Certain statements contained in this discussion and analysis which are not historical facts are forward looking statements that involve risks and uncertainties, including, but not limited to, customer demand and trends in the arts and crafts industry, related inventory risks due to shifts in customer demand, the effect of economic conditions, the impact of competitors' locations or pricing, the availability of acceptable real estate locations for new stores, difficulties with respect to new information system technologies and our ability to address the Year 2000 Issue, supply constraints or difficulties, the results of financing efforts, the effectiveness of advertising strategies and other risks detailed in our Securities and Exchange Commission filings.
During 1996 we focused on implementing initiatives to improve our merchandising and store operations, which included completing the installation of the point-of-sale ("POS") system, redefining the merchandise strategy, liquidating merchandise which did not support our focus toward return on capital, resetting and standardizing the stores, and improving store staffing effectiveness. These changes allowed us to focus on an expanded arts and crafts assortment as our core line of business.
In 1997 we moderated our expansion plans and focused on same-store sales growth, return on investment, productivity enhancements and improving cash flow. We increased the number of basic merchandise SKUs centrally purchased and available for store replenishment from our distribution centers, and we have continued this process into 1999 with a goal of having approximately 20,000 SKUs available by year-end. We believe that shifting more SKUs for inventory replenishment to the distribution centers will result in an increase in inventory turns in future years.
In 1998 we continued our focus on growing same-store sales, implemented information system enhancements in merchandising and distribution, and returned to an accelerated new store-opening program. In addition, we positioned the Company for significant operating improvements in future years by putting new inventory management tools in place.
Initiatives for 1999 include focusing on four cornerstones essential to our operational turnaround for top line growth: 1) an enhanced version of our store prototype; 2) effective distribution centers; 3) continued information system enhancements; and 4) disciplined inventory management and control to ensure we improve store in-stock positions while reducing store inventories.
Net sales in the fiscal year ended January 30, 1999 ("1998") increased $117.4 million, or 8%, over the fiscal year ended January 31, 1998 ("1997"). The results for 1998 included sales from 50 Michaels and 5 Aaron Brothers stores that were opened during the year, more than offsetting lost sales from 6 Michaels and 1 Aaron Brothers store closures. Same-store sales increased 1% in 1998. The improvement in same-store sales was due to a good performance in memory books, wood, beads, candles, art, books and yarn, more than offsetting the performance in apparel crafts, seasonal, needlecrafts and ribbon. Going forward we expect to achieve same-store sales increases for 1999, taken as a whole. Our ability to generate same-store sales increases is dependent, in part, on our ability to continue to improve 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.
Cost of sales and occupancy expense, as a percentage of net sales, for 1998 was 66.8%, a decrease of 1.1% compared to 1997. This decrease was primarily attributable to improvements in the initial markup and cost reductions in merchandise purchases, partially offset by increased occupancy costs, as a percentage of net sales, including higher rent reserves for store closures.
Selling, general and administrative expense, as a percentage of net sales, decreased by 0.2% in 1998 compared to 1997. This decrease resulted from improved expense leverage in corporate general and administrative expense, advertising and depreciation.
Store pre-opening costs, as a percentage of net sales, increased by 0.3% in 1998 compared to 1997, as we opened or relocated 64 Michaels and 12 Aaron Brothers stores compared to 23 Michaels and 4 Aaron Brothers stores in the prior year.
Interest expense, as a percentage of net sales, was 1.4% for 1998, a decrease of 0.2% compared to the prior year. This decrease was a result of leveraging the fixed interest costs over a larger sales base.
Cost of sales and occupancy expense, as a percentage of net sales, for 1997 was 67.9%, a decrease of 4.9% compared to 1996. Cost of sales and occupancy expense in 1996 included a $47.7 million charge for unusual costs and expenses recorded in the third quarter of 1996 to cover losses on an extended sidewalk sale, markdowns on discounted furniture and certain other home decor merchandise, and reserves for the closure of 4 stores and the write-down of leasehold improvements in 3 stores. Adjusting for the 1996 unusual items, cost of sales and occupancy expense for 1997 decreased by 2.0% compared to the prior year. This decrease was principally due to improved gross margins which management attributes to decreased dependency on promotional advertising and fewer seasonal clearance markdowns in the third and fourth quarters of 1997.
Selling, general and administrative expense, as a percentage of net sales, decreased by 1.3% in 1997 compared to 1996. This decrease resulted from a reduction in advertising costs of $8.3 million from 1996 levels and improved expense leverage in store labor and all other categories of store operating expenses with the exception of depreciation, which reflects the impact of increased investment in the POS system. Additionally, in the third quarter of 1996 we recorded a $3.1 million charge associated with unusual costs and expenses relating primarily to an extended sidewalk sale.
Interest expense, as a percentage of net sales, was 1.6% for 1997, a slight increase of 0.1% compared to the prior year. This increase was primarily a result of interest expense on the $125 million of Senior Notes issued in June 1996 which was, for the first time, outstanding for the full year in 1997. For 1997 the effective tax rate increased to 38% from 24% in 1996 as we returned to profitability. The 1996 effective tax rate was significantly lower due to the loss in 1996 and our inability to fully carryback the tax losses to prior years.
We plan to spend approximately $83 million on capital expenditures during fiscal 1999. We plan to open 70 Michaels and 15 Aaron Brothers stores for approximately $42 million, of which 18 Michaels and 2 Aaron Brothers stores have been opened as of April 14, 1999. In March 1999 we acquired leases for 16 stores (included in the 70 Michaels stores noted above), formerly operated by MJDesigns, Inc., for $4.5 million. We expect to spend approximately $9 million on information systems, $22 million on store relocations and remodeling, and $5 million on various other projects.
We believe that our available cash, funds generated by operating activities, funds available under a bank credit agreement, lease financing and proceeds from the sale of stock should be sufficient to finance continuing operations and sustain current growth plans. We believe that we can finance annual store expansion at a rate of 15% from internally generated cash flow.
Our working capital needs are driven primarily by a seasonal buildup of inventory to support higher sales in the third and fourth quarters, funding required for growth in new stores and improvements in our information systems. Net cash provided by operating activities for 1998 was $6.0 million as compared to $77.9 million for 1997, decreasing primarily as a result of an increase in merchandise inventories. Inventories per Michaels store increased 18% as a result of increasing the number of items replenished by our distribution centers from approximately 8,880 at year end 1997 to approximately 12,000 at year end 1998. Additional inventory was required for the opening of new stores in 1998 and 1999 and as the store in-stock position of top-selling merchandise in existing stores was improved.
Capital expenditures during 1998 were $59.6 million (net of $18.4 million in proceeds from sale/leaseback transactions), incurred primarily for the opening, relocation or expansion of stores, the relocation of a distribution center and various enhancements to our information systems.
In October 1997 we began issuing Common Stock through our 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 us with a cost-efficient and flexible mechanism to raise equity capital.
In October 1998 we repurchased 1,145,000 shares of our Common Stock for an aggregate purchase price of $20.4 million and placed the shares in treasury.
At January 30, 1999, we had working capital of $391.2 million, compared to $358.7 million at January 31, 1998. We currently have a bank credit agreement providing for an unsecured revolving line of credit of $100 million, which may be increased to $125 million under specific conditions. There were no borrowings outstanding under the previous revolving line of credit at any time during 1997, and in 1998 borrowings under the current bank credit agreement were outstanding for 54 days during our peak season of seasonal inventory buildup.
Our business is seasonal in nature with higher sales in the third and fourth 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 58% of our operating income.
We believe that the effects of inflation on 1998 results and the projected effect on 1999 financial results will be nominal.
We have implemented a comprehensive plan designed to make our operations fully Year 2000 compliant, utilizing both internal and external resources. A corporate project office has been established to oversee, monitor and coordinate the Company-wide Year 2000 efforts. An experienced consulting firm has been engaged to provide objective project management and technical expertise to assist us in the completion of the project.
Our information systems include proprietary and third party application systems and related hardware, software and data and telephone networks. Approximately 70% of our application systems are presently believed to be Year 2000 compliant. Remediation or replacement of the majority of our remaining systems is in process, with substantial completion anticipated by mid-1999. The testing and certification stage for these areas is targeted to be largely completed by the end of the third quarter 1999. We believe that we are on schedule to complete Year 2000 compliance plans with respect to our information systems.
We are currently assessing business equipment and systems, such as elevators and security systems, which contain embedded computer technology. Based on our preliminary assessment and assurances from third parties, we believe these systems present little Year 2000 exposure or risk.
We have surveyed our "mission critical" merchandise and service vendors to determine their Year 2000 status and are in the process of obtaining appropriate assurances from these vendors. In addition, we are conducting more detailed assessments of the progress of our electronic data interchange trading partners. In 1998, our top ten vendors accounted for approximately 21% of total purchases, with no single merchandise vendor accounting for more than 4.5% of total purchases; thus, we do not believe any single vendor poses a significant risk. We have completed the assessment phase with respect to vendors' systems.
We are developing contingency plans, such as alternative sourcing, and identifying what actions would need to be taken if critical systems or service providers are not Year 2000 compliant. We expect these plans to be finalized by mid-1999. Currently, we do not expect that substantial increases in inventory will be required as a contingency measure. We have begun, but not yet completed, a comprehensive analysis of the operational problems and costs (including loss of revenues) that would be reasonably likely to result from our failure or the failure of certain third parties to complete efforts to achieve Year 2000 compliance on a timely basis. A contingency plan has not been developed for dealing with the most reasonably likely worst-case scenario, and such scenario has not yet been clearly identified. We currently plan to complete such analysis and contingency plan by mid-1999.
Despite significant efforts to make our systems and facilities Year 2000 compliant, the ability of third party service providers, vendors and certain other third parties, including governmental entities and utility companies, to be Year 2000 compliant is beyond our control. Accordingly, we can give no assurances that the systems of other parties on which our systems or operations rely will be timely converted or compatible with our systems. The failure of these entities to comply on a timely basis could have a material adverse effect. At the present time, however, we do not expect Year 2000 issues to materially affect our products, services, competitive position, or financial performance or condition.
Total external non-capitalizable costs related to the Year 2000 effort (exclusive of the costs of planned development of new systems) are estimated to be approximately $2.5 million, of which approximately $1.2 million has been incurred through January 1999. In addition, we have accelerated the planned development of new information systems with improved business functionality to replace systems that were not Year 2000 compliant. The cost of these new information systems will approximate $4.0 million, of which approximately $1.4 million has been incurred prior to the date of this report. Our Year 2000 costs, including the acceleration of development of new systems already planned, have been, and are expected to be, funded with cash flow from operating activities. We do not separately track internal direct costs associated with the utilization of our officers and employees in Year 2000 compliance efforts. No significant information system projects have been deferred because of the Year 2000 effort.
The foregoing statements as to cost and timetables relating to the Year 2000 effort are forward looking and are made in reliance on the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. They are based on our best estimates, which may be updated as additional information becomes available. Forward looking statements are also based on assumptions about many important factors, including the technical skills of employees and independent contractors, the representations and preparedness of third parties, the ability of vendors to deliver merchandise or perform services required by us and the collateral effects of the Year 2000 issues on our business partners and customers. While we believe our assumptions are reasonable, we caution that it is impossible to predict the impact of certain factors that could cause actual costs or timetables to differ materially from those expected.