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)

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

For the quarterly period ended November 3, 2001

OR

|/ / | 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 0-11822

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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 /x/  No / /

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
December 11, 2001Common Stock, par value $.10 per share

65,646,980


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



|Item 1.                   |  | Financial Statements                                                                                              |  |   
|------------------------- |  | ----------------------------------------------------------------------------------------------------------------- |  | --
|                          |  | Consolidated Balance Sheets at November 3, 2001 (unaudited) and February 3, 2001                                  |  | 3 
|                          |  | Consolidated Statements of Income for the three months ended November 3, 2001 and October 28, 2000 (unaudited)    |  | 4 
|                          |  | Consolidated Statements of Income for the nine months ended November 3, 2001 and October 28, 2000 (unaudited)     |  | 5 
|                          |  | Consolidated Statements of Cash Flows for the nine months ended November 3, 2001 and October 28, 2000 (unaudited) |  | 6 
|                          |  | Notes to Consolidated Financial Statements (unaudited)                                                            |  | 7 
|Item 2.                   |  | Management's Discussion and Analysis of Financial Condition and Results of Operations                             |  | 12
|Item 3.                   |  | Quantitative and Qualitative Disclosures About Market Risk                                                        |  | 19
|Part IIOTHER INFORMATION
|Item 1.                   |  | Legal Proceedings                                                                                                 |  | 20
|Item 4.                   |  | Submission of Matters to a Vote of Security Holders                                                               |  | 21
|Item 6.                   |  | Exhibits and Reports on Form 8-K                                                                                  |  | 22
|Signatures                |  | 23                                                                                                               

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)

|                                                          |                                                                                                                                                                 | November 3,
2001            |           | February 3,
2001 |        
|--------------------------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------- | --------- | ---------------- | -------
|
|ASSETS                                                    |                                                                                                                                                                 |                             |           |                 
|Current assets:                                           |                                                                                                                                                                 |                             |           |                  |        
|                                                          | Cash and equivalents                                                                                                                                            |                             | $         | 45,991           |        
|                                                          | Merchandise inventories                                                                                                                                         |                             |           | 900,311          |        
|                                                          | Prepaid expenses and other                                                                                                                                      |                             |           | 16,084           |        
|                                                          | Deferred income taxes and income taxes receivable                                                                                                               |                             |           | 18,203           |        
|                                                          |                                                                                                                                                                 |                             |           |                  |        
|                                                          |                                                                                                                                                                 | Total current assets        |           |                  | 980,589
|                                                          |                                                                                                                                                                 |                             |           |                  |        
|Property and equipment, at cost                           |                                                                                                                                                                 |                             | 589,869   |                  |        
|Less accumulated depreciation                             |                                                                                                                                                                 |                             | (277,345  | )                |        
|                                                          |                                                                                                                                                                 |                             |           |                  |        
|                                                          |                                                                                                                                                                 |                             | 312,524   |                  |        
|                                                          |                                                                                                                                                                 |                             |           |                  |        
|Costs in excess of net assets of acquired operations, net |                                                                                                                                                                 |                             | 118,428   |                  |        
|Other assets                                              |                                                                                                                                                                 |                             | 8,383     |                  |        
|                                                          |                                                                                                                                                                 |                             |           |                  |        
|                                                          |                                                                                                                                                                 |                             | 126,811   |                  |        
|                                                          |                                                                                                                                                                 |                             |           |                  |        
|Total assets                                              |                                                                                                                                                                 | $                           | 1,419,924 |                  | $      
|                                                          |                                                                                                                                                                 |                             |           |                  |        
|LIABILITIES AND STOCKHOLDERS' EQUITY                      |                                                                                                                                                                 |                             |           |                 
|Current liabilities:                                      |                                                                                                                                                                 |                             |           |                  |        
|                                                          | Accounts payable                                                                                                                                                |                             | $         | 194,848          |        
|                                                          | Accrued liabilities and other                                                                                                                                   |                             |           | 181,401          |        
|                                                          | Borrowings under line of credit                                                                                                                                 |                             |           | 45,000           |        
|                                                          | Income taxes payable                                                                                                                                            |                             |           |                 |        
|                                                          |                                                                                                                                                                 |                             |           |                  |        
|                                                          |                                                                                                                                                                 | Total current liabilities   |           |                  | 421,249
|                                                          |                                                                                                                                                                 |                             |           |                  |        
|91/4% Senior Notes due 2009                               |                                                                                                                                                                 |                             | 200,000   |                  |        
|107/8% Senior Notes due 2006                              |                                                                                                                                                                 |                             |          |                  |        
|Deferred income taxes                                     |                                                                                                                                                                 |                             | 18,269    |                  |        
|Other long-term liabilities                               |                                                                                                                                                                 |                             | 22,468    |                  |        
|                                                          |                                                                                                                                                                 |                             |           |                  |        
|                                                          |                                                                                                                                                                 | Total long-term liabilities |           |                  | 240,737
|                                                          |                                                                                                                                                                 |                             |           |                  |        
|                                                          |                                                                                                                                                                 |                             | 661,986   |                  |        
|                                                          |                                                                                                                                                                 |                             |           |                  |        
|Commitments and contingencies                             |                                                                                                                                                                 |                             |           |                  |        
|Stockholders' equity:                                     |                                                                                                                                                                 |                             |           |                  |        
|                                                          | Common stock, $.10 par value, 150,000,000 shares authorized; shares issued and outstanding of 65,608,896 at November 3, 2001 and 63,673,680 at February 3, 2001 |                             |           | 6,561            |        
|                                                          | Additional paid-in capital                                                                                                                                      |                             |           | 456,267          |        
|                                                          | Retained earnings                                                                                                                                               |                             |           | 295,110          |        
|                                                          |                                                                                                                                                                 |                             |           |                  |        
|                                                          |                                                                                                                                                                 | Total stockholders' equity  |           |                  | 757,938
|                                                          |                                                                                                                                                                 |                             |           |                  |        
|Total liabilities and stockholders' equity                |                                                                                                                                                                 | $                           | 1,419,924 |                  | $      
|                                                          |                                                                                                                                                                 |                             |           |                  |        

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)

|                                                                                 |         | Three Months Ended |        
|-------------------------------------------------------------------------------- | ------- | ------------------ | -------
|
|Net sales                                                                        |         | $                  | 611,911
|Cost of sales and occupancy expense                                              |         |                    | 396,060
|                                                                                 |         |                    |        
|Gross profit                                                                     |         |                    | 215,851
|Selling, general, and administrative expense                                     |         |                    | 172,612
|Store pre-opening costs                                                          |         |                    | 5,298  
|                                                                                 |         |                    |        
|Operating income                                                                 |         |                    | 37,941 
|Interest expense                                                                 |         |                    | 6,064  
|Other (income) and expense, net                                                  |         |                    | (33    
|                                                                                 |         |                    |        
|Income before income taxes and extraordinary loss                                |         |                    | 31,910 
|Provision for income taxes                                                       |         |                    | 13,090 
|                                                                                 |         |                    |        
|Income before extraordinary loss                                                 |         |                    | 18,820 
|Extraordinary loss for early extinguishment of debt, net of income
tax of $3,695 |         |                    | 5,318  
|                                                                                 |         |                    |        
|Net income                                                                       |         | $                  | 13,502 
|                                                                                 |         |                    |        
|Earnings per common share excluding the extraordinary loss:                      |         |                    |        
|                                                                                 | Basic   |                    | $      
|                                                                                 |         |                    |        
|                                                                                 | Diluted |                    | $      
|                                                                                 |         |                    |        
|Earnings per common share including the extraordinary loss:                      |         |                    |        
|                                                                                 | Basic   |                    | $      
|                                                                                 |         |                    |        
|                                                                                 | Diluted |                    | $      
|                                                                                 |         |                    |        

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)

|                                                                                                       |         | Nine Months Ended |          
|------------------------------------------------------------------------------------------------------ | ------- | ----------------- | ---------
|
|Net sales                                                                                              |         | $                 | 1,622,709
|Cost of sales and occupancy expense                                                                    |         |                   | 1,070,065
|                                                                                                       |         |                   |          
|Gross profit                                                                                           |         |                   | 552,644  
|Selling, general, and administrative expense                                                           |         |                   | 472,896  
|Store pre-opening costs                                                                                |         |                   | 9,023    
|Litigation settlement                                                                                  |         |                   | 3,153    
|                                                                                                       |         |                   |          
|Operating income                                                                                       |         |                   | 67,572   
|Interest expense                                                                                       |         |                   | 15,796   
|Other (income) and expense, net                                                                        |         |                   | (409     
|                                                                                                       |         |                   |          
|Income before income taxes, extraordinary loss, and cumulative effect of accounting change             |         |                   | 52,185   
|Provision for income taxes                                                                             |         |                   | 21,403   
|                                                                                                       |         |                   |          
|Income before extraordinary loss and cumulative effect of accounting
change                            |         |                   | 30,782   
|Extraordinary loss for early extinguishment of debt, net of income
tax of $3,695                       |         |                   | 5,318    
|Cumulative effect of accounting change for revenue recognition, net of income tax of $1,235            |         |                   |         
|                                                                                                       |         |                   |          
|Net income                                                                                             |         | $                 | 25,464   
|                                                                                                       |         |                   |          
|Earnings per common share excluding the extraordinary loss and cumulative effect of accounting change: |         |                   |          
|                                                                                                       | Basic   |                   | $        
|                                                                                                       |         |                   |          
|                                                                                                       | Diluted |                   | $        
|                                                                                                       |         |                   |          
|Earnings per common share including the extraordinary loss and cumulative effect of accounting change: |         |                   |          
|                                                                                                       | Basic   |                   | $        
|                                                                                                       |         |                   |          
|                                                                                                       | Diluted |                   | $        
|                                                                                                       |         |                   |          

See
accompanying notes to consolidated financial statements.

5

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

|                                                |                                                       | Nine Months Ended                                         |                                
|----------------------------------------------- | ----------------------------------------------------- | --------------------------------------------------------- | -------------------------------
|
|Operating activities:                           |                                                       |                                                           |                                
|                                                | Net income                                            |                                                           | $                              
|                                                | Adjustments:                                          |                                                           |                                
|                                                |                                                       | Depreciation                                              |                                
|                                                |                                                       | Amortization                                              |                                
|                                                |                                                       | Extraordinary loss for early extinguishment of debt       |                                
|                                                |                                                       | Other                                                     |                                
|                                                |                                                       | Change in assets and liabilities, excluding acquisitions: |                                
|                                                |                                                       |                                                           | 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                   |                                                           |                                
|                                                | Proceeds from sale/leaseback transaction              |                                                           |                                
|                                                | Net proceeds from sales of property and equipment     |                                                           |                                
|                                                | Acquisitions                                          |                                                           |                                
|                                                |                                                       |                                                           |                                
|                                                |                                                       |                                                           |                                
|                                                |                                                       |                                                           |                                
|Financing activities:                           |                                                       |                                                           |                                
|                                                | Proceeds from issuance of 91/4% Senior Notes due 2009 |                                                           |                                
|                                                | Redemption of 107/8% Senior Notes due 2006            |                                                           |                                
|                                                | Redemption of convertible subordinated notes          |                                                           |                                
|                                                | Net borrowings under line of credit                   |                                                           |                                
|                                                | Acquisition of treasury stock                         |                                                           |                                
|                                                | Proceeds from stock options exercised                 |                                                           |                                
|                                                | Proceeds from issuance of common stock and other      |                                                           |                                
|                                                | Payment of other long-term liabilities                |                                                           |                                
|                                                |                                                       |                                                           |                                
|                                                |                                                       |                                                           |                                
|                                                |                                                       |                                                           |                                
|Net increase (decrease) in cash and equivalents |                                                       |                                                           | 17,800                         
|Cash and equivalents at beginning of period     |                                                       |                                                           | 28,191                         
|                                                |                                                       |                                                           |                                
|Cash and equivalents at end of period           |                                                       | $                                                         | 45,991                         
|                                                |                                                       |                                                           |                                

See
accompanying notes to consolidated financial statements.

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MICHAELS STORES, INC.        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS        For the Nine Months Ended November 3, 2001        (Unaudited)

Note 1.  Basis of Presentation

The consolidated financial statements include the accounts of Michaels Stores, Inc. and its 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 its 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 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 13 and 39 weeks ended November 3, 2001 are not
indicative of the results to be expected for the entire year.

The
balance sheet at February 3, 2001 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by
generally accepted accounting principles for complete financial statements. For further information, refer to the consolidated financial statements and footnotes thereto included in our 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 third quarter of fiscal 2001" and "the first nine months of fiscal 2001" relate to the 13 and 39 weeks ended November 3, 2001, respectively, and all
references to "the third quarter of fiscal 2000" and "the first nine months of fiscal 2000" relate to the 13 and 39 weeks ended October 28, 2000, respectively.

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:

|                                   |                                                                                                     | Three Months Ended     |   | Nine Months Ended |      
|---------------------------------- | --------------------------------------------------------------------------------------------------- | ---------------------- | - | ----------------- | -----
|
|
|Numerator:                         |                                                                                                     |                        |   |                   |      
|                                   | Income before extraordinary loss and cumulative effect of accounting change                         |                        | $ | 18,820            |      
|                                   | Extraordinary loss, net of income tax                                                               |                        |   | 5,318             |      
|                                   | Cumulative effect of accounting change, net of income tax                                           |                        |   |                  |      
|                                   |                                                                                                     |                        |   |                   |      
|                                   | Net income                                                                                          |                        | $ | 13,502            |      
|                                   |                                                                                                     |                        |   |                   |      
|Denominator:                       |                                                                                                     |                        |   |                   |      
|                                   | Denominator for basic earnings per share-weighted average shares                                    |                        |   | 65,052            |      
|                                   | Effect of dilutive securities:                                                                      |                        |   |                   |      
|                                   |                                                                                                     | Employee stock options |   |                   | 1,854
|                                   |                                                                                                     |                        |   |                   |      
|                                   | Denominator for diluted earnings per share-weighted average shares adjusted for dilutive securities |                        |   | 66,906            |      
|                                   |                                                                                                     |                        |   |                   |      
|Basic earnings per common share:   |                                                                                                     |                        |   |                   |      
|                                   | Income before extraordinary loss and cumulative effect of accounting change                         |                        | $ | 0.29              |      
|                                   | Extraordinary loss                                                                                  |                        |   | (0.08             | )    
|                                   | Cumulative effect of accounting change                                                              |                        |   |                  |      
|                                   |                                                                                                     |                        |   |                   |      
|                                   | Net income                                                                                          |                        | $ | 0.21              |      
|                                   |                                                                                                     |                        |   |                   |      
|Diluted earnings per common share: |                                                                                                     |                        |   |                   |      
|                                   | Income before extraordinary loss and cumulative effect of accounting change                         |                        | $ | 0.28              |      
|                                   | Extraordinary loss                                                                                  |                        |   | (0.08             | )    
|                                   | Cumulative effect of accounting change                                                              |                        |   |                  |      
|                                   |                                                                                                     |                        |   |                   |      
|                                   | Net income                                                                                          |                        | $ | 0.20              |      
|                                   |                                                                                                     |                        |   |                   |      

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.

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On August 6, 2001, we used a portion of the proceeds of the Senior Notes due 2009 offering described above to redeem our 107/8% Senior Notes due June 15,
2006, of which $125 million in aggregate principal amount was then outstanding. The redemption price was $1,054.38 per $1,000 principal amount of the Senior Notes due 2006, plus accrued
interest through August 6, 2001. We incurred an extraordinary loss from the early extinguishment of debt in the amount of $5.3 million, net of income tax, in the third quarter of fiscal
2001.

Note 4.  Change in Accounting Principle

Effective October 29, 2000, we changed our 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, we 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, we now effectively recognize 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, we have given retroactive effect to this change in accounting principle by
restatement of our previously published financial statements for the third quarter and the first nine months of fiscal 2000. The effect of the change on the third quarter and the first nine months of
fiscal 2000 was to reduce net sales by $769,000 and $3.5 million, respectively, and reduce income before the cumulative effect of the accounting change by $266,000 and $993,000, respectively.

Note 5.  Credit Agreement

Effective May 1, 2001, we completed a new $200 million unsecured bank credit facility with Fleet National Bank and other lending institutions,
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 we elect 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 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 we would otherwise be obligated to pay on such borrowings. We are required to pay a facility

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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 that vary depending on the fixed charge coverage ratio.

We
are in compliance with all terms and conditions of the Credit Agreement. Borrowings outstanding under the Credit Agreement were $45.0 million as of November 3, 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 November 3, 2001).
Borrowings under the Credit Agreement and the previous $100 million bank credit facility in the first nine months of fiscal 2001 were outstanding for 230 days, with average outstanding
borrowings of $11.1 million and a weighted average interest rate of 5.2%.

Note 6.  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 alleges that we violated various California laws by
erroneously treating Michaels stores' assistant store managers as "exempt" employees who are not entitled to overtime compensation. Based on these allegations, the Raniwala Complaint asserts 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 seeks back wages, interest, penalties, and
attorneys' fees.

On
July 20, 2000, Raniwala filed an amended complaint to correct certain deficiencies in the original 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. 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. The distribution of the settlement proceeds must be made by January 19, 2002. The Alameda County Superior Court has
dismissed the case against us, effective November 20, 2001.

Collins Proceeding

On April 14, 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

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(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 Aaron Brothers' 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.

On
November 28, 2001, the court established January 31, 2002 as the deadline, by which time the plaintiff must either file a motion for class certification or
file a motion for preliminary approval of any settlement which may be agreed to by the parties. A trial date has not yet been scheduled.

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.

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.

Note 7.  Recent Accounting Pronouncements

In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards 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 will adopt these provisions in the
first quarter of fiscal 2002. Application of these non-amortization provisions in fiscal 2001 would have resulted in an increase in net income of $566,000, or $0.01 per diluted share, in
the third quarter of fiscal 2001 and $1.7 million, or $0.03 per diluted share, for the first nine months of fiscal 2001. During fiscal 2002, we will perform the first of the required impairment
tests of goodwill and indefinite lived intangible assets as of February 2, 2002 and have not yet determined what the effect of these tests will be. However, we believe the adoption of the
provisions of SFAS No. 141 and No. 142 will not have a materially adverse impact on our operating results or financial position.

In
June 1998, the FASB issued 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. We adopted the requirements of SFAS No. 133
beginning in fiscal 2001. The adoption of SFAS No. 133 had no material impact on our operating results or financial position for the third quarter or the first nine months of fiscal 2001.

11

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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 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 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.

Unless otherwise noted, discussions relating to 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 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 third quarter of fiscal 2001" and "the first nine months of fiscal 2001" relate to the 13 and 39 weeks ended November 3,
2001, respectively, and all references to "the third quarter of fiscal 2000" and "the first nine months of fiscal 2000" relate to the 13 and 39 weeks ended October 28, 2000, respectively.

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

|                                           |  | Three Months Ended |         | Nine Months Ended |  
|------------------------------------------ |  | ------------------ | ------- | ----------------- | -
|
|Michaels stores:                           |  |                    |         |                   |  
|Retail stores open at end of period        |  |                    | 694     |                   |  
|Retail stores opened during the period     |  |                    | 37      |                   |  
|Retail stores closed during the period     |  |                    |        |                   |  
|Retail stores relocated during the period  |  |                    | 9       |                   |  
|Aaron Brothers stores:                     |  |                    |         |                   |  
|Retail stores open at end of period        |  |                    | 134     |                   |  
|Retail stores opened during the period     |  |                    | 6       |                   |  
|Retail stores relocated during the period  |  |                    | 3       |                   |  
|Star Wholesale store:                      |  |                    |         |                   |  
|Wholesale store open at end of period      |  |                    | 1       |                   |  
|Wholesale store acquired during the period |  |                    |        |                   |  
|Other Operating Data:                      |  |                    |         |                   |  
|EBITDA(1)                                  |  | $                  | 55,171  |                   | $
|Adjusted EBITDA(2)                         |  |                    | 55,171  |                   |  
|Working capital                            |  |                    | 559,340 |                   |  
|Comparable store sales increase(3)         |  |                    | 7       | %                 |  

---

(Notes on following page.)

12

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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 and related notes, included herein.

|                                                                                           |  | Three Months Ended |   | Six Months Ended |  
|------------------------------------------------------------------------------------------ |  | ------------------ | - | ---------------- | -
|
|Net sales                                                                                  |  | 100.0              | % | 100.0            | %
|Cost of sales and occupancy expense                                                        |  | 64.7               |   | 65.5             |  
|                                                                                           |  |                    |   |                  |  
|Gross profit                                                                               |  | 35.3               |   | 34.5             |  
|Selling, general, and administrative expense                                               |  | 28.2               |   | 28.2             |  
|Store pre-opening costs                                                                    |  | 0.9                |   | 0.7              |  
|Litigation settlement                                                                      |  |                   |   |                 |  
|                                                                                           |  |                    |   |                  |  
|Operating income                                                                           |  | 6.2                |   | 5.6              |  
|Interest expense                                                                           |  | 1.0                |   | 0.7              |  
|Other (income) and expense, net                                                            |  | (0.0               | ) | (0.1             | )
|                                                                                           |  |                    |   |                  |  
|Income before income taxes, extraordinary loss, and cumulative effect of accounting change |  | 5.2                |   | 5.0              |  
|Provision for income taxes                                                                 |  | 2.1                |   | 2.0              |  
|                                                                                           |  |                    |   |                  |  
|Income before extraordinary loss and cumulative effect of accounting change                |  | 3.1                |   | 3.0              |  
|Extraordinary loss for early extinguishment of debt, net of income tax                     |  | 0.9                |   |                 |  
|Cumulative effect of accounting change for revenue recognition, net of income tax          |  |                   |   |                 |  
|                                                                                           |  |                    |   |                  |  
|Net income                                                                                 |  | 2.2                | % | 3.0              | %
|                                                                                           |  |                    |   |                  |  

Quarter Ended November 3, 2001 Compared to the Quarter Ended October 28, 2000

Net sales for the third quarter of fiscal 2001 increased $86.2 million, or 16%, over the third quarter of fiscal 2000. At the end of the third quarter
of fiscal 2001, we operated 694 Michaels and 134

13

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Aaron Brothers retail stores. The results for the third quarter of fiscal 2001 included sales from 74 Michaels and 22 Aaron Brothers retail stores that were opened during the 12-month
period ended November 3, 2001, more than offsetting lost sales from one Michaels and one Aaron Brothers store closures. Sales at the new stores (net of closures) during the third quarter of
fiscal 2001 accounted for $52.6 million of the increase in net sales. Comparable store sales increased 7% in the third quarter of fiscal 2001 compared to the third quarter of fiscal 2000, which
contributed $37.8 million to the net sales increase. The improvement in comparable store sales was due to a strong performance in our core categories of Fall, Halloween, and Christmas seasonal
products as well as general crafts, ribbon, party, kids crafts, framing, and needlework. 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 point-of-sale 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 accounted for a $4.2 million decrease in net sales over the third quarter of fiscal 2000. 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.

Cost
of sales and occupancy expense, as a percentage of net sales, for the third quarter of fiscal 2001 was 64.7%, a decrease of 0.8% compared to the third quarter of fiscal 2000.
This decrease was primarily attributable to improved merchandise margins compared to the third quarter of fiscal 2000.

Selling,
general, and administrative expense remained relatively constant as a percentage of net sales for the third quarter of fiscal 2000 compared to the third quarter of fiscal
2001. Advertising costs in the third quarter of fiscal 2001 were higher as a percentage of net sales compared with the third quarter of fiscal 2000, offset by the leveraging of store payroll and
related expenses on increased sales.

Store
pre-opening costs, as a percentage of net sales, increased by 0.2% in the third quarter of fiscal 2001 compared to the third quarter of fiscal 2000. In the third
quarter of fiscal 2001, we opened or relocated 46 Michaels and nine Aaron Brothers stores compared to 33 Michaels and 11 Aaron Brothers stores opened or relocated in the third quarter of fiscal 2000.

Operating
income increased by 0.6%, as a percentage of net sales, to $37.9 million in the third quarter of fiscal 2001 compared to $29.3 million for the third quarter of
fiscal 2000, on a 16% increase in net sales during the same period.

Interest
expense (net of interest income), as a percentage of net sales, increased by 0.4% in the third quarter of fiscal 2001 compared to the third quarter of fiscal 2000. This
increase resulted principally from an increased debt level related to the 91/4% Senior Notes due July 1, 2009, which were issued in July 2001, and interest on higher
outstanding borrowings against the Credit Agreement during the third quarter of fiscal 2001.

The
effective tax rate was 41% for the third quarter of fiscal 2001 and 40% for the third quarter of fiscal 2000.

On
August 6, 2001, we redeemed our 107/8% Senior Notes due June 15, 2006 in aggregate principal amount of $125 million. As a result, we recorded an
extraordinary loss from the early extinguishment of debt in the amount of $5.3 million, net of income tax of $3.7 million, in the third quarter of fiscal 2001.

Net
income for the third quarter of fiscal 2001 was $13.5 million, or $0.20 per diluted share, compared to $15.7 million, or $0.22 per diluted share, for the third
quarter of fiscal 2000. Excluding the
extraordinary loss from the early extinguishment of debt, net income for the third quarter of fiscal 2001 was $18.8 million, or $0.28 per diluted share.

14

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First Nine Months Ended November 3, 2001 Compared to the First Nine Months Ended October 28, 2000

Net sales for the first nine months of fiscal 2001 increased $188.8 million, or 13%, over the first nine months of fiscal 2000. Sales at the new stores
(net of closures) during the first nine months of fiscal 2001 accounted for $138.1 million of the increase in net sales. Comparable store sales increased 4% in the first nine months of fiscal
2001 compared to the first nine months of fiscal 2000, which contributed $55.6 million to the net sales increase. The improvement in comparable store sales was due to a strong performance in
our core categories of Christmas and seasonal products as well as ribbon, general crafts, framing, and décor accents. The above increases in net sales were partially offset by the net
deferral of revenue related to the sale of custom frames, which accounted for a $4.9 million decrease in net sales over the first nine months of fiscal 2000. 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.

Cost
of sales and occupancy expense, as a percentage of net sales, for the first nine months of fiscal 2001 was 65.9%, a decrease of 0.4% compared to the first nine months of fiscal
2000. Improvements in merchandise margins for the first nine months of fiscal 2001 compared with the first nine months of fiscal 2000 were partially offset by higher occupancy costs associated with
new and relocated stores and higher utilities costs compared to the first nine months of fiscal 2000.

Selling,
general, and administrative expense, as a percentage of net sales, increased by 0.3% from the first nine months of fiscal 2000 to the first nine months of fiscal 2001. This
increase resulted principally from increased store payroll and related expenses, as a percentage of net sales, and costs of $1.0 million recorded in the first nine months of fiscal 2001 related
to senior executive severance.

Store
pre-opening costs remained relatively constant as a percentage of net sales in the first nine months of fiscal 2001 compared to the first nine months of fiscal 2000.
In the first nine months of fiscal 2001, we opened or relocated 82 Michaels and 18 Aaron Brothers stores compared to 81 Michaels and 21 Aaron Brothers stores opened or relocated in the first nine
months of fiscal 2000.

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 decreased by 0.1%, as a percentage of net sales, to $67.6 million in the first nine months of fiscal 2001 compared to $62.3 million for the first nine
months of fiscal 2000. Operating income for the first nine months of fiscal 2001 was negatively impacted by one-time severance costs of $1.0 million and the litigation settlement
charge of $3.2 million. Excluding the effects of the one-time severance charge and the litigation settlement charge, operating income increased 15% from $62.3 million in the
first nine months of fiscal 2000 to $71.7 million in the first nine months of fiscal 2001, on a 13% increase in net sales during the same period.

Interest
expense (net of interest income), as a percentage of net sales, increased by 0.1% from the first nine months of fiscal 2000 to the first nine months of fiscal 2001. This
increase resulted principally from non-recurring incremental interest expense of $1.5 million incurred while the Senior Notes due 2009 and the Senior Notes due 2006 were both
outstanding for a 30-day period. In addition, interest expense increased due to interest on higher outstanding borrowings against the Credit Agreement and lower interest income on lower
average cash balances during the first nine months of fiscal 2001. These increases in net interest expense were partially offset by interest savings of $2.5 million related to the conversion
and redemption of our convertible subordinated notes in June 2000, as discussed under "Liquidity and Capital Resources" below.

15

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The effective tax rate was 41% for the first nine months of fiscal 2001 and 40% for the first nine months of fiscal 2000.

On
August 6, 2001, we redeemed our 107/8% Senior Notes due June 15, 2006 in aggregate principal amount of $125 million. As a result, we recorded an
extraordinary loss from the early extinguishment of debt in the amount of $5.3 million, net of income tax of $3.7 million, in the third quarter of fiscal 2001.

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 income tax, in the first quarter of fiscal 2000 for the cumulative effect of the change on fiscal years prior to fiscal 2000.

Net
income for the first nine months of fiscal 2001 was $25.5 million, or $0.39 per diluted share, compared to $28.5 million, or $0.41 per diluted share, for the first
nine months of fiscal 2000. Excluding the one-time severance charges, litigation settlement, incremental interest, and extraordinary loss from the early extinguishment of debt, net income
for the first nine months of fiscal 2001 was $34.1 million,
or $0.52 per diluted share. For the first nine months of fiscal 2000, net income was $30.3 million, or $0.44 per diluted share, excluding the cumulative effect of the change in accounting.

Liquidity and Capital Resources

Changes in Cash and Equivalents

Cash flow used in operating activities during the first nine months of fiscal 2001 was $56.3 million, compared to cash provided by operating activities
of $21.2 million during the first nine months of fiscal 2000. The increase in cash flow used in operating activities was principally the result of higher investments in merchandise inventories,
net of accounts payable, in the amount of $185.0 million in the first nine months of fiscal 2001 compared with $84.6 million in the first nine months of fiscal 2000. The increased
inventories resulted from purchases made in the first nine months of fiscal 2001 to improve our in-stock position and receiving core merchandise for the holiday season earlier in the year
than in the prior fiscal year. Inventories per Michaels store of $1.243 million at November 3, 2001 increased 6% from $1.178 million at October 28, 2000. In connection with
our continuing supply chain management initiatives, our plans are to continue to increase the number of items 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 nine months of fiscal 2001 was $58.7 million compared to $70.3 million in the first nine months of fiscal 2000. Cash
flow from investing activities in the first nine months of fiscal 2001 was due in part to capital expenditures related to the opening of 66 Michaels and 15 Aaron Brothers stores and the relocation of
16 Michaels and three Aaron Brothers stores in the first nine months of fiscal 2001. In addition, we received proceeds in the amount of $26.9 million from the completion of a sale/leaseback
transaction in July 2001 for two distribution center properties which we purchased in December 2000. The gain from the sale/leaseback transaction was deferred and will be amortized over
the life of the sale/leaseback contract, which was accounted for as an operating lease.

16

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The following table sets forth capital expenditures for the first nine months of fiscal 2001 and the first nine months of fiscal 2000, net of the sale/leaseback transaction discussed
above (unaudited):

Nine Months EndedNovember 3,
2001

October 28,
2000(in thousands)New and relocated stores and stores not yet opened

$
46,645

$
45,785Existing stores


18,226


6,748Distribution system expansion


8,461


1,676Information systems


7,541


11,779Corporate and other


4,788


2,19785,661


68,185Proceeds from sale/leaseback transaction


(26,886
)

$
58,775

$
68,185


The
increase in capital expenditures for existing stores was primarily due to fixture costs for planogram resets at the stores during the second and third quarters of fiscal 2001. We
anticipate capital expenditures for fiscal 2001 to total approximately $125.0 million, which amount is net of proceeds of $26.9 million from the June 2001 sale/leaseback
transaction.

Cash
flow provided by financing activities in the first nine months of fiscal 2001 was $132.8 million compared to cash used in financing activities of $4.3 million in
the first nine months of fiscal 2000. The increase in cash provided by financing activities was primarily due to proceeds of $194.5 million from the issuance of the Senior Notes due 2009,
increased borrowings under the Credit Agreement, and a decrease in the acquisition of treasury stock. These cash flow increases were partially offset by the early redemption of the Senior Notes due
2006 and a decrease in the proceeds from the exercise of stock options. Proceeds from the exercise of stock options were $25.0 million for approximately 944,000 shares of our Common Stock,
unadjusted for the stock split, in the first nine months of fiscal 2001 and $89.0 million for approximately 4.4 million shares of Common Stock, unadjusted for the stock split, in the
first nine months of fiscal 2000.

Bank Credit Facility

Effective May 1, 2001, we completed a new $200 million unsecured bank credit facility with Fleet National Bank and other lending institutions,
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 we elect 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 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 we would otherwise be obligated to pay on such borrowings. We are required to pay a facility

17

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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 that vary depending on the fixed charge coverage ratio.

We
are in compliance with all terms and conditions of the Credit Agreement. Borrowings outstanding under the Credit Agreement were $45.0 million as of November 3, 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 November 3, 2001).
Borrowings under the Credit Agreement and our previous $100 million bank credit facility in the first nine months of fiscal 2001 were outstanding for 230 days, with average outstanding
borrowings of $11.1 million and a weighted average interest rate of 5.2%.

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. Stock options and all other agreements payable in our Common Stock
have been adjusted to reflect the split. 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 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
August 6, 2001, we used a portion of the proceeds of the Senior Notes due 2009 offering described above to redeem our Senior Notes due 2006, of which $125 million
aggregate principal amount was then outstanding. The redemption price was $1,054.38 per $1,000 principal amount of the Senior Notes due 2006, plus accrued interest to August 6, 2001. We
incurred an extraordinary loss from the early extinguishment of debt in the amount of $5.3 million, net of income tax, in the third quarter of fiscal 2001.

On
December 14, 2000, our Board of Directors authorized the repurchase of 2.0 million shares of outstanding Common Stock. In the fourth quarter of fiscal 2000, we
repurchased and retired 1,050,000 shares under this plan at an aggregate price of $17.2 million (average cost of $16.34 per share). No additional shares of Common Stock were repurchased in the
first nine months of fiscal 2001. We may continue our stock repurchases provided that market prices of our Common Stock make it advantageous. Securities and Exchange Commission regulations restrict us
from making repurchases during specified time periods. Finally, 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. As a result, we can give no assurance that we will repurchase any additional shares under the December 2000 stock repurchase plan.

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
Subordinated Notes outstanding was $96,935,000. The holders had the option to convert their Subordinated Notes into shares of Common Stock by June 22, 2000 at a price of $38.00 per share,
unadjusted for the stock split. 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

18

---

Notes was surrendered by the June 22, 2000 conversion date and was converted into 2,445,565 shares of Common Stock, unadjusted for the stock split. The remaining Subordinated Notes were
redeemed at a total redemption price of $4.2 million on June 29, 2000. The loss from the redemption was not material.

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. In July 2001, we issued $200 million of the Senior Notes due 2009 with a
fixed interest rate of 91/4%. Using a portion of the proceeds from the Senior Notes due 2009, in August 2001, we redeemed 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 3, 2001.

19

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MICHAELS STORES, INC.    Part IIOTHER INFORMATION

Item 1. 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 alleges that we violated various California laws by
erroneously treating Michaels stores' 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 certain deficiencies in the original 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. 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. The distribution of the settlement proceeds must be made by January 19, 2002. The Alameda County Superior Court has
dismissed the case against us, effective November 20, 2001.

Collins Proceeding

On April 14, 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
June 25, 2001, Collins filed an amended complaint which expanded the purported class to include all current Aaron Brothers' 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.

On
November 28, 2001, the court established January 31, 2002 as the deadline, by which time the plaintiff must either file a motion for class certification or
file for preliminary approval of any settlement which may be agreed to by the parties. A trial date has not yet been scheduled.

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.

20

---

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.

Item 4. Submission of Matters to a Vote of Security Holders.

Our 2001 Annual Meeting of Stockholders was held on October 5, 2001. The following items of business, as proposed in the Proxy Statement dated
August 31, 2001, were presented to the stockholders. The number of votes or abstentions below have not been adjusted to reflect the stock split.

Election of Directors

The two director nominees, information with respect to which was set forth in the Proxy Statement under the caption titled "Proposal No. 1: Election of
Two Directors," were elected. The vote with respect to the election of these directors was as follows:

|Name                 |  | Total Vote for
Each Director |  | Total Vote
Withheld
From Each
Director |  | Abstentions |  | Broker
Non-Votes
|-------------------- |  | ---------------------------- |  | -------------------------------------- |  | ----------- |  | ----------------
|Charles J. Wyly, Jr. |  | 30,003,078                   |  | 677,936                                |  |            |  |                
|Richard E. Hanlon    |  | 29,003,283                   |  | 1,677,731                              |  |            |  |                

Richard
C. Marcus, Elizabeth A. VanStory, and Sam Wyly will continue to serve as directors.

Amendment to the Restated Certificate of Incorporation

The amendment to the Restated Certificate of Incorporation eliminating the division of our Board of Directors into three classes, as described in more detail
in the Proxy Statement under the caption titled
"Proposal No. 2: Adoption of an Amendment to the Restated Certificate of Incorporation," was adopted. The vote on such proposal was as follows:

|For         |  | 28,336,180
|----------- |  | ----------
|Against     |  | 188,229   
|Abstentions |  | 26,051    
|            |  |           
|            |  | 28,550,460
|            |  |           

Stock Option Plan

The Michaels Stores, Inc. 2001 General Stock Option Plan, as described in more detail in the Proxy Statement under the caption titled "Proposal
No. 3: Approval of the Michaels Stores, Inc. 2001 General Stock Option Plan," was approved. The vote on such proposal was as follows:

|For         |  | 20,380,169
|----------- |  | ----------
|Against     |  | 10,257,340
|Abstentions |  | 43,505    
|            |  |           
|            |  | 30,681,014
|            |  |           

21

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

|(a) | Exhibits:           
|--- | --------------------
|    | 4.1                 
|    | 4.2                 
|    | 4.3                 
|    | 4.4                 
|(b) | Reports on Form 8-K:
|    | 1.                  
|    | 2.                  

22

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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:
December 18, 2001

23

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INDEX TO EXHIBITS

|Exhibits |  |                                                                                                                                                                                                                                               
|-------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|4.1      |  | Restated Certificate of Incorporation of Michaels Stores, Inc. (filed herewith).                                                                                                                                                              
|4.2      |  | Certificate of Amendment to Restated Certificate of Incorporation of Michaels Stores, Inc. (filed herewith).                                                                                                                                  
|4.3      |  | Certificate of Amendment to Restated Certificate of Incorporation of Michaels Stores, Inc., as amended (filed herewith).                                                                                                                      
|4.4      |  | Amended and Restated Bylaws of Michaels Stores, Inc. (previously filed as Exhibit 4.4 to Michaels Stores, Inc. Registration Statement on Form S-8, Commission File No. 33-71054, filed October 5, 2001, and incorporated herein
by reference).

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