing, and subject to the qualifications and limitations stated herein, we are of the opinion that when (i) the Exchange Notes, substantially in the form as set forth on an exhibit to the Indenture filed as Exhibit 4.3 to the Registration Statement, have been duly executed by the Company and authenticated by the Trustee in accordance with the Indenture and duly delivered in exchange for the Private Notes in accordance with the Senior Note Exchange Offer in the manner described in the Registration Statement and (ii) the Indenture has been qualified under the Trust Indenture Act of 1939, as amended, the Exchange Notes will constitute valid and legally binding obligations of the Company enforceable in accordance with their terms, under the laws of the State of New York which are expressed to govern the Exchange Notes, except to the extent enforceability may be limited by bankruptcy, insolvency, fraudulent conveyance, reorganization, moratorium and other similar laws relating to or affecting creditors' rights generally and general equitable principles (whether considered in a proceeding in equity or at law). This opinion is limited to the laws of the State of New York and the Delaware General Corporation Law. We hereby consent to the use of our name under the caption "Legal Matters" in the Prospectus forming part of the Registration Statement and to the filing of this opinion as Exhibit 5 to the Registration Statement. Very truly yours, /s/ Jones, Day, Reavis & Pogue EX-12.1 7 a2055355zex-12_1.txt EXHIBIT 12.1 EXHIBIT 12.1 MICHAELS STORES, INC. RATIO OF EARNINGS TO FIXED CHARGES (IN THOUSANDS)
FISCAL YEARS ----------------------------------------------------- 1996(1) 1997 1998 1999(2) 2000(3) -------- -------- -------- -------- -------- INCOME (LOSS) BEFORE INCOME TAXES $(41,073) $ 48,507 $ 70,324 $102,391 $134,069 Fixed charges: Interest on senior notes due 2006 8,217 13,594 13,594 13,594 13,594 Interest on subordinated notes due 2003 5,962 5,962 5,962 5,962 2,522 Amortization of senior notes deferred costs 253 447 447 452 451 Amortization of subordinated notes deferred costs 323 318 318 317 134 Other interest expense 6,283 3,127 2,357 2,329 1,325 Rental expense interest factor 38,943 40,175 46,871 59,958 75,019 -------- -------- -------- -------- -------- 59,981 63,623 69,549 82,612 93,045 -------- -------- -------- -------- -------- Adjusted income (loss) before taxes $ 18,908 $112,130 $139,873 $185,003 $227,114 ======== ======== ======== ======== ======== RATIO OF EARNINGS TO FIXED CHARGES 0.32 1.76 2.01 2.24 2.44 12 MONTHS ENDED Q1, 00(3) Q1, 01(4) MAY 5, 2001(4) -------- -------- ------------- INCOME (LOSS) BEFORE INCOME TAXES $16,807 $12,354 $129,616 Fixed charges: Interest on senior notes due 2006 3,398 3,398 13,594 Interest on subordinated notes due 2003 1,490 -0 1,032 Amortization of senior notes deferred costs 114 112 449 Amortization of subordinated notes deferred costs 79 -0 55 Other interest expense 439 268 1,154 Rental expense interest factor 18,755 22,554 78,819 -------- -------- ------------- 24,275 26,332 95,103 -------- -------- ------------- Adjusted income (loss) before taxes $41,082 $38,686 $224,719 ======== ======== ============= RATIO OF EARNINGS TO FIXED CHARGES 1.69 1.47 2.36
(1) Fiscal 1996 income before income taxes includes the effect of an unusual pre-tax charge of $41.2 million for costs associated with the sale to liquidate merchandise that was eliminated following store resets, markdowns on discontinued furniture and other home decor merchandise, and reserves for the closure of four stores and the write-down of leasehold improvements in three stores. (2) Fiscal 1999 includes a charge of $1.5 million in connection with the settlement of the MJDesigns litigation. (3) Fiscal 2000 and the first quarter of fiscal 2000 exclude the cumulative effect of a change in accounting principle in the amount of $3.1 million. (4) The first quarter of fiscal 2001 and the 12 months ended May 5, 2001 includes $1.0 million for senior executive severance and $3.2 million for a litigation settlement on the Raniwala case. EX-23.1 8 a2055355zex-23_1.txt EXHIBIT 23.1 EXHIBIT 23.1 We consent to the reference to our firm under the caption "Experts" and to the use of our report dated March 5, 2001, in the Registration Statement (Form S-4) and related Prospectus of Michaels Stores, Inc. dated August 1, 2001. /s/ Ernst & Young, LLP Dallas, Texas July 26, 2001 EX-24.1 9 a2055355zex-24_1.txt EXHIBIT 24.1 EXHIBIT 24.1 DIRECTOR AND/OR OFFICERS OF MICHAELS STORES, INC. REGISTRATION STATEMENT ON FORM S-4 POWER OF ATTORNEY The undersigned directors and/or officers of Michaels Stores, Inc., a Delaware corporation (the "Corporation"), hereby constitute and appoint R. Michael Rouleau, Bryan M. DeCordova and Mark V. Beasley, and each of them, with full power of substitution and resubstitution, as attorneys-in-fact or attorney-in-fact of the undersigned, for him or her and in his or her name, place and stead, to sign and file with the Securities and Exchange Commission under the Securities Act of 1933 (the "Securities Act") one or more Registration Statement(s) on Form S-4 relating to the registration of the Corporation's 9 1/4% Senior Notes due 2009 with any and all amendments, supplements and exhibits thereto, including pre-effective and post-effective amendments or supplements, with full power and authority to do and perform any and all acts and things whatsoever required, necessary or desirable to be done in the premises, hereby ratifying and approving the act of said attorneys and any of them and any such substitute. EXECUTED as of July 30, 2001. /s/ R. Michael Rouleau - ---------------------------------------------------- ----------------------------- R. Michael Rouleau Richard E. Hanlon President, Chief Executive Officer and Director Director (Principal Executive Officer) /s/ Charles J. Wyly, Jr. /s/ Richard C. Marcus - ---------------------------------------------------- ----------------------------- Charles J. Wyly, Jr. Richard C. Marcus Chairman of the Board of Directors Director /s/ Sam Wyly - ---------------------------------------------------- ----------------------------- Sam Wyly Elizabeth A. VanStory Vice Chairman of the Board of Directors Director /s/ Bryan M. DeCordova - ---------------------------------------------------- Bryan M. DeCordova Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)
EX-25.1 10 a2055355zex-25_1.txt EXHIBIT 25.1 Exhibit 25.1 = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = FORM T-1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 STATEMENT OF ELIGIBILITY UNDER THE TRUST INDENTURE ACT OF 1939 OF A CORPORATION DESIGNATED TO ACT AS TRUSTEE CHECK IF AN APPLICATION TO DETERMINE ELIGIBILITY OF A TRUSTEE PURSUANT TO SECTION 305(b)(2) |__| --------------------------- THE BANK OF NEW YORK (Exact name of trustee as specified in its charter) New York 13-5160382 (State of incorporation (I.R.S. employer if not a U.S. national bank) identification no.) One Wall Street, New York, N.Y. 10286 (Address of principal executive offices) (Zip code) --------------------------- MICHAELS STORES, INC. (Exact name of obligor as specified in its charter) Delaware 75-1943604 (State or other jurisdiction of (I.R.S. employer incorporation or organization) identification no.) 8000 Bent Branch Drive Irving, Texas 75063 P.O. Box 619566 DFW, Texas 75261-9566 (Address of principal executive offices) (Zip code) --------------------------- 9-1/4% Senior Notes Due 2009 (Title of the indenture securities) = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = 1. GENERAL INFORMATION. FURNISH THE FOLLOWING INFORMATION AS TO THE TRUSTEE: (a) NAME AND ADDRESS OF EACH EXAMINING OR SUPERVISING AUTHORITY TO WHICH IT IS SUBJECT. - -------------------------------------------------------------------------------- Name Address - -------------------------------------------------------------------------------- Superintendent of Banks of the 2 Rector Street, New York, N.Y. State of New York 10006, and Albany, N.Y. 12203 Federal Reserve Bank of New York 33 Liberty Plaza, New York, N.Y. 10045 Federal Deposit Insurance Corporation Washington, D.C. 20429 New York Clearing House Association New York, New York 10005 (b) WHETHER IT IS AUTHORIZED TO EXERCISE CORPORATE TRUST POWERS. Yes. 2. AFFILIATIONS WITH OBLIGOR. IF THE OBLIGOR IS AN AFFILIATE OF THE TRUSTEE, DESCRIBE EACH SUCH AFFILIATION. None. 16. LIST OF EXHIBITS. EXHIBITS IDENTIFIED IN PARENTHESES BELOW, ON FILE WITH THE COMMISSION, ARE INCORPORATED HEREIN BY REFERENCE AS AN EXHIBIT HERETO, PURSUANT TO RULE 7a-29 UNDER THE TRUST INDENTURE ACT OF 1939 (THE "ACT") AND 17 C.F.R. 229.10(d). 1. A copy of the Organization Certificate of The Bank of New York (formerly Irving Trust Company) as now in effect, which contains the authority to commence business and a grant of powers to exercise corporate trust powers. (Exhibit 1 to Amendment No. 1 to Form T-1 filed with Registration Statement No. 33-6215, Exhibits 1a and 1b to Form T-1 filed with Registration Statement No. 33-21672 and Exhibit 1 to Form T-1 filed with Registration Statement No. 33-29637.) 4. A copy of the existing By-laws of the Trustee. (Exhibit 4 to Form T-1 filed with Registration Statement No. 33-31019.) 6. The consent of the Trustee required by Section 321(b) of the Act. (Exhibit 6 to Form T-1 filed with Registration Statement No. 33-44051.) 7. A copy of the latest report of condition of the Trustee published pursuant to law or to the requirements of its supervising or examining authority. - 2 - SIGNATURE Pursuant to the requirements of the Act, the Trustee, The Bank of New York, a corporation organized and existing under the laws of the State of New York, has duly caused this statement of eligibility to be signed on its behalf by the undersigned, thereunto duly authorized, all in The City of New York, and State of New York, on the 24th day of July, 2001. THE BANK OF NEW YORK By: /s/ THOMAS E. TABOR ---------------------- Name: THOMAS E. TABOR Title: VICE PRESIDENT - 3 - EXHIBIT 7 - ------------------------------------------------------------------------------- Consolidated Report of Condition of THE BANK OF NEW YORK of One Wall Street, New York, N.Y. 10286 And Foreign and Domestic Subsidiaries, a member of the Federal Reserve System, at the close of business March 31, 2001, published in accordance with a call made by the Federal Reserve Bank of this District pursuant to the provisions of the Federal Reserve Act.
Dollar Amounts ASSETS In Thousands Cash and balances due from depository institutions: Noninterest-bearing balances and currency and coin.......................................... $2,811,275 Interest-bearing balances........................... 3,133,222 Securities: Held-to-maturity securities......................... 147,185 Available-for-sale securities....................... 5,403,923 Federal funds sold and Securities purchased under agreements to resell................................ 3,378,526 Loans and lease financing receivables: Loans and leases held for sale...................... 74,702 Loans and leases, net of unearned income............................................ 37,471,621 LESS: Allowance for loan and lease losses...................................... 599,061 Loans and leases, net of unearned income and allowance.............................. 36,872,560 Trading Assets......................................... 11,757,036 Premises and fixed assets (including capitalized leases)............................................. 768,795 Other real estate owned................................ 1,078 Investments in unconsolidated subsidiaries and associated companies................................ 193,126 Customers' liability to this bank on acceptances outstanding......................................... 592,118 Intangible assets...................................... Goodwill............................................ 1,300,295 Other intangible assets............................. 122,143 Other assets........................................... 3,676,375 ----------- Total assets........................................... $70,232,359 =========== LIABILITIES Deposits: In domestic offices................................. $25,962,242 Noninterest-bearing.......................10,586,346 Interest-bearing..........................15,395,896 In foreign offices, Edge and Agreement subsidiaries, and IBFs............................ 24,862,377 Noninterest-bearing..........................373,085 Interest-bearing..........................24,489,292 Federal funds purchased and securities sold under agreements to repurchase............................ 1,446,874 Trading liabilities.................................... 2,373,361 Other borrowed money: (includes mortgage indebtedness and obligations under capitalized leases)........................... 1,381,512 Bank's liability on acceptances executed and outstanding......................................... 592,804 Subordinated notes and debentures...................... 1,646,000 Other liabilities...................................... 5,373,065 ----------- Total liabilities...................................... $63,658,235 =========== EQUITY CAPITAL Common stock........................................... 1,135,284 Surplus................................................ 1,008,773 Retained earnings...................................... 4,426,033 Accumulated other comprehensive income................. 4,034 Other equity capital components........................ 0 Total equity capital................................... 6,574,124 ----------- Total liabilities and equity capital................... $70,232,359 ===========
I, Thomas J. Mastro, Senior Vice President and Comptroller of the above-named bank do hereby declare that this Report of Condition has been prepared in conformance with the instructions issued by the Board of Governors of the Federal Reserve System and is true to the best of my knowledge and belief. Thomas J. Mastro, Senior Vice President and Comptroller We, the undersigned directors, attest to the correctness of this Report of Condition and declare that it has been examined by us and to the best of our knowledge and belief has been prepared in conformance with the instructions issued by the Board of Governors of the Federal Reserve System and is true and correct. __ Thomas A. Renyi | Gerald L. Hassell | Directors Alan R. Griffith __| - ----------------------------------------------------------------------------- EX-99.1 11 a2055355zex-99_1.txt EXHIBIT 99.1 EXHIBIT 99.1 THE EXCHANGE OFFER WILL EXPIRE AT 5:00 P.M., NEW YORK CITY TIME, ON , 2001 UNLESS EXTENDED (THE "EXPIRATION DATE"). LETTER OF TRANSMITTAL OFFER TO EXCHANGE 9 1/4% SENIOR NOTES DUE 2009, WHICH HAVE BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, FOR ANY AND ALL OUTSTANDING 9 1/4% SENIOR NOTES DUE 2009 OF MICHAELS STORES, INC. DELIVER TO: THE BANK OF NEW YORK, EXCHANGE AGENT By Registered or Certified Mail: By Hand or Overnight Delivery: Facsimile Transmission Number: The Bank of New York The Bank of New York (For Eligible Institutions 101 Barclay Street, 7E 101 Barclay Street Only) New York, New York 10286 Corporate Trust Services Window (212) 815-6339 Attention: Diane Amorroso Ground Level Reorganization Section Attention: Diane Amorroso Confirm Receipt of Facsimile Reorganization Section by Telephone (212) 815-3738
Your delivery of this letter of transmittal will not be valid unless you deliver it to one of the addresses, or transmit it to the facsimile number, set forth above. Please carefully read this entire document, including the instructions, before completing this letter of transmittal. DO NOT DELIVER THIS LETTER OF TRANSMITTAL TO MICHAELS. By completing this letter of transmittal, you acknowledge that you have received and reviewed our prospectus dated July , 2001 and this letter of transmittal, which together constitute the "Exchange Offer." This letter of transmittal and the prospectus have been delivered to you in connection with Michaels' offer to exchange $1,000 in principal amount at maturity of its 9 1/4% Senior Notes due 2009, which have been registered under the Securities Act (the "Exchange Notes") for $1,000 in principal amount at maturity of its outstanding 9 1/4% Senior Notes due 2009 (the "Outstanding Notes"). $200,000,000 in principal amount of the Outstanding Notes are currently issued and outstanding. Michaels reserves the right, at any time or from time to time, to extend this exchange offer at its discretion, in which event the Expiration Date will mean the latest date to which the offer exchange is extended. This letter of transmittal is to be completed by Holder (this term is defined below) of Outstanding Notes if: (1) the Holder is delivering certificates for Outstanding Notes with this document, or (2) the tender of certificates for Outstanding Notes will be made by book-entry transfer to the account maintained by The Bank of New York, the exchange agent for these notes, at the Depository Trust Company ("DTC") according to the procedures described in the prospectus under the heading "The Exchange Offer--Procedures for Tendering." Please note that delivery of documents required by this letter of transmittal to DTC does not constitute delivery to the exchange agent. You must tender your Outstanding Notes according to the guaranteed delivery procedures described in this document if: (1) your Outstanding Notes are not immediately available, (2) you cannot deliver your Outstanding Notes, this letter of transmittal and all required documents to the exchange agent before on or before the Expiration Date, or (3) you are unable to obtain confirmation of a book-entry tender of your Outstanding Notes into the exchange agent's account at DTC on or before the Expiration Date. More complete information about guaranteed delivery procedures is contained in the prospectus under the heading "The Exchange Offer--Guaranteed Delivery Procedures." You should also read Instruction 1 to determine whether or not this section applies to you. As used in this letter of transmittal, the term "Holder" means (1) any person in whose name Outstanding Notes are registered on the books of Michaels Stores, (2) any other person who has obtained a properly executed bond power from the registered Holder or (3) any person whose Outstanding Notes are held of record by DTC who desires to deliver such notes by book-entry transfer at DTC. If you decide to tender your Outstanding Notes, you must complete this entire letter of transmittal. YOU MUST FOLLOW THE INSTRUCTIONS IN THIS LETTER OF TRANSMITTAL--PLEASE READ THIS ENTIRE DOCUMENT CAREFULLY. IF YOU HAVE QUESTIONS OR NEED HELP, OR IF YOU WOULD LIKE ADDITIONAL COPIES OF THE PROSPECTUS AND THIS LETTER OF TRANSMITTAL, YOU SHOULD CONTACT THE EXCHANGE AGENT AT [PHONE] OR AT ITS ADDRESS SET FORTH ABOVE. Please describe your Outstanding Notes below.
- --------------------------------------------------------------------------------------------------------- DESCRIPTION OF OUTSTANDING NOTES - --------------------------------------------------------------------------------------------------------- AGGREGATE PRINCIPAL AMOUNT OF PRINCIPAL AMOUNT NAME(S) AND OUTSTANDING OF ADDRESS(ES) OF NOTES OUTSTANDING REGISTERED HOLDER(S) CERTIFICATE REPRESENTED BY NOTES (PLEASE COMPLETE, IF BLANK) NUMBER(S) CERTIFICATE(S) TENDERED* - --------------------------------------------------------------------------------------------------------- -------------------------------------------- -------------------------------------------- -------------------------------------------- -------------------------------------------- -------------------------------------------- -------------------------------------------- TOTAL - ---------------------------------------------------------------------------------------------------------
* You will be deemed to have tendered the entire principal amount of Outstanding Notes represented in the column labeled "Aggregate Principal Amount of Outstanding Notes Represented by Certificate(s)" unless you indicate otherwise in the column labeled "Principal Amount of Outstanding Notes Tendered." 3 If you need more space, list the certificate numbers and principal amount of Outstanding Notes on a separate schedule, sign the schedule and attach it to this letter of transmittal. [ ] CHECK HERE IF YOU HAVE ENCLOSED OUTSTANDING NOTES WITH THIS LETTER OF TRANSMITTAL. [ ] CHECK HERE IF YOU WILL BE TENDERING OUTSTANDING NOTES BY BOOK-ENTRY TRANSFER MADE TO THE EXCHANGE AGENT'S ACCOUNT AT DTC. COMPLETE THE FOLLOWING ONLY IF YOU ARE AN ELIGIBLE INSTITUTION (THIS TERM IS DEFINED BELOW): Name of Tendering Institution: _________________________________________________ Account Number: ________________________________________________________________ Transaction Code Number: _______________________________________________________ [ ] CHECK HERE IF YOU ARE DELIVERING TENDERED OUTSTANDING NOTES THROUGH A NOTICE OF GUARANTEED DELIVERY AND HAVE ENCLOSED THAT NOTICE WITH THIS LETTER OF TRANSMITTAL. COMPLETE THE FOLLOWING ONLY IF YOU ARE AN ELIGIBLE INSTITUTION: Name(s) of Registered Holder(s) of Outstanding Notes: __________________________ ________________________________________________________________________________ Date of Execution of Notice of Guaranteed Delivery: ____________________________ ________________________________________________________________________________ Window Ticket Number (if available): ___________________________________________ ________________________________________________________________________________ Name of Institution that Guaranteed Delivery: __________________________________ ________________________________________________________________________________ Account Number (if delivered by book-entry transfer): __________________________ ________________________________________________________________________________ 4 - ------------------------------------------- SPECIAL ISSUANCE INSTRUCTIONS (SEE INSTRUCTIONS 4, 5 AND 6) Complete this section ONLY if: (1) certificates for untendered Outstanding Notes are to be issued in the name of someone other than you; (2) certificates for Exchange Notes issued in exchange for tendered and accepted Outstanding Notes are to be issued in the name of someone other than you; or (3) Outstanding Notes tendered by book-entry transfer that are not exchanged are to be returned by credit to an account maintained at DTC. Issue Certificate(s) to: Name _______________________________________________________________________ (PLEASE PRINT) Address ____________________________________________________________________ ____________________________________________________________________________ ____________________________________________________________________________ (INCLUDE ZIP CODE) ________________________________________________________________________ (TAXPAYER IDENTIFICATION OR SOCIAL SECURITY NUMBER) - ------------------------------------------------------------------------ - ------------------------------------------------------------------------ SPECIAL DELIVERY INSTRUCTIONS (SEE INSTRUCTIONS 4, 5 AND 6) Complete this section ONLY if certificates for untendered Outstanding Notes, or Exchange Notes issued in exchange for tendered and accepted Outstanding Notes are to be sent to someone other than you, or to you at an address other than the address shown above. Mail and deliver Certificate(s) to: Name _______________________________________________________________________ (PLEASE PRINT) Address ____________________________________________________________________ ____________________________________________________________________________ ____________________________________________________________________________ (INCLUDE ZIP CODE) - ---------------------------------------------------------------------- (PLEASE ALSO COMPLETE SUBSTITUTE FORM W-9) 5 Ladies and Gentlemen: According to the terms and conditions of the Exchange Offer, I hereby tender to Michaels Stores, Inc. the principal amount of Outstanding Notes indicated above. At the time these notes are accepted by Michaels, and exchanged for the same principal amount of Exchange Notes, I will sell, assign, and transfer to Michaels all right, title and interest in and to the Outstanding Notes I have tendered. I am aware that the exchange agent also acts as the agent of Michaels. By executing this document, I irrevocably appoint the exchange agent as my agent and attorney-in-fact for the tendered Outstanding Notes with full power of substitution to: 1. deliver certificates for the Outstanding Notes, or transfer ownership of the Outstanding Notes on the account books maintained by DTC, to Michaels and deliver all accompanying evidences of transfer and authenticity to Michaels, and 2. present the Outstanding Notes for transfer on the books of Michaels, receive all benefits and exercise all rights of beneficial ownership of these Outstanding Notes, according to the terms of the Exchange Offer. The power of attorney granted in this paragraph is irrevocable and coupled with an interest. I represent and warrant that I have full power and authority to tender, sell, assign, and transfer the Outstanding Notes that I am tendering. I represent and warrant that Michaels will acquire good and unencumbered title to the Outstanding Notes, free and clear of all liens, restrictions, charges and encumbrances and that the Outstanding Notes will not be subject to any adverse claim at the time Michaels acquires them. I further represent that: 1. any Exchange Notes I will acquire in exchange for the Outstanding Notes I have tendered will be acquired in the ordinary course of business; 2. I have not engaged in, do not intend to engage in, and have no arrangement with any person to engage in, a distribution of any Exchange Notes issued to me; and 3. I am not an "affiliate" (as defined in Rule 405 under the Securities Act) of Michaels Stores, Inc. I understand that the Exchange Offer is being made in reliance on interpretations contained in letters issued to third parties by the staff of the Securities and Exchange Commission ("Commission"). These letters provide that the Exchange Notes issued in exchange for the Outstanding Notes in the Exchange Offer may be offered for resale, resold, and otherwise transferred by a Holder of Exchange Notes, unless that person is an "affiliate" of Michaels within the meaning of Rule 405 under the Securities Act, without compliance with the registration and prospectus delivery provisions of the Securities Act. The Exchange Notes must be acquired in the ordinary course of the Holder's business and the Holder must not be engaging in, must not intend to engage in, and must not have any arrangement or understanding with any person to participate in, a distribution of the Exchange Notes. If I am a broker-dealer that will receive Exchange Notes for my own account in exchange for Outstanding Notes that were acquired as a result of market-making activities or other trading activities (a "Participating Broker-Dealer"), I acknowledge that I will deliver a prospectus in connection with any resale of the Exchange Notes. However, by this acknowledgment and by delivering a prospectus, I will not be deemed to admit that I am an "underwriter" within the meaning of the Securities Act. Upon request, I will execute and deliver any additional documents deemed by the exchange agent or Michaels to be necessary or desirable to complete the assignment, transfer, and purchase of the Outstanding Notes I have tendered. I understand that Michaels will be deemed to have accepted validly tendered Outstanding Notes when Michaels gives oral or written notice of acceptance to the exchange agent. 6 If, for any reason, any tendered Outstanding Notes are not accepted for exchange in the Exchange Offer, certificates for those unaccepted Outstanding Notes will be returned to me without charge at the address shown below or at a different address if one is listed under "Special Delivery Instructions." Any unaccepted Outstanding Notes which had been tendered by book-entry transfer will be credited to an account at DTC, as soon as reasonably possible after the Expiration Date. All authority granted or agreed to be granted by this letter of transmittal will survive my death, incapacity or, if I am a corporation or institution, my dissolution and every obligation under this letter of transmittal is binding upon my heirs, personal representatives, successors, and assigns. I understand that tenders of Outstanding Notes according to the procedures described in the prospectus under the heading "The Exchange Offer--Procedures for Tendering" and in the instructions included in this document constitute a binding agreement between myself and Michaels subject to the terms and conditions of the Exchange Offer. Unless I have described other instructions in this letter of transmittal under the section "Special Issuance Instructions," please issue the certificates representing Exchange Notes issued and accepted in exchange for my tendered and accepted Outstanding Notes in my name, and issue any replacement certificates for Outstanding Notes not tendered or not exchanged in my name. Similarly, unless I have instructed otherwise under the section "Special Delivery Instructions," please send the certificates representing the Exchange Notes issued in exchange for tendered and accepted Outstanding Notes and any certificates for Outstanding Notes that were not tendered or not exchanged, as well as any accompanying documents, to me at the address shown below my signature. If both "Special Issuance Instructions" and "Special Delivery Instructions" are completed, please issue the certificates representing the Exchange Notes issued in exchange for my tendered and accepted Outstanding Notes in the name(s) of, and return any Outstanding Notes that were not tendered or exchanged and send such certificates to, the person(s) so indicated. I understand that if Michaels does not accept any of the tendered Outstanding Notes for exchange, Michaels has no obligation to transfer any Outstanding Notes from the name of the registered Holder(s) according to my instructions in the "Special Issuance Instructions" and "Special Delivery Instructions" sections of this document. 7 PLEASE SIGN HERE WHETHER OR NOT OUTSTANDING NOTES ARE BEING PHYSICALLY TENDERED HEREBY - -------------------------------------------- -------------------------------------------- (Date) - -------------------------------------------- -------------------------------------------- Signature(s) of Registered Holder(s) (Date) or Authorized Signatory
Area Code and Telephone Number(s): ________________________________________________________________________________ Tax Identification or Social Security Number(s): ________________________________________________________________________________ The above lines must be signed by the registered Holder(s) of Outstanding Notes as their name(s) appear(s) on the certificate for the Outstanding Notes or by person(s) authorized to become registered Holders(s) by a properly completed bond power from the registered Holder(s). A copy of the completed bond power must be delivered with this letter of transmittal. If any Outstanding Notes tendered through this letter of transmittal are held of record by two or more joint Holders, then all such Holders must sign this letter of transmittal. If the signature is by trustee, executor, administrator, guardian, attorney-in-fact, officer of a corporation or other person acting in a fiduciary or representative capacity, then such person must (1) state his or her full title below and (2) unless waived by Michaels, submit evidence satisfactory to Michaels of such person's authority to act on behalf of the Holder. See Instruction 4 for more information about completing this letter of transmittal. Name(s): ________________________________________________________________________________ ________________________________________________________________________________ (Please Print) Capacity: ________________________________________________________________________________ Address: ________________________________________________________________________________ ________________________________________________________________________________ (Include Zip Code) Signature(s) Guaranteed by an Eligible Institution, if required by Instruction 4: ________________________________________________________________________________ (Authorized Signature) ________________________________________________________________________________ (Title) ________________________________________________________________________________ (Name of Firm) Dated __________, 2001 8 Please complete the Substitute Form W-9 below. PAYOR'S NAME: THE BANK OF NEW YORK - --------------------------------------------------------------------------------------------------------------- SUBSTITUTE PART 1--PLEASE ------------------------ FORM W-9 PROVIDE YOUR TIN IN Social Security Number Department of the Treasury THE BOX AT RIGHT AND OR Internal Revenue Service CERTIFY BY SIGNING ------------------------ AND DATING BELOW: Employer Identification Number ------------------------------------------------------------------ PART 2--Certification--Under Penalties of Perjury, I certify that: (1) The number shown on this form is my correct TIN (or I am Payer's Request for Taxpayer waiting for a number to be issued to me) and Identification Number ("TIN") (2) I am not subject to backup withholding because (a) I am exempt from backup withholding, or (b) I have not been notified by the Internal Revenue Service ("IRS") that I am subject to backup withholding as a result of failure to report all interest or dividends, or (c) the IRS has notified me that I am no longer subject to backup withholding. ------------------------------------------------------------------ PART 3--Awaiting TIN / / - --------------------------------------------------------------------------------------------------------------- CERTIFICATION INSTRUCTIONS--You must cross out item (2) in the box above if you have been notified by the IRS that you are currently subject to backup withholding because of underreporting interest or dividends on your tax return. Signature Date , 2001 --------------------------------------------------------------------------------------------------------------
NOTE: IF YOU DO NOT COMPLETE AND RETURN THIS FORM YOU MAY BE SUBJECT TO BACKUP WITHHOLDING OF 31% OF PAYMENTS MADE TO YOU UNDER THIS EXCHANGE OFFER. FOR MORE INFORMATION, PLEASE REVIEW THE ENCLOSED GUIDELINES FOR CERTIFICATION OF TAXPAYER IDENTIFICATION NUMBER ON SUBSTITUTE FORM W-9. NOTE: YOU MUST COMPLETE THE FOLLOWING CERTIFICATE IF YOU CHECKED THE BOX IN PART 3. CERTIFICATE OF AWAITING TAXPAYER IDENTIFICATION NUMBER I certify under penalties of perjury that a taxpayer identification number has not been issued to me, and either (a) I have mailed or delivered an application to receive a taxpayer identification number to the appropriate Internal Revenue Center or Social Security Administration Office or (b) I intend to mail or deliver an application in the near future. I understand that if I do not provide a taxpayer identification number within sixty (60) days, 31% of all repoartable payments made to me thereafter will be withheld until I provide a number. - ----------------------------------------------------------- ----------------------------- Signature Date
9 INSTRUCTIONS PART OF THE TERMS AND CONDITIONS OF THE EXCHANGE OFFER 1. DELIVERY OF THIS LETTER OF TRANSMITTAL AND OUTSTANDING NOTES. The tendered Outstanding Notes or a confirmation of book-entry delivery, as well as a properly completed and executed copy or facsimile of this letter of transmittal and any other required documents must be received by the exchange agent at its address listed on the cover of this document before 5:00 p.m., New York City time, on the Expiration Date. YOU ARE RESPONSIBLE FOR THE DELIVERY OF THE OUTSTANDING NOTES, THIS LETTER OF TRANSMITTAL AND ALL REQUIRED DOCUMENTS TO THE EXCHANGE AGENT. EXCEPT UNDER THE LIMITED CIRCUMSTANCES DESCRIBED BELOW, THE DELIVERY OF THESE DOCUMENTS WILL BE CONSIDERED TO HAVE BEEN MADE ONLY WHEN ACTUALLY RECEIVED OR CONFIRMED BY THE EXCHANGE AGENT. WHILE THE METHOD OF DELIVERY IS AT YOUR RISK AND CHOICE, MICHAELS RECOMMENDS THAT YOU USE AN OVERNIGHT OR HAND DELIVERY SERVICE RATHER THAN REGULAR MAIL. YOU SHOULD SEND YOUR DOCUMENTS WELL BEFORE THE EXPIRATION DATE TO ENSURE RECEIPT BY THE EXCHANGE AGENT. YOU MAY REQUEST THAT YOUR BROKER, DEALER, COMMERCIAL BANK, TRUST COMPANY OR NOMINEE DELIVER YOUR OUTSTANDING NOTES, THIS LETTER OF TRANSMITTAL AND ALL REQUIRED DOCUMENTS TO THE EXCHANGE AGENT. DO NOT SEND YOUR OUTSTANDING NOTES TO MICHAELS. If you wish to tender your Outstanding Notes, but: (a) your Outstanding Notes are not immediately available; (b) you cannot deliver your Outstanding Notes, this letter of transmittal and all required documents to the exchange agent before the Expiration Date; or (c) you are unable to complete the book-entry tender procedure before the Expiration Date, you must tender your Outstanding Notes according to the guaranteed delivery procedure. A summary of this procedure follows, but you should read the section in the prospectus titled "The Exchange Offer--Guaranteed Delivery Procedure" for more complete information. As used in this letter of transmittal, an "Eligible Institution" is any participant in a Recognized Signature Guarantee Medallion Program within the meaning of Rule 17Ad-15 of the Exchange Act. For a tender made through the guaranteed delivery procedure to be valid, the exchange agent must receive a properly completed and executed Notice of Guaranteed Delivery or a facsimile of that notice before 5:00 p.m., New York City time, on the Expiration Date. The Notice of Guaranteed Delivery must be delivered by an Eligible Institution and must: (a) state your name and address; (b) list the certificate numbers and principal amounts of the Outstanding Notes being tendered; (c) state that tender of your Outstanding Notes is being made through the Notice of Guaranteed Delivery; and (d) guarantee that this letter of transmittal, or a facsimile of it, the certificates representing the Outstanding Notes, or a confirmation of DTC book-entry transfer, and all other required documents will be deposited with the exchange agent by the Eligible Institution within three Nasdaq National Market trading days after the Expiration Date. The exchange agent must receive your Outstanding Notes certificates, or a confirmation of DTC book entry, in proper form for transfer, this letter of transmittal and all required documents within 10 three Nasdaq National Market trading days after the Expiration Date or your tender will be invalid and may not be accepted for exchange. Michaels has the sole right to decide any questions about the validity, form, eligibility, time of receipt, acceptance or withdrawal of tendered Outstanding Notes, and its decision will be final and binding. Michaels' interpretation of the terms and conditions of the Exchange Offer, including the instructions contained in this letter of transmittal and in the prospectus under the heading "The Exchange Offer--Conditions," will be final and binding on all parties. Michaels has the absolute right to reject any or all of the tendered Outstanding Notes if (1) the Outstanding Notes are not properly tendered or (2) in the opinion of counsel, the acceptance of those Outstanding Notes would be unlawful. Michaels may also decide to waive any conditions, defects, or invalidity of tender of Outstanding Notes and accept such Outstanding Notes for exchange. Any defect or invalidity in the tender of Outstanding Notes that is not waived by Michaels must be cured within the period of time set by Michaels. It is your responsibility to identify and cure any defect or invalidity in the tender of your Outstanding Notes. Your Outstanding Notes will not be considered to have been made until any defect is cured or waived. Neither Michaels, the exchange agent nor any other person is required to notify you that your tender was invalid or defective, and no one will be liable for any failure to notify you of such a defect or invalidity in your tender of Outstanding Notes. As soon as reasonably possible after the Expiration Date, the exchange agent will return to the Holder tendering any Outstanding Notes that were invalidly tendered if the defect of invalidity has not been cured or waived. 2. TENDER BY HOLDER. You must be a Holder of Outstanding Notes in order to participate in the Exchange Offer. If you are a beneficial holder of Outstanding Notes who wishes to tender, but you are not the registered Holder, you must arrange with the registered Holder to execute and deliver this letter of transmittal on his, her or its behalf. Before completing and executing this letter of transmittal and delivering the registered Holder's Outstanding Notes, you must either make appropriate arrangements to register ownership of the Outstanding Notes in your name, or obtain a properly executed bond power from the registered Holder. The transfer of registered ownership of Outstanding Notes may take a long period of time. 3. PARTIAL TENDERS. If you are tendering less than the entire principal amount of Outstanding Notes represented by a certificate, you should fill in the principal amount you are tendering in the third column of the box entitled "Description of Outstanding Notes." The entire principal amount of Outstanding Notes listed on the certificate delivered to the exchange agent will be deemed to have been tendered unless you fill in the appropriate box. If the entire principal amount of all Outstanding Notes is not tendered, a certificate will be issued for the principal amount of those untendered Outstanding Notes not tendered. Unless a different address is provided in the appropriate box on this letter of transmittal, certificate(s) representing Exchange Notes issued in exchange for any tendered and accepted Outstanding Notes will be sent to the registered Holder at his or her registered address, promptly after the Outstanding Notes are accepted for exchange. In the case of Outstanding Notes tendered by book-entry transfer, any untendered Outstanding Notes and any Exchange Notes issued in exchange for tendered and accepted Outstanding Notes will be credited to accounts at DTC. 11 4. SIGNATURES ON THE LETTER OF TRANSMITTAL; BOND POWERS AND ENDORSEMENTS; GUARANTEE OF SIGNATURES. - - If you are the registered Holder of the Outstanding Notes tendered with this document, and are signing this letter of transmittal, your signature must match exactly with the name(s) written on the face of the Outstanding Notes. There can be no alteration, enlargement, or change in your signature in any manner. If certificates representing the Exchange Notes, or certificates issued to replace any Outstanding Notes you have not tendered are to be issued to you as the registered Holder, do not endorse any tendered Outstanding Notes, and do not provide a separate bond power. - - If you are not the registered Holder, or if Exchange Note or any replacement Outstanding Note certificates will be issued to someone other than you, you must either properly endorse the Outstanding Notes you have tendered or deliver with this letter of transmittal a properly completed separate bond power. Please note that the signatures on any endorsement or bond power must be guaranteed by an Eligible Institution. - - If you are signing this letter of transmittal but are not the registered Holder(s) of any Outstanding Notes listed on this document under the "Description of Outstanding Notes," the Outstanding Notes tendered must be endorsed or accompanied by appropriate bond powers, in each case signed in the name of the registered Holder(s) exactly as it appears on the Outstanding Notes. Please note that the signatures on any endorsement or bond power must be guaranteed by an Eligible Institution. - - If this letter of transmittal, any Outstanding Notes tendered or any bond powers are signed by trustees, executors, administrators, guardians, attorneys-in-fact, officers of corporations, or others acting in a fiduciary or representative capacity, that person must indicate their title or capacity when signing. Unless waived by Michaels, evidence satisfactory to Michaels of that person's authority to act must be submitted with this letter of transmittal. Please note that the signatures on any endorsement or bond power must be guaranteed by an Eligible Institution. - - All signatures on this letter of transmittal must be guaranteed by an Eligible Institution unless one of the following situations apply: - If this letter of transmittal is signed by the registered Holder(s) of the Outstanding Notes tendered with this letter of transmittal and such Holder(s) has not completed the box titled "Special Issuance Instructions" or the box titled "Special Delivery Instructions;" or - If the Outstanding Notes are tendered for the account of an Eligible Institution. 5. SPECIAL PAYMENT AND ISSUANCE INSTRUCTIONS. If different from the name and address of the person signing this letter of transmittal, you should indicate, in the applicable box or boxes, the name and address where Outstanding Notes issued in replacement for any untendered or tendered but unaccepted Outstanding Notes should be issued or sent. If replacement Original Notes are to be issued in a different name, you must indicate the taxpayer identification or social security number of the person named. 6. TRANSFER TAXES. Michaels will pay all transfer taxes, if any, applicable to the exchange of Outstanding Notes in the Exchange Offer. However, transfer taxes will be payable by you (or by the tendering Holder if you are signing this letter on behalf of a tendering Holder) if: - certificates representing Exchange Notes or notes issued to replace any Outstanding Notes not tendered or accepted for exchange are to be delivered to, or are to be registered or issued in the name of, a person other than the registered Holder; - tendered Outstanding Notes are registered in the name of any person other than the person signing this letter of transmittal; or 12 - a transfer tax is imposed for any reason other than the exchange of Outstanding Notes according to the Exchange Offer. If satisfactory evidence of the payment of those taxes or an exemption from payment is not submitted with this letter of transmittal, the amount of those transfer taxes will be billed directly to the tendering Holder. Until those transfer taxes are paid, Michaels will not be required to deliver any Exchange Notes required to be delivered to, or at the direction of, such tendering Holder. Except as provided in this Instruction 6, it is not necessary for transfer tax stamps to be attached to the Outstanding Notes listed in this letter of transmittal. 7. FORM W-9. You must provide the exchange agent with a correct Taxpayer Identification Number ("TIN") for the Holder on the enclosed Form W-9. If the Holder is an individual, the TIN is his or her social security number. If you do not provide the required information on the Form W-9, you may be subject to 31% Federal income tax withholding on certain payments made to the Holders of Exchange Notes. Certain Holders, such as corporations and certain foreign individuals, are not subject to these backup withholding and reporting requirements. For additional information, please read the enclosed Guidelines for Certification of TIN on Substitute Form W-9. To prove to the exchange agent that a foreign individual qualifies as an exempt Holder, the foreign individual must submit a Form W-8, signed under penalties of perjury, certifying as to that individual's exempt status. You can obtain a Form W-8 from the exchange agent. 8. WAIVER OF CONDITIONS. Michaels may choose, at any time and for any reason, to amend, waive or modify certain of the conditions to the Exchange Offer. The conditions applicable to tenders of Outstanding Notes in the Exchange Offer are described in the prospectus under the heading "The Exchange Offer--Conditions." 9. MUTILATED, LOST, STOLEN OR DESTROYED OUTSTANDING NOTES. If your Outstanding Notes have been mutilated, lost, stolen or destroyed, you should contact the exchange agent at the address listed on the cover page of this document for further instructions. 10. REQUESTS FOR ASSISTANCE OR ADDITIONAL COPIES. If you have questions, need assistance, or would like to receive additional copies of the prospectus or this letter of transmittal, you should contact the exchange agent at the address listed in the prospectus. You may also contact your broker, dealer, commercial bank, trust company, or other nominee for assistance concerning the Exchange Offer. 13 GUIDELINES FOR CERTIFICATION OF TAXPAYER IDENTIFICATION NUMBER ON SUBSTITUTE FORM W-9 GUIDELINES FOR DETERMINING THE PROPER IDENTIFICATION NUMBER TO GUIDE THE PAYER.--Social Security Numbers have nine digits separated by two hyphens: i.e. 000-00-0000. Employer Identification Numbers have nine digits separated by only one hyphen: i.e. 00-0000000. The table below will help determine the number to give the payer. - ----------------------------------------------- GIVE THE SOCIAL SECURITY FOR THIS TYPE OF ACCOUNT NUMBER OF-- - ----------------------------------------------- 1. An individual's The individual account 2. Two or more The actual owner of individuals (joint the account or, if account) combined funds, the first individual on the account(1) 3. Custodian account of The minor (2) a minor (Uniform Gift to Minors Act) 4. a. The usual The grantor- revocable savings trustee(1) trust account (grantor is also trustee) b. So-called trust The actual owner(1) account that is not a legal or valid trust under State law 5. Sole proprietorship The owner(3) account - ----------------------------------------------- GIVE THE EMPLOYER IDENTIFICATION FOR THIS TYPE OF ACCOUNT: NUMBER OF-- - ----------------------------------------------- 6. A valid trust, The legal entity (Do estate, or pension not furnish the trust identifying number of the personal representative or trustee unless the legal entity itself is not designated in the account title.) (4) 7. Corporate account The corporation 8. Religious, The organization charitable, or education organization account 9. Partnership The partnership 10. Association, club or The organization other tax exempt organization 11. A broker or The broker or registered nominee nominee 12. Account with the The public entity Department of Agriculture in the name of a public entity (such as a State or local government, school district, or prison) that receives agricultural program payments
- --------------------------------------------- - --------------------------------------------- (1) List first and circle the name of the person whose number you furnish. If only one person on a joint account has a Social Security Number, that person's number must be furnished. (2) Circle the minor's name and furnish the minor's Social Security Number. (3) Show the name of the owner. You may also enter your business name. You may use your Social Security Number or Employer Identification Number. (4) List first and circle the name of the legal trust, estate, or pension trust. NOTE: If no name is circled when there is more than one name, the number will be considered to be that of the first name listed. 14 GUIDELINES FOR CERTIFICATION OF TAXPAYER IDENTIFICATION NUMBER ON SUBSTITUTE FORM W-9 OBTAINING A NUMBER If you don't have a Taxpayer Identification Number or you don't know your number, obtain Form SS-5, Application for a Social Security Number Card, or Form SS-4, Application for Employer Identification Number, at the local office of the Social Security Administration or the Internal Revenue Service and apply for a number. PAYEES EXEMPT FROM BACKUP WITHHOLDING Payees specifically exempted from backup withholding on broker transactions include the following: - - A corporation. - - A financial institution. - - An organization exempt from tax under Section 501(a), an individual retirement plan, or a custodial account under Section 403(b)(7), if the account satisfies the requirements of Section 401(f)(2). - - The United States or any agency or instrumentality thereof.--A State, the District of Columbia, a possession of the United States, or any subdivision or instrumentality thereof. - - A foreign government, a political subdivision of a foreign government, or any agency or instrumentality thereof. - - An international organization or any agency or instrumentality thereof. - - A dealer in securities or commodities required to be registered in the United States, the District of Columbia, or a possession of the United States. - - A real estate investment trust. - - A futures commissions merchant registered with the Commodity Futures Trading Commission. - - A common trust fund operated by a bank under Section 584(a). - - An entity registered at all times under the Investment Company Act of 1940. - - A foreign central bank of issue. - - A person registered under the Investment Advisors Act of 1940 who regularly acts as a broker. Payments of dividends not generally subject to backup withholding include the following: - - Payments to nonresident aliens subject to withholding under Section 1441. - - Payments to partnerships not engaged in a trade or business in the United States and which have at least one nonresident partner. - - Payments of patronage dividends where the amount received is not paid in money. - - Payments made by certain foreign organizations. - - Payments described in Section 404(k) made by an employee stock ownership plan. Payments of interest not generally subject to backup withholding include the following: - - Payments of interest on obligations issued by individuals. Note: You may be subject to backup withholding if this interest is $600 or more and is paid in the course of the payer's trade or business and you have not provided your correct Taxpayer Identification Number to the payer. - - Payments of tax-exempt interest (including tax-exempt interest dividends under Section 852). - - Payments described in Section 6049(b)(5) to nonresident aliens. - - Payments on tax-free covenant bonds under Section 1451. - - Payments made by certain foreign organizations. - - Payments of mortgage interest to you. Exempt payees described above should file Substitute Form W-9 to avoid possible erroneous backup withholding. FILE THIS FORM WITH THE PAYER, FURNISH YOUR TAXPAYER IDENTIFICATION NUMBER, WRITE "EXEMPT" ON THE FACE OF THE FORM, SIGN AND DATE THE FORM AND RETURN IT TO THE PAYER. PRIVACY ACT NOTICE--Section 6109 requires most recipients of dividend, interest, or other payments to give Taxpayer Identification Numbers to payers who must report the payments to the IRS. The IRS uses the numbers for identification purposes. Payers must be given the numbers whether or not recipients are required to file tax returns. Payers must generally withhold 31% of taxable interest, dividend, and certain other payments to a payee who does not furnish a Taxpayer Identification Number to a payer. Certain penalties may also apply. PENALTIES (1) PENALTY FOR FAILURE TO FURNISH TAXPAYER IDENTIFICATION NUMBER.--If you fail to furnish your Taxpayer Identification Number to a payer, you are subject to a penalty of $50 for each such failure unless your failure is due to reasonable cause and not to willful neglect. (2) CIVIL PENALTY FOR FALSE INFORMATION WITH RESPECT TO WITHHOLDING.--If you make a false statement with no reasonable basis which results in no imposition of backup withholding, you are subject to a penalty of $500. (3) CRIMINAL PENALTY FOR FALSIFYING INFORMATION.--Falsifying certifications or affirmations may subject you to criminal penalties including fines and/or imprisonment. FOR ADDITIONAL INFORMATION CONTACT YOUR TAX CONSULTANT OR THE IRS.
15 (DO NOT WRITE IN SPACE BELOW)
OUTSTANDING OUTSTANDING CERTIFICATE NOTES NOTES SURRENDERED TENDERED ACCEPTED - ------------------------------------------------------------------------------------------- - ------------------------------------------------------------------------------------------- - ------------------------------------------------------------------------------------------- Delivery Prepared by: ----------------------------------------------------------- Checked by: ----------------------------------------------------------- Date: - ------------------------------------------------------------
16 EX-99.2 12 a2055355zex-99_2.txt EXHIBIT 99.2 EXHIBIT 99.2 NOTICE OF GUARANTEED DELIVERY FOR 9 1/4% SENIOR NOTES DUE 2009 OF MICHAELS STORES, INC. As set forth in the Prospectus dated July , 2001 (the "Prospectus"), of Michaels Stores, Inc. and in the letter of transmittal, this form or one substantially similar must be used to accept Michaels' offer to exchange all of its outstanding 9 1/4% Senior Notes due 2009 (the "Outstanding Notes") for its 9 1/4% Senior Notes due 2009, which have been registered under the Securities Act of 1933, if certificates for the Outstanding Notes are not immediately available or if the Outstanding Notes, the letter of transmittal or any other required documents cannot be delivered to the exchange agent, or the procedure for book-entry transfer cannot be completed, prior to 5:00 p.m., New York City time, on the Expiration Date (as defined in the Prospectus). This form may be delivered by an Eligible Institution by hand or transmitted by facsimile transmission, overnight courier or mail to the exchange agent as indicated below. - -------------------------------------------------------------------------------- THE EXCHANGE OFFER WILL EXPIRE AT 5:00 P.M., NEW YORK CITY TIME, ON , 2001, UNLESS THE OFFER IS EXTENDED (THE "EXPIRATION DATE"). TENDERS OF OUTSTANDING NOTES MAY BE WITHDRAWN AT ANY TIME PRIOR TO 5:00 P.M. ON THE EXPIRATION DATE. - -------------------------------------------------------------------------------- Deliver to: THE BANK OF NEW YORK, EXCHANGE AGENT BY REGISTERED OR CERTIFIED MAIL: BY HAND OR OVERNIGHT DELIVERY: FACSIMILE TRANSMISSION NUMBER: The Bank of New York The Bank of New York (For Eligible Institutions Only) 101 Barclay Street, 7E 101 Barclay Street (212) 815-6339 New York, NY 10286 Corporate Trust Services Window Attention: Diane Amorroso Ground Level Reorganization Section Attention Diane Amorroso Reorganization Section CONFIRM RECEIPT OF FACSIMILE BY TELEPHONE (212) 815-3738
DELIVERY OF THIS NOTICE TO AN ADDRESS, OR TRANSMISSION OF INSTRUCTIONS VIA A FACSIMILE, OTHER THAN AS SET FORTH ABOVE, DOES NOT CONSTITUTE A VALID DELIVERY. This form is not to be used to guarantee signatures. If a signature on the letter of transmittal to be used to tender Outstanding Notes is required to be guaranteed by an "Eligible Institution" under the instructions thereto, such signature guarantee must appear in the applicable space provided in the letter of transmittal. Ladies and Gentlemen: The undersigned hereby tenders to Michaels Stores, Inc., upon the terms and subject to the conditions set forth in the Prospectus and the letter of transmittal (which together constitute the "Exchange Offer"), receipt of which is hereby acknowledged, Outstanding Notes pursuant to guaranteed delivery procedures set forth in Instruction 1 of the letter of transmittal. The undersigned understands that tenders of Outstanding Notes will be accepted only in principal amounts equal to $1,000 or integral multiples thereof. The undersigned understands that tenders of Outstanding Notes pursuant to the Exchange Offer may be withdrawn only in accordance with the procedures set forth in "The Exchange Offer--Withdrawal of Tenders" section of the Prospectus. All authority herein conferred or agreed to be conferred by this Notice of Guaranteed Delivery shall survive the death, incapacity or dissolution of the undersigned and every obligation of the undersigned under this Notice of Guaranteed Delivery shall be binding upon the heirs, personal representatives, executors, administrators, successors, assigns, trustees in bankruptcy and other legal representatives of the undersigned. NOTE: SIGNATURES MUST BE PROVIDED WHERE INDICATED BELOW. Certificate No(s). for Outstanding Notes Principal Amount of Outstanding Notes (if available) - -------------------------------------------- -------------------------------------------- Principal Amount of Outstanding Notes Signature(s) Tendered - -------------------------------------------- -------------------------------------------- Dated: If Outstanding Notes will be delivered by book-entry transfer at the Depository Trust Company, Depository Account No.: - -------------------------------------------- --------------------------------------------
This Notice of Guaranteed Delivery must be signed by the registered holder(s) of Outstanding Notes exactly as its (their) name(s) appear on certificates of Outstanding Notes or on a security position listing as the owner of Outstanding Notes, or by person(s) authorized to become registered holder(s) by endorsements and documents transmitted with this Notice of Guaranteed Delivery. If signature is by a trustee, executor, administrator, guardian, attorney-in-fact, officer or other person acting in a fiduciary or representative capacity, such person must provide the following information: PLEASE PRINT NAME(S) AND ADDRESS(ES) Name(s): -------------------------------------------------- -------------------------------------------------- Capacity: -------------------------------------------------- -------------------------------------------------- Address(es): -------------------------------------------------- -------------------------------------------------- Area Code and Telephone No.: -------------------------------------------------- --------------------------------------------------
GUARANTEE (NOT TO BE USED FOR SIGNATURE GUARANTEE) The undersigned, a member firm of a registered national securities exchange or of the National Association of Securities Dealers, Inc., or a commercial bank or trust company having an office or correspondent in the United States or an "eligible guarantor institution" within the meaning of Rule 17Ad-15 under the Securities Exchange Act of 1934 (the "Exchange Act"), hereby (a) represents that the above named person(s) "own(s)" the Outstanding Notes to be tendered within the meaning of Rule 14e-4 under the Exchange Act, (b) represents that such tender of Outstanding Notes complies with Rule 14e-4 under the Exchange Act and (c) guarantees that delivery to the exchange agent of certificates for the Outstanding Notes to be tendered, proper form for transfer (or confirmation of the book-entry transfer of such Outstanding Notes into the exchange agent's account at the Depository Trust Company, pursuant to the procedures for book-entry transfer set forth in the prospectus), with delivery of a properly completed and duly executed (or manually signed facsimile) letter of transmittal with any required signatures and any other required documents, will be received by the exchange agent at one of its addresses set forth above within three trading days after the Expiration Date.
I HEREBY ACKNOWLEDGE THAT I MUST DELIVER THE LETTER OF TRANSMITTAL AND OUTSTANDING NOTES TO BE TENDERED TO THE EXCHANGE AGENT WITHIN THE TIME PERIOD SET FORTH AND THAT FAILURE TO DO SO COULD RESULT IN FINANCIAL LOSS TO ME. - -------------------------------------------- -------------------------------------------- Name of Firm Authorized Signature - -------------------------------------------- -------------------------------------------- Address Title Name: - -------------------------------------------- Zip Code (Please Type or Print) Area Code and Telephone No.: Dated:
NOTE: DO NOT SEND OUTSTANDING NOTES WITH THIS FORM; OUTSTANDING NOTES SHOULD BE SENT WITH YOUR LETTER OF TRANSMITTAL SO THAT THEY ARE RECEIVED BY THE EXCHANGE AGENT WITHIN THREE NASDAQ NATIONAL MARKET TRADING DAYS AFTER THE EXPIRATION DATE. EX-99.3 13 a2055355zex-99_3.txt EXHIBIT 99.3 EXHIBIT 99.3 MICHAELS STORES, INC. EXCHANGE OF ALL OUTSTANDING 9 1/4% SENIOR NOTES DUE 2009 FOR 9 1/4% SENIOR NOTES DUE 2009 THE EXCHANGE OFFER WILL EXPIRE AT 5:00 P.M., NEW YORK CITY TIME, ON , 2001 UNLESS EXTENDED (THE "EXPIRATION DATE"). NOTES TENDERED IN THE EXCHANGE OFFER MAY BE WITHDRAWN AT ANY TIME PRIOR TO 5:00 P.M., NEW YORK CITY TIME, ON THE EXPIRATION DATE. To Our Clients: We are enclosing herewith a Prospectus, dated , 2001, of Michaels Stores, Inc., and the accompanying Letter of Transmittal that together constitute the offer by Michaels (the "Exchange Offer"), to exchange its 9 1/4% Senior Notes due 2009 (the "Exchange Notes"), which have been registered under the Securities Act of 1933, as amended (the "Securities Act"), for a like principal amount of its issued and outstanding 9 1/4% Senior Notes due 2009 (the "Outstanding Notes"), upon the terms and subject to the conditions set forth in the Exchange Offer. The Exchange Offer is not conditioned upon any minimum number of Outstanding Notes being tendered. We are the holder of record of Outstanding Notes held by us for your own account. A tender of such Outstanding Notes can be made only by us as the record holder and pursuant to your instructions. The Letter of Transmittal is furnished to you for your information only and cannot be used by you to tender Outstanding Notes held by us for your account. We request instructions as to whether you wish to tender any or all of the Outstanding Notes held by us for your account pursuant to the terms and conditions of the Exchange Offer. We also request that you confirm that we may, on your behalf, make the representations contained in the Letter of Transmittal. Pursuant to the Letter of Transmittal, each holder of Outstanding Notes will represent to Michaels that: (i) any Exchange Notes that the holder will acquire in exchange for Outstanding Notes will be acquired in the ordinary course of business of the holder, (ii) the holder has not engaged in, does not intend to engage in, and has no arrangement with any person to engage in, a distribution of any Exchange Notes issued to the holder, and (iii) the holder is not an "affiliate" (as defined in Rule 405 under the Securities Act) of Michaels. If the holder is a broker-dealer that will receive Exchange Notes for its own account in exchange for Outstanding Notes, it will represent that the Outstanding Notes were acquired as a result of market-making activities or other trading activities, and it will acknowledge that it will deliver a prospectus meeting the requirements of the Securities Act in connection with any resale of those Exchange Notes. By acknowledging that it will deliver and by delivering a prospectus meeting the requirements of the Securities Act in connection with any resale of those Exchange Notes, the broker-dealer is not deemed to admit that it is an "underwriter" within the meaning of the Securities Act. Very truly yours, Please return your instructions to us in the enclosed envelope within ample time to permit us to submit a tender on your behalf prior to the Expiration Date. INSTRUCTION TO BOOK ENTRY TRANSFER PARTICIPANT To Participant of the DTC: The undersigned hereby acknowledges receipt of the Prospectus, dated , 2001 (the "Prospectus") of Michaels Stores, Inc., and the accompanying Letter of Transmittal (the "Letter of Transmittal"), that together constitute Michaels' offer (the "Exchange Offer") to exchange its 9 1/4% Senior Notes due 2009 (the "Exchange Notes"), for all of its outstanding 9 1/4% Senior Notes due 2009 (the "Outstanding Notes"). Capitalized terms used but not defined herein have the meanings ascribed to them in the Prospectus or the Letter of Transmittal. This will instruct you, the DTC participant, as to the action to be taken by you relating to the Exchange Offer with respect to the Outstanding Notes held by you for the account of the undersigned. The aggregate face amount of the Outstanding Notes held by you for the account of the undersigned is (FILL IN AMOUNT): $ of the 9 1/4% Senior Notes due 2009. With respect to the Exchange Offer, we hereby instruct you (CHECK APPROPRIATE BOX): [ ] To TENDER the following amount of Outstanding Notes you hold for our account (INSERT PRINCIPAL AMOUNT OF OUTSTANDING NOTES TO BE TENDERED, IF ANY): $ . [ ] NOT To TENDER any Outstanding Notes you hold for our account. If we instruct you to tender the Outstanding Notes held by you for our account, it is understood that you are authorized to make, on behalf of us (and, by signing below, we hereby make to you), the representations contained in the Letter of Transmittal that are to be made with respect to us as a beneficial owner, including, but not limited to, the representations, that: (i) any Exchange Notes that we will acquire in exchange for Outstanding Notes will be acquired in the ordinary course of our business, (ii) we have not engaged in, do not intend to engage in, and have no arrangement with any person to engage in, a distribution of any Exchange Notes issued to us, and (iii) we are not an "affiliate" (as defined in Rule 405 under the Securities Act) of Michaels. If we are a broker-dealer that will receive Exchange Notes for our own account in exchange for Outstanding Notes, we represent that the Outstanding Notes were acquired as a result of market-making activities or other trading activities, and we acknowledge that we will deliver a prospectus meeting the requirements of the Securities Act in connection with any resale of those Exchange Notes. By acknowledging that we will deliver and by delivering a prospectus meeting the requirements of the Securities Act in connection with any resale of such Exchange Notes, we are not deemed to admit that we are an "underwriter" within the meaning of the Securities Act. SIGN HERE Name of beneficial owner(s): ___________________________________________________ Signature(s): __________________________________________________________________ Name(s) (please print): ________________________________________________________ Address: _______________________________________________________________________ Telephone Number: ______________________________________________________________ Taxpayer Identification or Social Security Number: _____________________________ Date: __________________________________________________________________________ EX-99.4 14 a2055355zex-99_4.txt EXHIBIT 99.4 EXHIBIT 99.4 MICHAELS STORES, INC. LETTER TO DEPOSITORY TRUST COMPANY PARTICIPANTS EXCHANGE OF ALL OUTSTANDING 9 1/4% SENIOR NOTES DUE 2009 FOR 9 1/4% SENIOR NOTES DUE 2009 - -------------------------------------------------------------------------------- THE EXCHANGE OFFER WILL EXPIRE AT 5:00 P.M., NEW YORK CITY TIME, ON , 2001, UNLESS EXTENDED (THE "EXPIRATION DATE"). - -------------------------------------------------------------------------------- OUTSTANDING NOTES TENDERED IN THE EXCHANGE OFFER MAY BE WITHDRAWN AT ANY TIME PRIOR TO 5:00 P.M., NEW YORK CITY TIME, ON THE EXPIRATION DATE. To Depository Trust Company Participants: We are enclosing herewith the material listed below relating to the offer by Michaels Stores, Inc., to exchange its 9 1/4% Senior Notes due 2009 (the "Exchange Notes"), which have been registered under the Securities Act of 1933, as amended (the "Securities Act"), for a like principal amount of its issued and outstanding 9 1/4% Senior Notes due 2009 (the "Outstanding Notes"), upon the terms and subject to the conditions set forth in Michaels' Prospectus, dated , 2001, and the related Letter of Transmittal (which together constitute the "Exchange Offer"). Enclosed are copies of the following documents: 1. Prospectus, dated , 2001; 2. Letter of Transmittal (together with accompanying Substitute Form W-9 Guidelines); 3. Notice of Guaranteed Delivery; and 4. Letter that may be sent to your clients for whose account you hold Outstanding Notes in your name or in the name of your nominee, with space provided for obtaining such client's instruction with regard to the Exchange Offer. We urge you to contact your clients promptly. Please note that the Exchange Offer will expire on the Expiration Date unless extended. The Exchange Offer is not conditioned upon any minimum number of Outstanding Notes being tendered. Pursuant to the Letter of Transmittal, each holder of Outstanding Notes will represent to Michaels that: (i) any Exchange Notes that the holder will acquire in exchange for Outstanding Notes will be acquired in the ordinary course of business of the holder, (ii) the holder has not engaged in, does not intend to engage in, and has no arrangement with any person to engage in, a distribution of any Exchange Notes issued to the holder, and (iii) the holder is not an "affiliate" (as defined in Rule 405 under the Securities Act) of Michaels. If the holder is a broker-dealer (whether or not it is also an "affiliate") that will receive Exchange Notes for its own account in exchange for Outstanding Notes, it will represent that the Outstanding Notes were acquired as a result of market-making activities or other trading activities, and it will acknowledge that it will deliver a prospectus meeting the requirements of the Securities Act in connection with any resale of those Exchange Notes. By acknowledging that it will deliver and by delivering a prospectus meeting the requirements of the Securities Act in connection with any resale of those Exchange Notes, the broker-dealer is not deemed to admit that it is an "underwriter" within the meaning of the Securities Act. The enclosed Letter to Clients contains an authorization by the beneficial owners of the Outstanding Notes for you to make the foregoing representations. Michaels will not pay any fee or commission to any broker or dealer to any other persons (other than the Exchange Agent) in connection with the solicitation of tenders of Outstanding Notes pursuant to the Exchange Offer. Michaels will pay or cause to be paid any transfer taxes payable on the transfer of Outstanding Notes to it, except as otherwise provided in Instruction 6 of the enclosed Letter of Transmittal. Additional copies of the enclosed material may be obtained from the undersigned. Very truly yours, THE BANK OF NEW YORK -----END PRIVACY-ENHANCED MESSAGE-----