Use these links to rapidly review the documentMICHAELS STORES, INC. FORM 10-Q Part IFINANCIAL INFORMATION

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

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FORM 10-Q

(Mark One)

|ý | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
|- | ---------------------------------------------------------------------------------------------------------

For the quarterly period ended May 4, 2002

OR

|o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
|- | ----------------------------------------------------------------------------------------------------------

For the transition period from  to

Commission file number 001-09338

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MICHAELS STORES, INC.(Exact name of registrant as specified in its charter)

Delaware(State or other jurisdiction of
incorporation or organization)

75-1943604(I.R.S. employer identification number)8000 Bent Branch Drive
Irving, Texas 75063
P.O. Box 619566
DFW, Texas 75261-9566(Address of principal executive offices, including zip code)(972) 409-1300(Registrant's telephone number, including area code)


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Indicate
by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past
90 days. Yes ý    No o

Indicate
the number of shares outstanding of each of the Registrant's classes of Common Stock, as of the latest practicable date.

Title

Shares Outstanding as of
June 11, 2002Common Stock, par value $.10 per share

66,370,673


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MICHAELS STORES, INC.    FORM 10-Q    Part IFINANCIAL INFORMATION



|Item 1.                   |  | Financial Statements                                                                                |  |   
|------------------------- |  | --------------------------------------------------------------------------------------------------- |  | --
|                          |  | Consolidated Balance Sheets at May 4, 2002 (unaudited) and February 2, 2002                         |  | 3 
|                          |  | Consolidated Statements of Income for the quarter ended May 4, 2002 and May 5, 2001 (unaudited)     |  | 4 
|                          |  | Consolidated Statements of Cash Flows for the quarter ended May 4, 2002 and May 5, 2001 (unaudited) |  | 5 
|                          |  | Notes to Consolidated Financial Statements (unaudited)                                              |  | 6 
|Item 2.                   |  | Management's Discussion and Analysis of Financial Condition and Results of Operations               |  | 11
|Item 3.                   |  | Quantitative and Qualitative Disclosures About Market Risk                                          |  | 15
|Part IIOTHER INFORMATION
|Item 1.                   |  | Legal Proceedings                                                                                   |  | 16
|Item 6.                   |  | Exhibits and Reports on Form 8-K                                                                    |  | 17
|Signatures                |  | 18                                                                                                 

2

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MICHAELS STORES, INC.    Part IFINANCIAL INFORMATION

Item 1. Financial Statements.

MICHAELS STORES, INC.        CONSOLIDATED BALANCE SHEETS    (In thousands, except share data)

|                                           |                                                                                                                                                             | May 4,
2002                 |           | February 2,
2002 |        
|------------------------------------------ | ----------------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------- | --------- | ---------------- | -------
|
|ASSETS                                     |                                                                                                                                                            
|Current assets:                            |                                                                                                                                                             |                             |           |                  |        
|                                           | Cash and equivalents                                                                                                                                        |                             | $         | 160,293          |        
|                                           | Merchandise inventories                                                                                                                                     |                             |           | 767,795          |        
|                                           | Prepaid expenses and other                                                                                                                                  |                             |           | 20,034           |        
|                                           | Deferred income taxes                                                                                                                                       |                             |           | 21,017           |        
|                                           |                                                                                                                                                             |                             |           |                  |        
|                                           |                                                                                                                                                             | Total current assets        |           |                  | 969,139
|                                           |                                                                                                                                                             |                             |           |                  |        
|Property and equipment, at cost            |                                                                                                                                                             |                             | 661,184   |                  |        
|Less accumulated depreciation              |                                                                                                                                                             |                             | (302,520  | )                |        
|                                           |                                                                                                                                                             |                             |           |                  |        
|                                           |                                                                                                                                                             |                             | 358,664   |                  |        
|                                           |                                                                                                                                                             |                             |           |                  |        
|Goodwill, net                              |                                                                                                                                                             |                             | 115,839   |                  |        
|Other assets                               |                                                                                                                                                             |                             | 11,505    |                  |        
|                                           |                                                                                                                                                             |                             |           |                  |        
|                                           |                                                                                                                                                             |                             | 127,344   |                  |        
|                                           |                                                                                                                                                             |                             |           |                  |        
|Total assets                               |                                                                                                                                                             | $                           | 1,455,147 |                  | $      
|                                           |                                                                                                                                                             |                             |           |                  |        
|LIABILITIES AND STOCKHOLDERS' EQUITY       |                                                                                                                                                            
|Current liabilities:                       |                                                                                                                                                             |                             |           |                  |        
|                                           | Accounts payable                                                                                                                                            |                             | $         | 171,121          |        
|                                           | Accrued liabilities and other                                                                                                                               |                             |           | 175,752          |        
|                                           | Income taxes payable                                                                                                                                        |                             |           | 6,768            |        
|                                           |                                                                                                                                                             |                             |           |                  |        
|                                           |                                                                                                                                                             | Total current liabilities   |           |                  | 353,641
|                                           |                                                                                                                                                             |                             |           |                  |        
|Senior Notes due 2009                      |                                                                                                                                                             |                             | 200,000   |                  |        
|Deferred income taxes                      |                                                                                                                                                             |                             | 15,873    |                  |        
|Other long-term liabilities                |                                                                                                                                                             |                             | 25,701    |                  |        
|                                           |                                                                                                                                                             |                             |           |                  |        
|                                           |                                                                                                                                                             | Total long-term liabilities |           |                  | 241,574
|                                           |                                                                                                                                                             |                             |           |                  |        
|                                           |                                                                                                                                                             |                             | 595,215   |                  |        
|                                           |                                                                                                                                                             |                             |           |                  |        
|Commitments and contingencies              |                                                                                                                                                             |                             |           |                  |        
|Stockholders' equity:                      |                                                                                                                                                             |                             |           |                  |        
|                                           | Common Stock, $0.10 par value, 150,000,000 shares authorized;
shares issued and outstanding of 66,301,087 at May 4, 2002
and 65,697,393 at February 2, 2002 |                             |           | 6,630            |        
|                                           | Additional paid-in capital                                                                                                                                  |                             |           | 473,214          |        
|                                           | Retained earnings                                                                                                                                           |                             |           | 380,088          |        
|                                           |                                                                                                                                                             |                             |           |                  |        
|                                           |                                                                                                                                                             | Total stockholders' equity  |           |                  | 859,932
|                                           |                                                                                                                                                             |                             |           |                  |        
|Total liabilities and stockholders' equity |                                                                                                                                                             | $                           | 1,455,147 |                  | $      
|                                           |                                                                                                                                                             |                             |           |                  |        

See
accompanying notes to consolidated financial statements.

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MICHAELS STORES, INC.        CONSOLIDATED STATEMENTS OF INCOME        (In thousands, except per share data)  (Unaudited)

|                                             |         | Quarter Ended |        
|-------------------------------------------- | ------- | ------------- | -------
|
|Net sales                                    |         | $             | 603,220
|Cost of sales and occupancy expense          |         |               | 396,851
|                                             |         |               |        
|Gross profit                                 |         |               | 206,369
|Selling, general, and administrative expense |         |               | 165,403
|Store pre-opening costs                      |         |               | 1,684  
|Litigation settlement                        |         |               |       
|                                             |         |               |        
|Operating income                             |         |               | 39,282 
|Interest expense                             |         |               | 5,084  
|Other (income) and expense, net              |         |               | (854   
|                                             |         |               |        
|Income before income taxes                   |         |               | 35,052 
|Provision for income taxes                   |         |               | 14,371 
|                                             |         |               |        
|Net income                                   |         | $             | 20,681 
|                                             |         |               |        
|Earnings per common share:                   |         |               |        
|                                             | Basic   |               | $      
|                                             |         |               |        
|                                             | Diluted |               | $      
|                                             |         |               |        

See
accompanying notes to consolidated financial statements.

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MICHAELS STORES, INC.    CONSOLIDATED STATEMENTS OF CASH FLOWS    (In thousands)    (Unaudited)

|                                            |                                                   | Quarter Ended                     |                                
|------------------------------------------- | ------------------------------------------------- | --------------------------------- | -------------------------------
|
|Operating activities:                       |                                                   |                                   |                                
|                                            | Net income                                        |                                   | $                              
|                                            | Adjustments:                                      |                                   |                                
|                                            |                                                   | Depreciation                      |                                
|                                            |                                                   | Amortization                      |                                
|                                            |                                                   | Other                             |                                
|                                            |                                                   | Change in assets and liabilities: |                                
|                                            |                                                   |                                   | Merchandise inventories        
|                                            |                                                   |                                   | Prepaid expenses and other     
|                                            |                                                   |                                   | Deferred income taxes and other
|                                            |                                                   |                                   | Accounts payable               
|                                            |                                                   |                                   | Income taxes payable           
|                                            |                                                   |                                   | Accrued liabilities and other  
|                                            |                                                   |                                   |                                
|                                            |                                                   |                                   |                                
|                                            |                                                   |                                   |                                
|                                            |                                                   |                                   |                                
|                                            |                                                   |                                   |                                
|Investing activities:                       |                                                   |                                   |                                
|                                            | Additions to property and equipment               |                                   |                                
|                                            | Net proceeds from sales of property and equipment |                                   |                                
|                                            |                                                   |                                   |                                
|                                            |                                                   |                                   |                                
|                                            |                                                   |                                   |                                
|Financing activities:                       |                                                   |                                   |                                
|                                            | Net borrowings under the Credit Agreement         |                                   |                                
|                                            | Payment of other long-term liabilities            |                                   |                                
|                                            | Proceeds from stock options exercised             |                                   |                                
|                                            | Proceeds from issuance of common stock and other  |                                   |                                
|                                            |                                                   |                                   |                                
|                                            |                                                   |                                   |                                
|                                            |                                                   |                                   |                                
|Net decrease in cash and equivalents        |                                                   |                                   | (32,732                        
|Cash and equivalents at beginning of period |                                                   |                                   | 193,025                        
|                                            |                                                   |                                   |                                
|Cash and equivalents at end of period       |                                                   | $                                 | 160,293                        
|                                            |                                                   |                                   |                                

See
accompanying notes to consolidated financial statements.

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MICHAELS STORES, INC.        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS        For the Quarter Ended May 4, 2002        (Unaudited)

Note 1.    Basis of Presentation

The consolidated financial statements include the accounts of Michaels Stores, Inc. and our wholly-owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated. All expressions of "us," "we," "our," and all similar expressions are references to Michaels Stores, Inc. and our consolidated wholly-owned
subsidiaries, unless otherwise expressly stated or the context otherwise requires.

The
accompanying unaudited consolidated financial statements 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 notes 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 our business, the results of operations for the 13 weeks ended May 4, 2002 are not indicative of the
results to be expected for the entire year.

The
balance sheet at February 2, 2002 has been derived from the audited financial statements at that date but does not include all of the information and notes required by
generally accepted accounting principles for complete financial statements. For further information, refer to the consolidated financial
statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended February 2, 2002.

All
references herein to "fiscal 2002" relate to the 52 weeks ending February 1, 2003 and all references to "fiscal 2001" relate to the 52 weeks ended February 2, 2002. In
addition, all references herein to "the first quarter of fiscal 2002" relate to the 13 weeks ended May 4, 2002 and all references to "the first quarter of fiscal 2001" relate to the 13 weeks
ended May 5, 2001.

Note 2.    Common Stock and Earnings per Share

On October 31, 2001, our Board of Directors declared a two-for-one common stock split effected in the form of a stock dividend to
stockholders of record as of the close of business on November 12, 2001, payable on November 26, 2001. An amount equal to the par value of shares issued in the split has been transferred
from paid-in capital to the common stock account. All references to the number of shares of Common Stock (except for shares authorized), per share prices, and earnings per share amounts in
the consolidated financial statements and accompanying notes included in this Quarterly Report on Form 10-Q have been adjusted to reflect the split on a retroactive basis.

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The
following table sets forth the computation of basic and diluted earnings per common share:

|                           |                                                                                                            | Quarter Ended         
|-------------------------- | ---------------------------------------------------------------------------------------------------------- | ----------------------
|
|
|Numerator:                 |                                                                                                            |                       
|                           | Net income                                                                                                 |                       
|                           |                                                                                                            |                       
|Denominator:               |                                                                                                            |                       
|                           | Denominator for basic earnings per common share-weighted average shares                                    |                       
|                           | Effect of dilutive securities:                                                                             |                       
|                           |                                                                                                            | Employee stock options
|                           |                                                                                                            |                       
|                           | Denominator for diluted earnings per common share-weighted average shares adjusted for dilutive securities |                       
|                           |                                                                                                            |                       
|Earnings per common share: |                                                                                                            |                       
|                           | Basic                                                                                                      |                       
|                           |                                                                                                            |                       
|                           | Diluted                                                                                                    |                       
|                           |                                                                                                            |                       

Note 3.    Senior Notes

In July 2001, we issued $200 million in principal amount of 91/4% Senior Notes due July 1, 2009 in a private placement under
Securities and Exchange Commission Rule 144A to a limited number of qualified institutional buyers. The Senior Notes due 2009 are unsecured and interest thereon is payable
semi-annually on each January 1 and July 1, beginning on January 1, 2002. In August 2001, as required by the contract with the purchasers of the Senior Notes
due 2009, we made an offer to exchange all of the privately placed Senior Notes due 2009 for an equal principal amount of Senior Notes due 2009, which are registered with the Securities and Exchange
Commission and have substantially identical terms. As of October 1, 2001, all of the privately placed Senior Notes due 2009 were exchanged for registered Senior Notes due 2009.

Note 4.    Credit Agreement

Effective May 1, 2001, we signed a new $200 million unsecured revolving bank credit facility with Fleet National Bank and other lending
institutions, which replaced the previous $100 million unsecured revolving bank credit facility. The Credit Agreement had an original 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. Effective
May 24, 2002, pursuant to the terms of the Credit Agreement, our lenders agreed to extend the term of our Credit Agreement from April 30, 2004 to April 30, 2005.

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We
are in compliance with all terms and conditions of the Credit Agreement. No borrowings were outstanding under the Credit Agreement as of May 4, 2002 or at any time during the
first quarter of
fiscal 2002. 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 as of May 4, 2002). In the first quarter of fiscal 2001, borrowings under the Credit Agreement and the previous
$100 million bank credit facility 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

Raniwala Proceeding

On May 2, 2000, Taiyeb Raniwala, a former assistant manager of a Michaels store, filed a purported class action complaint against us, on behalf of Michaels
stores' former and current assistant store managers. The Raniwala Complaint was filed in the Alameda County Superior Court, California and alleged that we violated various California laws by
erroneously treating Michaels stores' assistant store managers as "exempt" employees who were not entitled to overtime compensation. Based on these allegations, the Raniwala Complaint asserted that
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 sought back wages, interest, penalties, and attorneys' fees.

On
June 6, 2001, we negotiated a tentative settlement of the purported class action with Raniwala. As a result, we recorded a litigation settlement charge of $3.2 million
in the first quarter of fiscal 2001, covering all claims, attorneys' fees, and estimated payroll taxes. The settlement, in exchange for a full release of claims, received final approval from the
Alameda County Superior Court on November 20, 2001, and as a result, the case against us was dismissed effective November 20, 2001. The distribution of the settlement proceeds was made
on January 19, 2002.

Collins Proceeding

On April 16, 1999, Suzanne Collins, a former assistant manager of our subsidiary, Aaron Brothers, Inc., filed a class action 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, 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
March 15, 2002, Aaron Brothers negotiated a definitive settlement of the purported class action with Collins, subject to final court approval. The Court granted preliminary
approval of the settlement on March 29, 2002. As a result, Aaron Brothers recorded a litigation settlement charge of

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$5.0 million in the fourth quarter of fiscal 2001, covering all claims, attorneys' fees, and estimated payroll taxes. On June 12, 2002, the Court approved the settlement and the
judgment was entered. The appeal period expires on August 12, 2002.

General

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 Collins proceeding 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 October 2001, the FASB issued SFAS No. 144,Accounting for the Impairment or Disposal of Long-Lived
Assets. SFAS No. 144 addresses the accounting and reporting for the impairment or disposal of long-lived assets and supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to Be Disposed of, and Accounting Principles Board
Opinion No. 30,Reporting the Results of OperationsReporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions. SFAS No. 144 establishes a single accounting model for long-lived assets to be disposed of by sale and resolves
implementation issues related to SFAS No. 121. SFAS No. 144 is effective for financial statements issued for fiscal years beginning after December 15, 2001. In the first quarter
of fiscal 2002, we adopted the provisions of SFAS No. 144, and they had no material impact on our consolidated operating results or financial position.

In
June 2001, the FASB issued SFAS No. 141,Business Combinations, and No. 142,Goodwill and
Other Intangible Assets, effective for fiscal years beginning after December 15, 2001. Under the provisions of SFAS No. 141 and No. 142, goodwill and
intangible assets deemed to have indefinite lives will no longer be amortized but will be subject to annual impairment tests. Other intangible assets with finite useful lives will continue to be
amortized over their useful lives. We adopted these provisions in the first quarter of fiscal 2002. During the first quarter of fiscal 2002, we performed the first of the required impairment tests of
goodwill and indefinite lived intangible assets, and the tests did not result in an impairment charge.

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The
following pro forma financial information reflects net income and diluted earnings per common share as if goodwill were not subject to amortization in the first quarter of fiscal
2001.

|                                     |                                            | Quarter Ended
|------------------------------------ | ------------------------------------------ | -------------
|
|
|Net income as reported               |                                            | $            
|Add back:                            |                                            |              
|                                     | Goodwill amortization, net of income taxes |              
|                                     |                                            |              
|Pro forma net income                 |                                            | $            
|                                     |                                            |              
|Pro forma earnings per common share: |                                            |              
|                                     | Basic                                      |              
|                                     |                                            |              
|                                     | Diluted                                    |              
|                                     |                                            |              

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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Certain statements contained in this discussion and analysis (or elsewhere in this Quarterly Report on Form 10-Q),
which are not historical facts, are forward-looking statements that reflect our plans, estimates, and beliefs. Words such as "anticipates," "plans," "expects," "believes," and similar expressions
often identify forward-looking statements. Our actual results could materially differ from those discussed in these forward-looking statements, which involve risks and uncertainties, including, but
not limited to, customer demand and trends in the arts and crafts industry, impact of competitors' locations, pricing, and products, related inventory risks due to shifts in customer demand, impact of
economic conditions, the availability of acceptable locations for new stores, difficulties in implementing information system technologies, supply constraints, results of financing efforts,
effectiveness of advertising strategies, and other risks detailed in our Securities and Exchange Commission filings.

All expressions of "us," "we," "our," and all similar expressions are references to Michaels Stores, Inc. and its consolidated wholly-owned subsidiaries,
unless otherwise expressly stated or the context otherwise requires.

Discussions relating to our Common Stock reflect the effects of the two-for-one Common Stock split effected in the form of a stock
dividend to stockholders of record as of the close of business on November 12, 2001.

General

All references herein to "fiscal 2002" relate to the 52 weeks ending February 1, 2003 and all references to "fiscal 2001" relate to the 52 weeks ended
February 2, 2002. In addition, all references herein to "the first quarter of fiscal 2002" relate to the 13 weeks ended May 4, 2002 and all references to "the first quarter of fiscal
2001" relate to the 13 weeks ended May 5, 2001.

The
following table sets forth certain of our unaudited operating data (dollar amounts in thousands):

|                                          |  | Quarter Ended |        
|----------------------------------------- |  | ------------- | -------
|
|Michaels stores:                          |  |               |        
|Retail stores open at end of period       |  |               | 713    
|Retail stores opened during the period    |  |               | 19     
|Retail stores closed during the period    |  |               | 1      
|Retail stores relocated during the period |  |               | 8      
|Aaron Brothers stores:                    |  |               |        
|Retail stores open at end of period       |  |               | 142    
|Retail stores opened during the period    |  |               | 3      
|Star Wholesale store:                     |  |               |        
|Wholesale store open at end of period     |  |               | 1      
|Other operating data:                     |  |               |        
|EBITDA(1)                                 |  | $             | 58,845 
|Adjusted EBITDA(2)                        |  |               | 58,845 
|Working capital                           |  |               | 615,498
|Comparable store sales increase(3)        |  |               | 5      

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(Notes on following page.)

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(Notes from table on preceding page.)

Results of Operations

The following table sets forth the percentage relationship to net sales of each line item of our unaudited 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 contained herein.

|                                             |  | Quarter Ended |  
|-------------------------------------------- |  | ------------- | -
|
|Net sales                                    |  | 100.0         | %
|Cost of sales and occupancy expense          |  | 65.8          |  
|                                             |  |               |  
|Gross profit                                 |  | 34.2          |  
|Selling, general, and administrative expense |  | 27.4          |  
|Store pre-opening costs                      |  | 0.3           |  
|Litigation settlement                        |  |              |  
|                                             |  |               |  
|Operating income                             |  | 6.5           |  
|Interest expense                             |  | 0.8           |  
|Other (income) and expense, net              |  | (0.1          | )
|                                             |  |               |  
|Income before income taxes                   |  | 5.8           |  
|Provision for income taxes                   |  | 2.4           |  
|                                             |  |               |  
|Net income                                   |  | 3.4           | %
|                                             |  |               |  

Quarter Ended May 4, 2002 Compared to the Quarter Ended May 5, 2001

Net sales for the first quarter of fiscal 2002 increased $78.5 million, or 15%, over the first quarter of fiscal 2001. At the end of the first quarter of
fiscal 2002, we operated 713 Michaels and 142 Aaron
Brothers retail stores. The results for the first quarter of fiscal 2002 included sales from 78 Michaels and 19 Aaron Brothers retail stores that were opened during the 12-month period
ended May 4, 2002,

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more than offsetting lost sales from the closure of nine Michaels stores. Sales at the new stores (net of closures) during the first quarter of fiscal 2002 accounted for $51.4 million of the
increase in net sales. Comparable store sales increased 5% in the first quarter of fiscal 2002 compared to the first quarter of fiscal 2001, which contributed $26.0 million to the net sales
increase. The improvement in comparable store sales was due to a strong performance in our core categories of apparel crafts, books, kid's crafts, art supplies, ribbon, general crafts, and stitchery.
Going forward, we expect to achieve comparable store sales increases for the remainder of fiscal 2002, 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 our stores, and the
success of our sales promotion efforts.

Cost
of sales and occupancy expense, as a percentage of net sales, for the first quarter of fiscal 2002 was 65.8%, a decrease of 0.4% compared to the first quarter of fiscal 2001. This
decrease was primarily attributable to improved merchandise margins and a leveraging of occupancy expense on higher average net sales per store compared with the first quarter of fiscal 2001.

Selling,
general, and administrative expense was $165.4 million, or 27.4% of net sales, in the first quarter of fiscal 2002 compared with $156.4 million, or 29.8% of net
sales, in the first quarter of fiscal 2001, which includes one-time costs of $1.3 million related to senior executive severance. Excluding this one-time severance
charge, selling, general, and administrative expense was $155.1 million, or 29.6% of net sales, in the first quarter of fiscal 2001. The decrease as a percentage of net sales to 27.4% in the
first quarter of fiscal 2002 from 29.6% in the first quarter of fiscal 2001 was due in part to a decrease in net advertising expense as a result of fewer promotional events and higher
co-op advertising income recognized in the first quarter of fiscal 2002 compared with the first quarter of fiscal 2001. In addition, payroll and related expenses decreased as a percentage
of net sales as a result of our higher average net sales per store compared with the first quarter of fiscal 2001. Furthermore, as a result of our adoption of the provisions of SFAS No. 142 in
the first quarter of fiscal 2002, amortization expense decreased $921,000 in the first quarter of fiscal 2002 compared with the first quarter of fiscal 2001.

Store
pre-opening costs remained relatively constant at 0.3% of net sales for both the first quarter of fiscal 2002 and the first quarter of fiscal 2001. In the first quarter
of fiscal 2002, we opened or relocated 27 Michaels and three Aaron Brothers stores compared to 20 Michaels and four Aaron Brothers stores opened or relocated in the first quarter of fiscal 2001.

On
June 6, 2001, we negotiated a tentative settlement of the purported class action with one of our former assistant managers, Taiyeb Raniwala. As a result, we recorded a
litigation settlement charge of $3.2 million in the first quarter of fiscal 2001, covering all claims, attorneys' fees, and estimated payroll taxes. The settlement, in exchange for a full
release of claims, received final approval from the court on November 20, 2001.

Operating
income increased by 3.4%, as a percentage of net sales, to $39.3 million in the first quarter of fiscal 2002 compared with $16.1 million for the first quarter of
fiscal 2001. Operating income for the first quarter of fiscal 2001 was negatively impacted by one-time severance costs of $1.3 million and the litigation settlement charge of
$3.2 million. Excluding the effects of the one-time severance charge and the litigation settlement charge in the first quarter of fiscal 2001, operating income increased 91% from
$20.6 million, or 3.9% of net sales, in the first quarter of fiscal 2001.

Interest
expense (net of interest income) increased to $4.2 million, or 0.7% of net sales, in the first quarter of fiscal 2002 from $3.7 million, or 0.7% of net sales, in
the first quarter of fiscal 2001 as a result of higher interest expense on the $200 million of 91/4% Senior Notes due July 1, 2009, which were issued in July 2001,
compared to the $125 million of 107/8% Senior Notes due 2006, which were redeemed in August 2001. This increase was partially offset by higher interest income in the first
quarter of fiscal 2002 as a result of larger invested cash balances compared to the first quarter of fiscal 2001.

13

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The
effective tax rate was 41% for both the first quarter of fiscal 2002 and the first quarter of fiscal 2001.

Net
income for the first quarter of fiscal 2002 was $20.7 million, or $0.29 per diluted share, compared to $7.3 million, or $0.11 per diluted share, for the first quarter
of fiscal 2001. Excluding the effects of the one-time severance charge and the litigation settlement charge, net income for the first quarter of fiscal 2001 was $9.9 million, or
$0.15 per diluted share.

Liquidity and Capital Resources

Changes in Cash and Equivalents

Cash flow used in operating activities during the first quarter of fiscal 2002 was $3.2 million, compared to $24.8 million during the first quarter
of fiscal 2001. The decrease in cash used in operating activities of $21.6 million, from the first quarter of fiscal 2001 to the first quarter of fiscal 2002, was primarily attributable to an
increase in net income of $13.4 million and the change in merchandise inventories net of the change in accounts payable of $44.3 million, partially offset by the increase in the change
in income taxes payable and accrued liabilities of $38.9 million. Inventories per Michaels store of $1.027 million at May 4, 2002 decreased 7.1% from $1.106 million at
May 5, 2001. We anticipate average inventory per Michaels store to increase 4% to 6% by the end of fiscal 2002.

Cash
flow used in investing activities in the first quarter of fiscal 2002 was $38.9 million compared to $19.0 million in the first quarter of fiscal 2001. Cash flow from
investing activities in the first quarter of fiscal 2002 was due in part to capital expenditures related to the completion of our new Hazleton, Pennsylvania distribution center, the expansion of our
Lancaster, California distribution center, and the opening of 19 Michaels and three Aaron Brothers stores and the relocation of eight Michaels stores in the first quarter of fiscal 2002.

The
following table sets forth capital expenditures for the first quarter of fiscal 2002 and the first quarter of fiscal 2001 (unaudited):

|                                                   |  | Quarter Ended
|-------------------------------------------------- |  | -------------
|
|
|New and relocated stores and stores not yet opened |  | $            
|Existing stores                                    |  |              
|Distribution system expansion                      |  |              
|Information systems                                |  |              
|Corporate and other                                |  |              
|                                                   |  |              
|                                                   |  | $            
|                                                   |  |              

We
anticipate capital expenditures for fiscal 2002 to total approximately $150.0 million. In fiscal 2002, we plan to open approximately 65 Michaels and approximately 15 Aaron
Brothers stores.

Cash
flow provided by financing activities in the first quarter of fiscal 2002 was $9.4 million compared to $37.0 million in the first quarter of fiscal 2001. The decrease
in cash provided by financing activities was primarily due to a decrease in borrowings against our revolving bank credit facility from the first quarter of fiscal 2001 to the first quarter of fiscal
2002. This decrease in cash provided by financing activities was partially offset by an increase in the proceeds from the exercise of stock options. Proceeds from the exercise of stock options were
$9.2 million for approximately 592,000 shares of our Common Stock in the first quarter of fiscal 2002 and $7.8 million for approximately 651,000 shares of our Common Stock in the first
quarter of fiscal 2001.

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Bank Credit Facility

Effective May 1, 2001, we signed a new $200 million unsecured revolving bank credit facility with Fleet National Bank and other lending
institutions, which replaced the previous $100 million unsecured revolving bank credit facility. The Credit Agreement had an original 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. Effective
May 24, 2002, pursuant to the terms of the Credit Agreement, our lenders agreed to extend the term of our Credit Agreement from April 30, 2004 to April 30, 2005.

We
are in compliance with all terms and conditions of the Credit Agreement. No borrowings were outstanding under the Credit Agreement as of May 4, 2002 or at any time during the
first quarter of fiscal 2002. 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 as of May 4, 2002, and increased to $16.7 million as of May 28, 2002). In the
first quarter of fiscal 2001, borrowings under the Credit Agreement and the previous $100 million bank credit facility were outstanding for 79 days, with average outstanding borrowings
of $13.0 million and a weighted average interest rate of 7.33%.

General

On October 31, 2001, our Board of Directors declared a two-for-one common stock split effected in the form of a stock dividend to
stockholders of record as of the close of business on November 12, 2001, payable on November 26, 2001. An amount equal to the par value of shares issued in the split has been transferred
from paid-in capital to the common stock account.

In
July 2001, we issued $200 million in principal amount of the 91/4% Senior Notes due 2009 in a private placement under Securities and Exchange Commission
Rule 144A to a limited number of qualified institutional buyers. The Senior Notes due 2009 are unsecured and interest thereon is payable
semi-annually on each January 1 and July 1, beginning on January 1, 2002. In August 2001, as required by the contract with the purchasers of the Senior Notes
due 2009, we made an offer to exchange all of the privately placed Senior Notes due 2009 for an equal principal amount of Senior Notes due 2009, which are registered with the Securities and Exchange
Commission and have substantially identical terms. As of October 1, 2001, all of the privately placed Senior Notes due 2009 were exchanged for registered Senior Notes due 2009.

On
December 14, 2000, our Board of Directors authorized the repurchase of 2.0 million shares of our outstanding Common Stock. Under the agreements governing our outstanding
indebtedness, we can only repurchase shares of our Common Stock if we maintain or comply with specified financial ratios and other covenants. While we are in full compliance with the covenants of our
outstanding indebtedness, we made no purchases of shares of our Common Stock during the first quarter of fiscal 2002. As of May 4, 2002, we have repurchased and retired 1.05 million
shares under this plan at an average cost of $16.34 per share. We may also be restricted by regulations of the Securities and Exchange Commission from making future repurchases during certain time
periods.

We
believe that our available cash, funds generated by operating activities, funds available under the Credit Agreement, net proceeds from the Senior Notes due 2009, and proceeds from
the exercise of stock options will be sufficient to fund anticipated capital expenditures, working capital requirements, and any stock repurchases for the foreseeable future.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

We have market risk exposure arising from changes in interest rates. The interest rates on our Credit Agreement are repriced frequently, at market prices, which
would result in carrying amounts that approximate fair value. We had no borrowings outstanding under our Credit Agreement at May 4, 2002. In July 2001, we issued $200 million of
the Senior Notes due 2009 with a fixed interest rate of 91/4%. In August 2001, we used a portion of the proceeds from the Senior Notes due 2009 to redeem the Senior Notes due
2006. Generally, the fair market value of our fixed interest rate long-term debt will increase as interest rates fall and decrease as interest rates rise. Our market risk is described in
more detail in our Annual Report on Form 10-K for the fiscal year ended February 2, 2002.

15

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MICHAELS STORES, INC.    Part IIOTHER INFORMATION

Item 1. Legal Proceedings.

Collins Proceeding

On April 16, 1999, Suzanne Collins, a former assistant manager of our subsidiary, Aaron Brothers, Inc., filed a class action 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, 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
March 15, 2002, Aaron Brothers negotiated a definitive settlement of the purported class action with Collins, subject to final court approval. The Court granted preliminary
approval of the settlement on March 29, 2002. As a result, Aaron Brothers recorded a litigation settlement charge of $5.0 million in the fourth quarter of fiscal 2001, covering all
claims, attorneys' fees, and estimated payroll taxes. On June 12, 2002, the Court approved the settlement and the judgment was entered. The appeal period expires on August 12, 2002.

General

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.

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Item 6. Exhibits and Reports on Form 8-K.

|(a) |  | Exhibits:
|--- |  | ---------
|    |  | 10.1     
|    |  | 10.2     
|    |  | 10.3     

|(b) |  | Reports on Form 8-K:
|--- |  | --------------------
|    |  | 1.                  
|    |  | 2.                  
|    |  | 3.                  

17

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MICHAELS STORES, INC.  SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.

| |  | MICHAELS STORES, INC.
| |  | ---------------------
| |  | By:                  

Dated: June 18, 2002

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INDEX TO EXHIBITS

|Exhibits |  |                                                                                                                                                           
|-------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------
|10.1     |  | First Amendment to Michaels Stores, Inc. Deferred Compensation Plan, as amended and restated as of January 1, 2002, dated April 30, 2002 (filed herewith).
|10.2     |  | First Amendment to the Michaels Stores, Inc. Employees 401(k) Plan, as amended and restated, dated December 5, 2001 (filed herewith).                     
|10.3     |  | Second Amendment to Michaels Stores, Inc. Employees 401(k) Plan, as amended and restated, dated January 17, 2002 (filed herewith).                        

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