**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSIONWASHINGTON, DC 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** |
|                                                                                                                                            |   |
| **For the  quarterly period ended May 5, 2007**                                                                                                 |
| ** **                                                                                                                                      | ** ** |
| **OR**                                                                                                                                          |
|                                                                                                                                            |   |
| **o**                                                                                                                                           | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| ** **                                                                                                                                      | ** ** |
| **For the  transition period from                     to** |

 

**Commissionfile number 001-09338**

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**MICHAELSSTORES, INC.**

(Exact name ofregistrant as specified in its charter)

| **Delaware**                     |   | **75-1943604**          |
|----------------------------------|--------|-------------------------|
| (State or other  jurisdiction of |   | (I.R.S. employer        |
| incorporation or  organization)  |   | identification  number) |

 

**8000Bent Branch Drive**

**Irving,Texas 75063**

**P.O.Box 619566**

**DFW,Texas 75261-9566**

(Address ofprincipal executive offices, including zip code)

**(972) 409-1300**

(Registrant’stelephone number, including area code)

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Indicate by check markwhether the Registrant: (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the Registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  Yes **x     **No**o**

Indicate by check mark whetherthe Registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large acceleratedfiler **o**     Acceleratedfiler **o**     Non-acceleratedfiler **x**

Indicate by check markwhether the Registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).  Yes **o     **No **x**

Indicate the number ofshares outstanding of each of the Registrant’s classes of Common Stock, as ofthe latest practicable date.

| Title                                   | ** ** | **Shares Outstanding as of  June 1, 2007** |
|-----------------------------------------|------------|---------------------------------------------------------------------|
| Common Stock,  par value $.10 per share |       | 118,262,731                                                         |

 

 

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**MICHAELS STORES, INC.FORM 10-Q**
|                  | ** ** | **Part I—FINANCIAL  INFORMATION**                                                              |   | **3**  |
|------------------|------------|----------------------------------------------------------------------------------------------------------|--------|--------|
| **Item 1.** | ** ** | **Financial Statements**                                                                                 |   | **3**  |
|             |       | Consolidated Balance  Sheets at May 5, 2007, February 3, 2007, and April 29, 2006 (unaudited)            |   | **3**  |
|             |       | Consolidated  Statements of Income for the quarter ended May 5, 2007 and April 29, 2006  (unaudited)     |   | **4**  |
|             |       | Consolidated  Statements of Cash Flows for the quarter ended May 5, 2007 and April 29, 2006  (unaudited) |   | **5**  |
|             |       | Notes to Consolidated  Financial Statements (unaudited)                                                  |   | **6**  |
| **Item 2.** | ** ** | **Management’s  Discussion and Analysis of Financial Condition and Results of Operations**          |   | **12** |
| **Item 3.** | ** ** | **Quantitative and  Qualitative Disclosures About Market Risk**                                          |   | **18** |
| **Item 4.** | ** ** | **Controls and Procedures**                                                                              |   | **18** |
| ** **       | ** ** | **Part II—OTHER  INFORMATION**                                                                 |   | **19** |
| **Item 1.** | ** ** | **Legal Proceedings**                                                                                    |   | **19** |
| **Item 2.** | ** ** | **Unregistered Sale  of Equity Securities and Use of Proceeds**                                          |   | **19** |
| **Item 4.**      | ** ** | **Submission of  Matters to a Vote of Security Holders**                                                 |   | **19** |
| **Item 6.** | ** ** | **Exhibits**                                                                                             |   | **20** |
| **Signatures**   |       | **21**                                                                                                   |
|                  |            |                                                                                                          |        |        |  |

 

2

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**MICHAELS STORES, INC.**

**Part I—FINANCIALINFORMATION**

**Item 1.  FinancialStatements.**

**MICHAELS STORES, INC.CONSOLIDATED BALANCE SHEETS(In thousands, except share data)(Unaudited)**
| ** **                                                                                                                                                                                                                                                                                                     | ** ** | **May 5,** | ** ** | **February 3,** | ** ** | **April 29,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|------------|----------------------|------------|--------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                     | ** ** | **2007**        | ** ** | **2007**             | ** ** | **2006**           | ** ** |
| **ASSETS**                                                                                                                                                                                                                                                                                                     | ** ** | ** **      | ** ** | ** **           | ** ** | ** **         | ** ** |
| **Current assets:**                                                                                                                                                                                                                                                                                            | ** ** | ** **      | ** ** | ** **           | ** ** | ** **         | ** ** |
| Cash and  equivalents                                                                                                                                                                                                                                                                                          |       | $               | 45,056     |                 | $          | 30,098             |       | $ | 441,843 |   |
| Merchandise  inventories                                                                                                                                                                                                                                                                                       |       | 878,634         |       | 847,529              |       | 793,984            |       |
| Prepaid expenses  and other                                                                                                                                                                                                                                                                                    |       | 77,382          |       | 54,435               |       | 46,397             |       |
| Deferred income  taxes                                                                                                                                                                                                                                                                                         |       | 35,312          |       | 35,216               |       | 34,548             |       |
| Income tax  receivable                                                                                                                                                                                                                                                                                         |       | 48,861          |       | 32,902               |       | —             |       |
| Total current  assets                                                                                                                                                                                                                                                                                          |       | 1,085,245       |       | 1,000,180            |       | 1,316,772          |       |
| **Property and equipment, at cost**                                                                                                                                                                                                                                                                            |       | 1,139,950       |       | 1,122,948            |       | 1,046,956          |       |
| Less accumulated  depreciation                                                                                                                                                                                                                                                                                 |       | (686,605        | )          | (674,275             | )          | (611,495           | )          |
|                                                                                                                                                                                                                                                                                                           |       | 453,345         |       | 448,673              |       | 435,461            |       |
| **Goodwill**                                                                                                                                                                                                                                                                                                   |       | 115,839         |       | 115,839              |       | 115,839            |       |
| **Debt issuance costs, net of  accumulated amortization of $8,853 at May 5, 2007 and $4,537 at February 3,  2007**                                                                                                                                                                                             | ** ** | 115,877         | ** ** | 120,193              | ** ** | —             | ** ** |
| **Other  assets**                                                                                                                                                                                                                                                                                              |       | 7,523           |       | 8,117                |       | 23,082             |       |
|                                                                                                                                                                                                                                                                                                           |       | 239,239         |       | 244,149              |       | 138,921            |       |
| Total assets                                                                                                                                                                                                                                                                                                   |       | $               | 1,777,829  |                 | $          | 1,693,002          |       | $ | 1,891,154 |   |
|                                                                                                                                                                                                                                                                                                           |       |            |       |                 |       |               |       |
| **LIABILITIES  AND STOCKHOLDERS’ (DEFICIT) EQUITY**                                                                                                                                                                                                                                                       | ** ** | ** **      | ** ** | ** **           | ** ** | ** **         | ** ** |
| **Current liabilities:**                                                                                                                                                                                                                                                                                       | ** ** | ** **      | ** ** | ** **           | ** ** | ** **         | ** ** |
| Accounts payable                                                                                                                                                                                                                                                                                               |       | $               | 237,749    |                 | $          | 214,470            |       | $ | 267,154 |   |
| Accrued  liabilities and other                                                                                                                                                                                                                                                                                 |       | 256,563         |       | 290,431              |       | 226,541            |       |
| Income taxes  payable                                                                                                                                                                                                                                                                                          |       | —          |       | 7,331                |       | 15,730             |       |
| Current portion  of long-term debt                                                                                                                                                                                                                                                                             |       | 345,119         |       | 229,765              |       | —             |       |
| Total current  liabilities                                                                                                                                                                                                                                                                                     |       | 839,431         |       | 741,997              |       | 509,425            |       |
| **Long-term  debt**                                                                                                                                                                                                                                                                                            |       | 3,731,064       |       | 3,728,745            |       | —             |       |
| **Deferred  income taxes**                                                                                                                                                                                                                                                                                     |       | 16,346          |       | 29,139               |       | 2,791              |       |
| **Other long-term liabilities**                                                                                                                                                                                                                                                                                |       | 81,320          |       | 68,444               |       | 89,098             |       |
| Total long-term  liabilities                                                                                                                                                                                                                                                                                   |       | 3,828,730       |       | 3,826,328            |       | 91,889             |       |
|                                                                                                                                                                                                                                                                                                           |       | 4,668,161       |       | 4,568,325            |       | 601,314            |       |
| **Commitments and contingencies Stockholders’  (deficit) equity:**                                                                                                                                                                                                                                        | ** ** | ** **      | ** ** | ** **           | ** ** | ** **         | ** ** |
| Common Stock,  $0.10 par value, 220,000,000 shares authorized;  118,262,731 shares issued and outstanding at May 5, 2007;  117,973,396 shares issued and outstanding at February 3, 2007;  1,026,666,655 shares authorized and 395,534,488 shares issued and 387,419,715  shares outstanding at April 29, 2006 |       | 11,826          |       | 11,797               |       | 39,553             |       |
| Additional  paid-in capital                                                                                                                                                                                                                                                                                    |       | 5,702           |       | —               |       | 417,080            |       |
| Retained  (deficit) earnings                                                                                                                                                                                                                                                                                   |       | (2,917,455      | )          | (2,893,918           | )          | 919,134            |       |
| Accumulated  other comprehensive income                                                                                                                                                                                                                                                                        |       | 9,595           |       | 6,798                |       | 8,200              |       |
| Treasury Stock  (none at May 5, 2007 and February 3, 2007;  8,114,773 shares at April 29, 2006)                                                                                                                                                                                                                |       | —          |       | —               |       | (94,127            | )          |
| Total  stockholders’ (deficit) equity                                                                                                                                                                                                                                                                     |       | (2,890,332      | )          | (2,875,323           | )          | 1,289,840          |       |
| Total liabilities and stockholders’ (deficit) equity                                                                                                                                                                                                                                                      |       | $               | 1,777,829  |                 | $          | 1,693,002          |       | $ | 1,891,154 |   |

 

See accompanyingnotes to consolidated financial statements.

3

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**MICHAELSSTORES, INC**.**CONSOLIDATED STATEMENTS OF INCOME(In thousands, except per share data)(Unaudited)**
| ** **                                    | ** ** | **Quarter Ended** | ** ** |
|-----------------------------------------------|------------|------------------------|------------|
| ** **                                    | ** ** | **May 5,**        | ** ** | **April 29,** | ** ** |
| ** **                                    | ** ** | **2007**               | ** ** | **2006** | ** ** |
| **Net  sales**                                |       | $                      | 844,133    |   | $ | 832,481 |   |
| Cost of sales  and occupancy expense          |       | 516,421                |       | 513,245 |   |
| **Gross  profit**                             |       | 327,712                |       | 319,236 |   |
| Selling,  general, and administrative expense |       | 255,904                |       | 237,036 |   |
| Transaction  expenses                         |       | 5,564                  |       | 4,700 |   |
| Related party  expenses                       |       | 5,262                  |       | — |   |
| Store  pre-opening costs                      |       | 1,548                  |       | 1,437 |   |
| **Operating  income**                         |       | 59,434                 |       | 76,063 |   |
| Interest expense                              |       | 95,352                 |       | 172 |   |
| Other (income)  and expense, net              |       | (2,446                 | )          | (7,162 | ) |
| **(Loss)  income before income taxes**        |       | (33,472                | )          | 83,053 |   |
| Provision for  income taxes                   |       | (10,869                | )          | 31,352 |   |
| **Net  (loss) income**                        |       | $                      | (22,603    | ) | $ | 51,701 |   |

 

See accompanyingnotes to consolidated financial statements.

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**MICHAELSSTORES, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS**(In thousands)(Unaudited)
| ** **                                           | ** ** | **Quarter Ended** | ** ** |
|------------------------------------------------------|------------|------------------------|------------|
| ** **                                           | ** ** | **May 5,**        | ** ** | **April 29,** | ** ** |
| ** **                                           | ** ** | **2007**               | ** ** | **2006** | ** ** |
| **Operating  activities:**                           | ** ** | ** **             | ** ** | ** ** | ** ** |
| Net (loss) income                                    |       | $                      | (22,603    | ) | $ | 51,701 |   |
| Adjustments:                                         |       |                   |       |   |   |
| Depreciation and amortization                        |       | 30,731                 |       | 27,456 |   |
| Share-based compensation                             |       | 1,451                  |       | 5,568 |   |
| Tax benefits from stock options exercised            |       | —                 |       | (8,203 | ) |
| Other                                                |       | 4,316                  |       | 2 |   |
| Changes in assets and liabilities:                   |       |                   |       |   |   |
| Merchandise inventories                              |       | (31,106                | )          | (9,760 | ) |
| Prepaid expenses and other                           |       | (3,179                 | )          | (2,689 | ) |
| Deferred income taxes and other                      |       | (13,996                | )          | (3,654 | ) |
| Accounts payable                                     |       | 13,015                 |       | 60,874 |   |
| Accrued liabilities and other                        |       | (27,343                | )          | (19,615 | ) |
| Income taxes payable                                 |       | (9,513                 | )          | 3,261 |   |
| Other long-term liabilities                          |       | 7,000                  |       | 1,526 |   |
| Net cash (used in) provided by operating activities  |       | (51,227                | )          | 106,467 |   |
|                                                 |       |                   |       |   |   |
| **Investing  activities:**                           | ** ** | ** **             | ** ** | ** ** | ** ** |
| Additions to property and equipment                  |       | (28,039                | )          | (38,914 | ) |
| Net cash used in investing activities                |       | (28,039                | )          | (38,914 | ) |
|                                                 |       |                   |       |   |   |
| **Financing  activities:**                           | ** ** | ** **             | ** ** | ** ** | ** ** |
| Borrowings on asset-based revolving credit facility  |       | 448,025                |       | — |   |
| Payments on asset-based revolving credit facility    |       | (332,671               | )          | — |   |
| Repayments on senior secured term loan facility      |       | (5,875                 | )          | — |   |
| Equity investment of Management                      |       | 4,280                  |       | — |   |
| Cash dividends paid to stockholders                  |       | —                 |       | (26,625 | ) |
| Repurchase of old Common Stock                       |       | —                 |       | (66,182 | ) |
| Proceeds from stock options exercised                |       | —                 |       | 14,876 |   |
| Tax benefits from stock options exercised            |       | —                 |       | 8,203 |   |
| Proceeds from issuance of old Common Stock and other |       | —                 |       | 1,095 |   |
| Payment of capital leases                            |       | (4,141                 | )          | — |   |
| Change in cash overdraft                             |       | (15,394                | )          | (9,526 | ) |
| Net cash provided by (used in) financing activities  |       | 94,224                 |       | (78,159 | ) |
| **Net  increase (decrease) in cash and equivalents** |       | 14,958                 |       | (10,606 | ) |
| **Cash  and equivalents at beginning of period**     |       | 30,098                 |       | 452,449 |   |
| **Cash and equivalents at end of  period**           |       | $                      | 45,056     |   | $ | 441,843 |   |

 

See accompanying notes to consolidated financialstatements.

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**/MICHAELSSTORES, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSFor the Three Months Ended May 5, 2007(Unaudited)**

**Note 1.  Summary ofSignificant Accounting Policies**

*Basis of Presentation*

The consolidatedfinancial statements include the accounts of Michaels Stores, Inc. and ourwholly-owned subsidiaries. All significant intercompany accounts andtransactions have been eliminated. All expressions of “us,” “we,” “our,” andall similar expressions are references to Michaels Stores, Inc. and ourconsolidated, wholly-owned subsidiaries, unless otherwise expressly stated orthe context otherwise requires.

The accompanyingunaudited consolidated financial statements have been prepared in accordancewith U.S. generally accepted accounting principles for interim financialinformation and with the instructions to Form 10-Q and Article 10 ofRegulation S-X. Accordingly, they do not include all of the informationand notes required by generally accepted accounting principles for completefinancial statements. In the opinion of management, all adjustments (consistingof normal recurring accruals and other items, as disclosed) considerednecessary for a fair presentation have been included. Because of the seasonalnature of our business, the results of operations for the quarter ended May 5,2007 are not indicative of the results to be expected for the entire year.

The balance sheet atFebruary 3, 2007 has been derived from the audited financial statements at thatdate but does not include all of the information and notes required bygenerally accepted accounting principles for complete financial statements. Forfurther information, refer to the consolidated financial statements and notesthereto included in our Annual Report on Form 10-K for the fiscal yearended February 3, 2007.

All references herein to “fiscal2007” relate to the 52 weeks ending February 2, 2008 and all references to“fiscal 2006” relate to the 53 weeks ended February 3, 2007. Inaddition, all references herein to “the first quarter of fiscal 2007” and “thefirst three months of fiscal 2007” relate to the 13 weeks ended May 5, 2007 andall references to “the first quarter of fiscal 2006” and “the first threemonths of fiscal 2006” relate to the 13 weeks ended April 29, 2006.

*Recent Accounting Pronouncements*

In July 2006, theFASB issued FASB Interpretation No. 48, *Accountingfor Uncertainty in Income Taxes — an interpretation of FASB StatementNo. 109*, which clarifies the accounting for uncertainty inincome tax positions. FIN 48 requires that a company recognize in itsconsolidated financial statements the impact of a tax position that is morelikely than not to be sustained upon examination based on the technical meritsof the position. We adopted FIN 48 as of the beginning of our first quarter offiscal 2007 with no material impact to our consolidated income statement,balance sheet, shareholders’ equity, or cash flows statement.

Upon adoption, we electedto record any interest and penalties associated with audits as a component ofincome tax expense. The Company identified its federal tax return, Canadian taxreturn, and its state tax returns in California, Florida, Illinois, New York,North Carolina, Pennsylvania, and Texas as “major” tax jurisdictions.  The periods subject to examination for ourfederal return are 2002 to present, 2000 to present for our Canadian return,2003 to present for all state returns except for California, and 1998 topresent for California.

In September 2006, theFASB issued Statement of Financial Accounting Standard No. 158, *Employers’ Accounting for Defined Benefit Pensions and OtherPostretirement Plans*, which requires an entity to recognize theoverfunded or underfunded status of a defined benefit postretirement plan as anasset or liability in its balance sheet and to recognize changes in that fundedstatus in the year in which the changes occur through comprehensiveincome.  It also requires an entity tomeasure the funded status of a plan as of the date of its year-end balancesheet.  As we have no publicly tradedsecurities (due to the Merger as described in Note 2 below), FAS 158 iseffective for us at the end of fiscal 2007, with early adoption permitted.  We plan to adopt FAS 158 at the end of fiscal2007, with no material impact expected on our consolidated income statement,balance sheet, shareholders’ equity, or cash flows statement.

In February 2007, theFASB issued Statement of Financial Accounting Standard No. 159, *The Fair Value Option for Financial Assets and Financial Liabilities*,which permits companies to measure certain financial instruments and otheritems at fair value (at specified measurement dates) that are not currentlyrequired to be measured at fair value. Any unrealized gains or lossesapplicable to those items measured at fair value shall be reported in earnings.The decision to apply fair value shall generally be made on an instrument byinstrument basis, is irrevocable, and is applied only to an entire instrument.The provisions of FAS 159 will be effective for us as of the beginning forfiscal 2008, with early adoption permitted.

6

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**Note 2.  MergerTransaction**

On October 31, 2006,substantially all of the Common Stock of Michaels Stores, Inc. was acquiredthrough a merger transaction (the “Merger”) by affiliates of two privateinvestment firms, Bain Capital Partners, LLC and The Blackstone Group(collectively, together with their applicable affiliates, the “Sponsors”), withcertain shares retained by affiliates of Highfields Capital Partners (athen-existing shareholder of Michaels Stores, Inc.). As a result of the Merger,Michaels Holdings LLC, an entity controlled by the Sponsors, owns approximately93.3% of our outstanding Common Stock, which is no longer publicly traded. Weaccounted for the Merger as a leveraged recapitalization whereby the historicalbook value of the assets and liabilities of Michaels were maintained with nopush down accounting required.

The Merger considerationpaid to then-existing equity holders was approximately $5.8 billion, with feesand expenses totaling an additional $239.7 million. The purchase price wasfunded by:

·                  Aggregate cashequity contribution by the Sponsors of approximately $1.7 billion;

·                  Retention ofcertain shares held by affiliates of Highfields Capital Partners totaling$110.0 million;

·                  The issuance ofthe following debt (See Note 4 for further information concerning our issuanceof debt):

·                  $750.0million of 10% Senior Notes due 2014;

·                  $400.0million of 113¤8%Senior Subordinated Notes due 2016;

·                  $250.0million of 13% Subordinated Discount Notes due 2016;

·                  $2.4billion Senior secured term loan facility; and

·                  $400.0 millionof borrowings under our Asset-based revolving credit facility; and

·                  Our availablecash as of the date of the Merger.

The Mergeroccurred simultaneously with the closing of the financing and equitytransactions described above as well as the termination of our previous $300million senior unsecured credit facility with Bank of America, N.A (CreditAgreement).

We capitalized $124.7million of costs related to our issuance of various debt instruments.  We amortize the deferred financing costs overthe lives of the respective debt agreements (which range from five to tenyears) and record the amortization to interest expense. Amortization of the deferredfinancing costs was $4.3 million for the quarter ended May 5, 2007.

Transaction expenses inthe first quarter of fiscal 2007 relate primarily to compensation arrangementsassociated with the change in control.

**Note 3.  Share-BasedCompensation**

On February 15, 2007, ourshareholders and Board of Directors approved the 2006 Equity Incentive Plan (“2006Plan”), which provides for the grant of share-based awards exercisable for upto 14.2 million shares of Common Stock. During the first quarter of fiscal 2007, stock options exercisable forapproximately 9.7 million shares of Common Stock were granted to certainemployees. As of May 5, 2007, share-based awards exercisable for up to 4.5million shares of Common Stock remain available for grant.

As of May 5, 2007, all ofthe awards granted under the 2006 Plan vest ratably over five years and expireeight years from the grant date. The exercise prices of the awards issuedduring the first quarter of fiscal 2007 ranged, depending upon the tranche inwhich issued, from $15 per share to $52.50 per share. The fair value of theawards was determined using the Black-Scholes-Merton option valuation model andcompensation expense associated with these awards was $1.5 million for thefirst quarter of fiscal 2007.

All share-based awardsoutstanding immediately prior to the Merger were settled on the Merger date.There were no share-based awards outstanding as of February 3, 2007.

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**Note 4.  Debt**

Our outstanding debt isdetailed in the table below.  We had nodebt outstanding as of April 29, 2006. We were in compliance with the terms andconditions of all debt agreements as of May 5, 2007.
|                                        | ** ** | **May 5, 2007** | ** ** | **February 3, 2007** | ** ** | ** ** | ** ** |
|----------------------------------------|------------|---------------------------|------------|--------------------------------|------------|------------|------------|
| ** **                             | ** ** | **Principal**             | ** ** | **Interest Rate**         | ** ** |
| ** **                             | ** ** | **(In thousands)**   | ** ** | ** **                     | ** ** |
|                                   |       |                      |       |                           |       |       |       |
| Senior notes                           |       | $                         | 750,000    |                           | $          | 750,000    |       | 10.000 | % |
| Senior subordinated  notes             |       | 400,000                   |       | 400,000                        |       | 11.375     | %          |
| Subordinated  discount notes           |       | 266,814                   |       | 258,620                        |       | 13.000     | %          |
| Senior secured  term loan              |       | 2,338,250                 |       | 2,344,125                      |       | Variable   |       |
| Asset-based  revolving credit facility |       | 321,119                   |       | 205,765                        |       | Variable   |       |
| Total debt                             |       | 4,076,183                 |       | 3,958,510                      |       |       |       |
| Less current  portion                  |       | 345,119                   |       | 229,765                        |       |       |       |
| Long-term debt                         |       | $                         | 3,731,064  |                           | $          | 3,728,745  |       |   |   |

 

*Asset-based revolving credit facility*

The Asset-based revolvingcredit facility provides senior secured financing of up to $1.0 billion,subject to a borrowing base described below. Asof May 5, 2007, the borrowing base was $767.2 million with $433.3 million ofunused availability.

The borrowing base equalsthe sum of (i) 90% of eligible credit card receivables and debit cardreceivables; (ii) between 85% and 90% of the appraised net orderly liquidationvalue of eligible inventory and of eligible letters of credit; (iii) apercentage of eligible in-transit inventory, less certain reserves; and (iv)the sum of an additional 10% of the appraised net orderly liquidation value ofeligible inventory and of eligible letters of credit plus an additional 5% ofeligible credit card receivables and debit card receivables, up to a maximumamount of $100.0 million.

*Senior secured term loan facility*

During the first quarterof fiscal 2007, borrowings under the Senior secured term loan facility boreinterest at a rate per annum equal to, at our option, either (a) a baserate determined by reference to the higher of (1) the prime rate ofDeutsche Bank and (2) the federal funds effective rate plus 1⁄2 of 1%or (b) a LIBOR rate, subject to certain adjustments, in each case plus anapplicable margin. The applicable margin was 1.75% with respect to base rateborrowings and 2.75% with respect to LIBOR borrowings, subject to downward adjustmentbased on the leverage and ratings thresholds set forth in the Senior securedterm loan facility agreement.

On May 10, 2007, weamended the Senior secured term loan facility to reduce the applicable marginto 1.25% with respect to base rate borrowings and 2.25% with respect to LIBORborrowings. The amendment also provides that if there is a repricingtransaction that reduces the interest rate margins prior to May 10, 2008, theneach lender will receive a fee equal to 1.00% of the principal amounts of loansthat are repriced. Finally, the amendment eliminated the requirement that wemaintain a specified consolidated secured debt ratio.

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**Note 5.  ComprehensiveIncome**

Our comprehensive incomeis as follows:
|                                                   | ** ** | **Quarter Ended**  | ** ** |
|---------------------------------------------------|------------|-------------------------|------------|
| ** **                                        | ** ** | **May 5,**         | ** ** | **April 29,** | ** ** |
| ** **                                        | ** ** | **2007**                | ** ** | **2006** | ** ** |
| ** **                                        | ** ** | **(In thousands)** | ** ** |
| Net (loss)  income                                |       | $                       | (22,603    | ) | $ | 51,701 |   |
| Other  comprehensive income (loss):               |       |                    |       |   |   |
| Foreign currency translation adjustment and other |       | 2,797                   |       | 611 |   |
| Comprehensive (loss)  income                      |       | $                       | (19,806    | ) | $ | 52,312 |   |

 

**Note 6.  Derivativeinstruments**

During the first quarterof fiscal 2007, we executed an interest rate collar to hedge our variability ofcash flows associated with our interest payments on our Senior secured termloan that result from fluctuations in the three-month LIBOR rate. We accountedfor the interest rate collar as a cash flow hedge. The interest rate collarprovided a fixed interest rate, with respect to the three-month LIBOR rate, ata cap of 6.0% and a floor of 3.21% for a notional value of $1.755 billion fromMarch 2, 2007 through May 10, 2007. We terminated the interest rate collar onMay 10, 2007 in connection with the repricing of the Senior secured term loandescribed in Note 4 above. There were no material amounts of unrealized lossesas of May 5, 2007 and the termination of the interest rate collar resulted inan immaterial loss recorded in the second quarter of fiscal 2007.

**Note 7.  Commitmentsand Contingencies**

Reference is made to the consolidated action describedunder “Part I. Item 3. Legal Proceedings — Shareholder Claims — FederalCourt Litigation” in our Annual Report on Form 10-K for fiscal2006.  In that action, on May 21, 2007the lead plaintiff, Massachusetts Laborers’ Annuity Fund, filed a motion forleave to file a first amended consolidated class action complaint (the “AmendedComplaint”).  As proposed, the AmendedComplaint names Michaels and certain of its current and former officers anddirectors as defendants.  The AmendedComplaint alleges that the defendants misrepresented and/or omitted materialfacts in Michaels’ annual proxy statements for 2004, 2005 and 2006, including,among others, failing to disclose: (a) Michaels’ and the defendants’ alleged option backdatingpractices; (b) information regarding transactions and holdings of MichaelsCommon Stock by certain trusts owned by or for the benefit of two of Michaels’former officers and directors and their family members; and (c) that Michaelsand the defendants had reported false financial statements as a result of thosepractices.  Further, the AmendedComplaint makes allegations regarding the Company’s financial restatement ofperiods prior to 2006, as well as the recently completed merger with entitiesaffiliated with Bain Capital Partners LLC and The Blackstone Group.  In the Amended Complaint, the lead plaintiffasserts claims against all defendants for violations of Section 14(a) of theSecurities Exchange Act of 1934 and Rule 14a-9 promulgated thereunder, andSection 20(a) of the Securities Exchange Act of 1934.  The plaintiff seeks, among other relief, (a)an indeterminate amount of damages, (b) pre-judgment and post-judgmentinterest, (c) an award of attorneys fees and costs, and (d) equitable orinjunctive relief, including the rescission of stock option grants. We areunable to estimate a range of possible loss, if any, in these claims, andintend to defend this lawsuit vigorously.

We are involved in ongoing legal and regulatoryproceedings. Other than the update described in the preceding paragraph, therewere no material changes to our disclosures of commitments and contingenciesfrom our Annual Report on Form 10-K for fiscal 2006.

**Note 8.  Segments**

We consider our Michaels,Aaron Brothers, and Recollections stores and our Star Decorators Wholesaleoperations to be our operating segments for purposes of determining reportablesegments based on the criteria of SFAS No. 131, *Disclosures About Segments of an Enterprise and Related Information.*We determined that our Michaels and Aaron Brothers operating segments have similareconomic characteristics and meet the aggregation criteria set forth inparagraph 17 of SFAS No. 131. With regard to our Aaron Brothers operatingsegment, we determined that it did not meet the quantitative thresholds forseparate disclosure set forth in SFAS No. 131. We also determined thatindividually, and in the aggregate, the Recollections stores and StarDecorators Wholesale operations were immaterial for segment reporting purposes.Therefore, we combine all operating segments into one reporting segment.

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Subsequent to theMerger, our chief operating decision makers evaluate historical operatingperformance, plan and forecast future periods’ operating performance and baseincentive compensation targets for certain management personnel on earningsbefore interest, income taxes, and depreciation and amortization (“EBITDA”). Areconciliation of income before income taxes and cumulative effect ofaccounting change to EBITDA is presented below. Segment income for the quarterended April 29, 2006 was restated to conform to current year presentation.
|                                    | ** ** | **Quarter Ended**    | ** ** |
|------------------------------------|------------|---------------------------|------------|
| ** **                         | ** ** | **May 5, 2007** | ** ** | **April 29, 2006** | ** ** |
| ** **                         | ** ** | **(in thousands)**   | ** ** |
|                               |       |                      |       |   |   |
| (Loss) Income  before income taxes |       | $                         | (33,472    | ) | $ | 83,053 |   |
| Interest expense                   |       | 95,352                    |       | 172 |   |
| Interest income                    |       | (225                      | )          | (3,400 | ) |
| Depreciation and  amortization     |       | 30,731                    |       | 27,456 |   |
| EBITDA                             |       | $                         | 92,386     |   | $ | 107,281 |   |

 

Our sales and assets bycountry are as follows:
|                                    | ** ** | **Net Sales**      | ** ** | **Total Assets** | ** ** |
|------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                         | ** ** | **(in thousands)** | ** ** |
| **Quarter  ended May 5, 2007:**    | ** ** | ** **              | ** ** | ** **            | ** ** |
| United States                      |       | $                       | 783,866    |                  | $          | 1,684,039 |   |
| Canada                             |       | 60,267                  |       | 93,790                |       |
| Consolidated  Total                |       | $                       | 844,133    |                  | $          | 1,777,829 |   |
|                               |       |                    |       |                  |       |
| **Quarter  ended April 29, 2006:** | ** ** | ** **              | ** ** | ** **            | ** ** |
| United States                      |       | $                       | 778,356    |                  | $          | 1,807,896 |   |
| Canada                             |       | 54,125                  |       | 83,258                |       |
| Consolidated Total                 |       | $                       | 832,481    |                  | $          | 1,891,154 |   |

 

10

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**Note 9.  Related PartyTransactions**

We pay annual managementfees to the Sponsors in the amount of $12.0 million and an annual managementfee to Highfields Capital Management LP in the amount of $1.0 million. Duringthe quarter ended May 5, 2005, we recognized $3.4 million of expense related toannual management fees and related expenses.

In connection with theconsummation of the Merger, the Company entered into a Separation Agreementwith each of Charles Wyly and Sam Wyly, executive officers and directors of theCompany prior to the Merger.  Under theSeparation Agreements, each of Charles Wyly and Sam Wyly received a lump sumpayment of $3.0 million in exchange for his agreement to adhere to certainnon-competition, non-solicitation and confidentiality restrictions. We amortizethese Separation Agreements over two years, which resulted in $792,000 ofexpense for the quarter ended May 5, 2007.

During the fourth quarterof fiscal 2006, we executed a participation agreement with CoreTrust PurchasingGroup (“CPG”), which designates CPG as our exclusive supplier ofnon-merchandise supplies and equipment. In exchange, we are offerednon-merchandise supplies and equipment from a variety of vendors at apre-determined price. We do not pay any fees to participate in this grouparrangement, and we can terminate our participation prior to the expiration ofthe agreement without penalty. The vendors separately pay fees to CPG foraccess to its consortium of customers. The Blackstone Group, one of ourSponsors, entered into an agreement with CPG whereby The Blackstone Groupreceives a portion of the gross fees vendors pay to CPG based on the volume ofpurchases made by us and other participants.

During the first quarterof fiscal 2007, The Blackstone Group acquired a majority ownership stake in anexternal vendor we utilize to count our store inventory. Expenses associatedwith this vendor during the first quarter of fiscal 2007 were approximately$1.0 million.

During the first quarterof fiscal 2007, officers of Michaels Stores, Inc. and its subsidiaries wereoffered the opportunity to purchase shares of our Common Stock at a price of$15 per share. We sold approximately $4.3 million, or 289,334 shares of ourCommon Stock to certain officers, and such shares represent approximately 0.24%of the total outstanding shares of Michaels Stores, Inc.

**Note 10.  Subsequent Event**

On June 4, 2007, theBoard of Directors named Brian C. Cornell Chief Executive Officer of the Companyeffective that day.   Mr. Cornell recently served as ExecutiveVice President and Chief Marketing Officer of Safeway, Inc., where he wasresponsible for the merchandising, marketing, manufacturing, supply chain, andonline business. Mr. Cornell is also a director of OfficeMax Inc.

Pursuant to hisemployment contract, in addition to his base salary, Mr. Cornell receiveda sign-on bonus, was granted shares of restricted stock, was granted 2.3 millionoptions to purchase shares of our Common Stock, which are divided into sixtranches with exercise prices ranging from $15 to $52.50 per share, and iseligible to receive an annual bonus should the Company meet certain financialtargets.  The options vest 20% on each ofthe first five anniversaries of February 16, 2007 while the restrictedshares vest 50% each on the first and second anniversaries of the grant date.

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**Item 2.  Management’sDiscussion and Analysis of Financial Condition and****Results of Operations.**

All expressions of “us,” “we,”“our,” and all similar expressions are references to Michaels Stores, Inc. andits consolidated wholly-owned subsidiaries, unless otherwise expressly statedor the context otherwise requires.

**Disclosure Regarding Forward-LookingInformation**

The following discussionshould be read in conjunction with our consolidated financial statements andrelated notes included elsewhere in this Quarterly Report on Form 10-Q.The following discussion, as well as other portions of this Quarterly Report onForm 10-Q, contains forward-looking statements that reflect our plans,estimates, and beliefs. Any statements contained herein (including, but notlimited to, statements to the effect that Michaels or its management “anticipates,”“plans,” “estimates,” “expects,” “believes,” and other similar expressions)that are not statements of historical fact should be considered forward-lookingstatements and should be read in conjunction with our consolidated financialstatements and related notes in our Annual Report on Form 10-K for thefiscal year ended February 3, 2007. Specific examples of forward-lookingstatements include, but are not limited to, statements regarding our forecastsof financial performance, capital expenditures, and working capitalrequirements. Our actual results could materially differ from those discussedin these forward-looking statements. Factors that could cause or contribute to suchdifferences include, but are not limited to:

·                  our substantialleverage, which could adversely affect our ability to raise additional capitalto fund our operations, limit our ability to react to changes in the economy orour industry, and expose us to interest rate risk to the extent of our variablerate debt;

·                  our ability toservice the interest and principal payments of our debt;

·                  restrictionscontained in our various debt agreements that limit our flexibility inoperating our business, including compliance with the covenants containedtherein;

·                  our ability toremain competitive in the areas of merchandise quality, price, breadth ofselection, customer service, and convenience;

·                  our ability toanticipate and/or react to changes in customer demand and preferences forproducts and supplies used in creative activities and the related potentialimpact to merchandise inventories in categories that represent a significantportion of our business;

·                  changes inconsumer confidence resulting in a reduction in consumer spending on itemsperceived to be discretionary;

·                  theeffectiveness of, or unexpected consumer responses to, our promotionalprograms;

·                  our ability tomitigate any continued declines in newspaper subscription rates, which affectthe frequency in which our customers receive our circular advertisements;

·                  unusual weatherconditions;

·                  the executionand management of our store growth, including new concepts, the impact of newcompetitor stores in locations near our existing stores, and the availabilityof acceptable real estate locations for new store openings;

·                  the effectiveoptimization and maintenance of our perpetual inventory and automatedreplenishment systems and related impacts to inventory levels;

·                  theidentification and implementation of enhancements to our supply chain to enableus to distribute additional SKUs through our distribution centers;

·                  delays in thereceipt of merchandise ordered from suppliers due to delays in connection witheither the manufacture or shipment of such merchandise;

·                  transportationdelays (including dock strikes, other work stoppages, and shortages of truckdrivers) and increases in transportation costs due to fuel surcharges andtransportation regulations;

·                  restrictiveactions by foreign governments or changes in United States laws and regulationsaffecting imports or domestic distribution;

·                  significantincreases in inflation or commodity prices, such as petroleum, natural gas,electricity, steel, and paper, which may

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adversely affect our costs, including cost ofmerchandise;

·                  significantincreases in tariffs or duties levied on imports which may limit theavailability of certain merchandise from our foreign suppliers;

·                  changes inpolitical, economic, and social conditions;

·                  significantfluctuations in exchange rates;

·                  significantfluctuations in interest rates;

·                  financialdifficulties of any of our key vendors, suppliers, or insurance providers;

·                  the design andimplementation of new management information systems as well as the maintenanceand enhancement of existing systems, particularly in light of our continuedstore growth and the addition of new concepts;

·                  our ability tomaintain the security of electronic and other confidential information;

·                  our ability toattract and retain qualified personnel, including management and seniorexecutives, to successfully execute our operating plans;

·                  our ability toaddress any conflict between the interests of our controlling stockholders andour creditors;

·                  the seasonalityof the retail business; and

·                  other factors asset forth in our Annual Report on Form 10-K for the fiscal year endedFebruary 3, 2007 (particularly in “Part I. Item 1A Risk Factors” and “Part II.Item 7. Management’s Discussion and Analysis of Financial Condition and Resultsof Operations – Critical Accounting Policies and Estimates”).

We intend theseforward-looking statements to speak only as of the time of filing thisQuarterly Report on Form 10-Q and do not undertake to update or revisethem as more information becomes available.

**General**

All references herein to “fiscal2007” relate to the 52 weeks ending February 2, 2008 and all references to“fiscal 2006” relate to the 53 weeks ended February 3, 2007. Inaddition, all references herein to “the first quarter of fiscal 2007” and “thefirst three months of fiscal 2007” relate to the 13 weeks ended May 5, 2007 andall references to “the first quarter of fiscal 2006” and “the first threemonths of fiscal 2006” relate to the 13 weeks ended April 29, 2006.

The following table setsforth certain of our unaudited operating data:

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|                                                      | ** ** | **Quarter Ended** | ** ** |
|------------------------------------------------------|------------|------------------------|------------|
| ** **                                           | ** ** | **May 5,**        | ** ** | **April 29,** | ** ** |
| ** **                                           | ** ** | **2007**               | ** ** | **2006** | ** ** |
| **Michaels  stores:**                                | ** ** | ** **             | ** ** | ** ** | ** ** |
| Retail stores open at beginning of period            |       | 920                    |       | 885 |   |
| Retail stores opened during the period               |       | 11                     |       | 17 |   |
| Retail stores opened (relocations) during the period |       | 5                      |       | 3 |   |
| Retail stores closed during the period               |       | (3                     | )          | (3 | ) |
| Retail stores closed (relocations) during the period |       | (5                     | )          | (3 | ) |
| Retail stores open at end of period                  |       | 928                    |       | 899 |   |
|                                                 |       |                   |       |   |   |
| **Aaron  Brothers stores:**                          | ** ** | ** **             | ** ** | ** ** | ** ** |
| Retail stores open at beginning of period            |       | 166                    |       | 166 |   |
| Retail stores opened during the period               |       | 2                      |       | — |   |
| Retail stores closed during the period               |       | —                 |       | (1 | ) |
| Retail stores open at end of period                  |       | 168                    |       | 165 |   |
|                                                 |       |                   |       |   |   |
| **Recollections  stores:**                           | ** ** | ** **             | ** ** | ** ** | ** ** |
| Retail stores open at beginning of period            |       | 11                     |       | 11 |   |
| Retail stores opened during the period               |       | —                 |       | — |   |
| Retail stores open at end of period                  |       | 11                     |       | 11 |   |
|                                                 |       |                   |       |   |   |
| **Star  Decorators Wholesale stores:**               | ** ** | ** **             | ** ** | ** ** | ** ** |
| Wholesale stores open at beginning of period         |       | 4                      |       | 4 |   |
| Wholesale stores opened during the period            |       | —                 |       | — |   |
| Wholesale stores open at end of period               |       | 4                      |       | 4 |   |
|                                                 |       |                   |       |   |   |
| Total store  count at end of period                  |       | 1,111                  |       | 1,079 |   |
|                                                 |       |                   |       |   |   |
| **Other  operating data:**                           | ** ** | ** **             | ** ** | ** ** | ** ** |
| Average inventory per Michaels store (1)             |       | $                      | 892        |   | $ | 820 |   |
| Comparable store  sales (decrease) increase (2)      |       | (0.5                   | )%         | (3.0 | )% |
|                                                      |            |                        |            |  |  |  |  |

 

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| (1)    | Average inventory per Michaels store calculation  excludes our Aaron Brothers, Recollections, and Star Decorators Wholesale  stores.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| (2)    | Comparable store sales increase represents the  increase in net sales for stores open the same number of months in the  indicated period and the comparable period of the previous year, including  stores that were relocated or expanded during either period. A store is  deemed to become comparable in its 14th month of operation in order to  eliminate grand opening sales distortions. A store temporarily closed more  than 2 weeks due to a catastrophic event is not considered comparable  during the month it closed. If a store is closed longer than 2 weeks but  less than 2 months, it becomes comparable in the month in which it  reopens, subject to a mid-month convention. A store closed longer than  2 months becomes comparable in its 14th month of operation after  its reopening. |

 

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**Results of Operations**

The following table setsforth the percentage relationship to net sales of each line item of ourunaudited consolidated statements of income. This table should be read inconjunction with the following discussion and with our consolidated financialstatements, including the related notes, contained herein.
|                                               | ** ** | **Quarter Ended** | ** ** |
|-----------------------------------------------|------------|------------------------|------------|
| ** **                                    | ** ** | **May 5,**        | ** ** | **April 29,** | ** ** |
| ** **                                    | ** ** | **2007**               | ** ** | **2006** | ** ** |
| **Net  sales**                                |       | 100.0                  | %          | 100.0 | % |
| Cost of sales  and occupancy expense          |       | 61.2                   |       | 61.7 |   |
| **Gross  profit**                             |       | 38.8                   |       | 38.3 |   |
| Selling,  general, and administrative expense |       | 30.3                   |       | 28.5 |   |
| Transaction  expenses.                        |       | 0.7                    |       | 0.5 |   |
| Related party  expenses                       |       | 0.6                    |       | — |   |
| Store  pre-opening costs                      |       | 0.2                    |       | 0.2 |   |
| **Operating  income**                         |       | 7.0                    |       | 9.1 |   |
| Interest expense                              |       | 11.3                   |       | — |   |
| Other (income)  and expense, net              |       | (0.3                   | )          | (0.9 | ) |
| **(Loss)  Income before income taxes**        |       | (4.0                   | )          | 10.0 |   |
| Provision for  income taxes                   |       | (1.3                   | )          | 3.8 |   |
| **Net  (loss) income**                        |       | (2.7                   | )%         | 6.2 | % |

 

*Quarter Ended May 5, 2007 Comparedto the Quarter Ended April 29, 2006*

*NetSales*—Net sales increased for the first quarter of fiscal2007 by $11.7 million, or 1.4%, over the first quarter of fiscal 2006. Atthe end of the first quarter of fiscal 2007, we operated 928 Michaels, 168Aaron Brothers, 11 Recollections, and four Star Decorators Wholesale stores.The results for the first quarter of fiscal 2007 include sales from 37 Michaelsand three Aaron Brothers stores that were opened during the 12-monthperiod ended May 5, 2007, more than offsetting lost sales from the closure ofeight Michaels stores during the same period. Non-comparable sales increased$15.5 million, while comparable store sales decreased 0.5%, or $3.8million.

Comparable store salesdeclined 0.5% in the first quarter of fiscal 2007 compared to the first quarterof fiscal 2006, reflecting a decrease in customer transactions of 4.2%,partially offset by increases in the average ticket of 3.5% and custom framingdeliveries of 0.2%. Comparable store sales were negatively impacted by weaknessin the domestic Yarn category, which we estimate adversely impacted same storesales by approximately 80 basis points. Our ability to generate comparablestore sales increases is dependent, in part, on our ability to continue tomaintain store in-stock positions on the top-selling items, to properlyallocate merchandise to our stores, to effectively execute our pricing andsales promotion efforts, to anticipate and react to customer demand and trendsin the arts and crafts industry, and to respond to competitors’ activities.

*Cost ofSales and Occupancy Expense*—Cost of sales and occupancyexpense increased $3.2 million primarily due to increases in the storebase. Cost of sales and occupancy expense, as a percentage of net sales,decreased approximately 50 basis points in the first quarter of fiscal2007 compared to the first quarter of fiscal 2006. Merchandise marginsincreased approximately 150 basis points primarily due to a reduction in depthof promotional programs in addition to benefits from ongoing product sourcinginitiatives.  Occupancy costs, as apercentage of sales, increased approximately 100 basis points primarily due todecreased leverage on the comparable store sales decline and a variety ofincreases in other costs, such as maintenance, utilities, and property taxes.

*Selling,General, and Administrative Expense*—Selling, general, andadministrative expense was $255.9 million, or 30.3% of net sales, in the firstquarter of fiscal 2007 compared to $237.0 million, or 28.5% of net sales, inthe first quarter of fiscal 2006. The expense increase was primarily due tohigher store operating expenses and costs associated with the development andimplementation of certain strategic initiatives. These strategic initiativesinclude our pricing and promotion strategy, consumer insight research, andproduct sourcing, which are more fully described in our Fiscal 2006 AnnualReport on Form 10-K.

As a percentage of netsales, selling, general, and administrative expense increased approximately180 basis points. The 180 basis point increase was primarily due to anapproximate 80 basis point increase in store operating expenses due to decreasedleverage associated with the 0.5% decline in comparable store sales andapproximately 60 basis points of incremental costs associated with ourstrategic initiatives.

*TransactionExpenses*—Transaction expenses incurred during the firstquarter of fiscal 2007 relate primarily to bonus arrangements associated withthe change in control that are ratably amortized for a period of one yearfollowing the Merger date.

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*RelatedParty Expenses*—Related party expenses were $5.3 million inthe first quarter of fiscal 2007 and consisted primarily of $3.4 million ofmanagement fees and associated expenses paid to our Sponsors and Highfields.Also included in related party expenses are $1.0 million of fees related to anexternal vendor we utilize to count store inventory in which The BlackstoneGroup acquired a majority ownership stake during the first quarter of fiscal2007 as well as $0.8 million of amortization expense related to the SeparationAgreements as more fully described in Note 9 to the consolidated financial statements.We expect to incur a similar amount of related party expenses in each of ourquarters for the remainder of fiscal 2007.

*OperatingIncome*—Operating income decreased from $76.1 million, or 9.1%of sales, in the first quarter of fiscal 2006 to $59.4 million, or 7.0% ofsales, in the first quarter of fiscal 2007.

*InterestExpense*—Interest expense increased $95.2 million to $95.4million as a result of debt issued during the fourth quarter of fiscal 2006 tofinance the Merger. We expect to incur a substantial amount of interest expensein future quarters as a result of our outstanding debt.

*OtherIncome*—Other income declined from $7.2 million in thefirst quarter of fiscal 2006 to $2.4 million during the first quarter offiscal 2007 primarily as a result of lower interest income due to lowerinvested cash balances. Other income for the first quarter of fiscal 2006 alsocontained a $3.0 million favorable resolution of a civil lawsuit.

*Provisionfor Income Taxes*—The effective tax rate was 32.5% for thefirst quarter of fiscal 2007 and 37.8% for the first quarter of fiscal 2006. Weexpect the effective tax rate for fiscal 2007 to range from 38% - 42%.

*Net(Loss) Income*—As a result of the above, we reported a netloss of $22.6 million for the first quarter of fiscal 2007 as compared to netincome of $51.7 million for the first quarter of fiscal 2006.

**Liquidity and Capital Resources**

We require cashprincipally for day-to-day operations and to finance capital investments,inventory for new stores, inventory replenishment for existing stores, serviceour outstanding debt, and seasonal working capital needs. In recent years priorto the Merger, we financed our operations, new store openings, old Common Stockrepurchases, dividend payments, and other capital investments with cash fromoperations and proceeds from stock option exercises. We expect that ouravailable cash, cash flow generated from operating activities, and fundsavailable under our Asset-based revolving credit facility will be sufficient tofund planned capital expenditures, working capital requirements, debtrepayments, debt service requirements, and future growth throughout fiscal2007.

Our cash and equivalentsincreased $15.0 million, or 49.9%, from $30.1 million at the end offiscal 2006 to $45.1 million at the end of the first quarter of fiscal2007. Compared to the end of the first quarter of fiscal 2006, cash andequivalents decreased $396.7 million, or 89.8%, as existing cash at theMerger date was used to help finance the Merger.

*Cash Flow from Operating Activities*

Cash flow used inoperating activities during the first three months of fiscal 2007 was $51.2million compared to cash provided by operating activities of$106.5 million during the first three months of fiscal 2006. The$157.7 million change was primarily due to lower net income and anincrease in merchandise inventory in connection with the increase of storein-stock positions, net of accounts payable. During the first quarter of fiscal 2006, our working capital leveragewith respect to merchandise inventories and accounts payable was unusuallyhigh.

Inventories per Michaelsstore (including supporting distribution centers) increased 8.8% from April 29,2006 to May 5, 2007 primarily from higher levels of in-stock positions. Weexpect inventories per Michaels store at the end of fiscal 2007 to be flat tohigher by approximately 2% as compared to the end of fiscal 2006.

*Cash Flow used in InvestingActivities*

Cash flow used ininvesting activities was primarily the result of the following capitalexpenditure activities:

16

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|                                                     | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------|------------|----------------------------------|------------|
| ** **                                          | ** ** | **May 5,**                  | ** ** | **April 29,** | ** ** |
| ** **                                          | ** ** | **2007 (1)**                | ** ** | **2006 (2)** | ** ** |
| ** **                                          | ** ** | **(In thousands)**          | ** ** |
| New and  relocated stores and stores not yet opened |       | $                                | 6,237      |   | $ | 8,590 |   |
| Existing stores                                     |       | 7,214                            |       | 15,159 |   |
| Distribution  system expansion                      |       | 7,706                            |       | 3,815 |   |
| Information  systems                                |       | 6,238                            |       | 10,343 |   |
| Corporate and  other                                |       | 644                              |       | 1,007 |   |
|                                                |       | $                                | 28,039     |   | $ | 38,914 |   |

 

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| (1)    |   | In the first three months of fiscal 2007, we  incurred capital expenditures related to the opening of 11 Michaels and two  Aaron Brothers store in addition to the relocation of five Michaels stores. |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                   |
| (2)    |   | In the first three months of fiscal 2006, we  incurred capital expenditures related to the opening of 17 Michaels stores  and the relocation of three Michaels stores.                                 |

 

*Cash Flow provided by FinancingActivities*

During the first quarterof fiscal 2007, cash provided by financing activities was a result ofincremental borrowings against our asset-based revolving credit facility. Priorto the Merger, proceeds from the exercise of outstanding stock options servedas a source of cash for us. Proceeds from the exercise of stock options were$14.9 million for the three-month period ending April 29, 2006. During thefirst quarter of fiscal 2006, we repurchased $66.2 million of old Common Stockand paid dividends of $26.6 million. As a result of the Merger, we do notexpect any material repurchases of our Common Stock and we do not expect thatstock option exercise proceeds will serve as a material future source of cashso long as our equity is not listed on a public exchange.

*Debt*

To finance the completionof the Merger, we issued 10% Senior Notes due 2014, 11 3/8% Senior Subordinated Notes due 2016,and 13% Subordinated Discount Notes due 2016. We also executed an asset-basedrevolving credit facility as well as a senior secured term loan facility.Borrowings under our asset-based revolving credit facility are influenced by anumber of factors as more fully described below.

*Asset-based revolving credit facility*

The Asset-based revolvingcredit facility provides senior secured financing of up to $1.0 billion,subject to a borrowing base. As of May 5,2007, the borrowing base was $767.2 million with $433.3 million of unusedavailability.

The borrowing base equalsthe sum of (i) 90% of eligible credit card receivables and debit cardreceivables; (ii) between 85% and 90% of the appraised net orderly liquidationvalue of eligible inventory and of eligible letters of credit; (iii) apercentage of eligible in-transit inventory, less certain reserves; and (iv)the sum of an additional 10% of the appraised net orderly liquidation value ofeligible inventory and of eligible letters of credit plus an additional 5% ofeligible credit card receivables and debit card receivables, up to a maximumamount of $100.0 million.

*Senior secured term loan facility*

During the first quarterof fiscal 2007, borrowings under the Senior secured term loan facility boreinterest at a rate per annum equal to, at our option, either (a) a baserate determined by reference to the higher of (1) the prime rate ofDeutsche Bank and (2) the federal funds effective rate plus 1⁄2 of 1%or (b) a LIBOR rate, subject to certain adjustments, in each case plus anapplicable margin. The applicable margin was 1.75% with respect to base rateborrowings and 2.75% with respect to LIBOR borrowings, subject to downwardadjustment based on the leverage and ratings thresholds set forth in the Seniorsecured term loan facility agreement.

On May 10, 2007, we amendedthe Senior secured term loan facility to reduce the applicable margin to 1.25%with respect to base rate borrowings and 2.25% with respect to LIBORborrowings. The amendment also provides that if there is a repricingtransaction that reduces the interest rate margins prior to May 10, 2008, theneach lender will receive a fee equal to 1.00% of the principal amounts of loansthat are repriced. Finally, the amendment eliminated the requirement that wemaintain a specified consolidated secured debt ratio.

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**Recent Accounting Pronouncements**

In July 2006, theFASB issued FASB Interpretation No. 48, *Accountingfor Uncertainty in Income Taxes — an interpretation of FASB StatementNo. 109*, which clarifies the accounting for uncertainty inincome tax positions. FIN 48 requires that a company recognize in itsconsolidated financial statements the impact of a tax position that is morelikely than not to be sustained upon examination based on the technical meritsof the position. We adopted FIN 48 as of the beginning of our first quarter offiscal 2007 with no material impact to our consolidated income statement,balance sheet, shareholders’ equity, or cash flows statement.

Upon adoption, we electedto record any interest and penalties associated with audits as a component ofincome tax expense. The Company identified its federal tax return, Canadian taxreturn, and its state tax returns in California, Florida, Illinois, New York,North Carolina, Pennsylvania, and Texas as “major” tax jurisdictions.  The periods subject to examination for ourfederal return are 2002 to present, 2000 to present for our Canadian return,2003 to present for all state returns except for California, and 1998 topresent for California.

In September 2006, theFASB issued Statement of Financial Accounting Standard No. 158, *Employers’ Accounting for Defined Benefit Pensions and OtherPostretirement Plans*, which requires an entity to recognize theoverfunded or underfunded status of a defined benefit postretirement plan as anasset or liability in its balance sheet and to recognize changes in that fundedstatus in the year in which the changes occur through comprehensiveincome.  It also requires an entity tomeasure the funded status of a plan as of the date of its year-end balancesheet.  As we have no publicly tradedsecurities (due to the Merger), FAS 158 is effective for us at the end offiscal 2007, with early adoption permitted. We plan to adopt FAS 158 at the end of fiscal 2007, with no materialimpact expected on our consolidated income statement, balance sheet,shareholders’ equity, or cash flows statement.

In February 2007, theFASB issued Statement of Financial Accounting Standard No. 159, *The Fair Value Option for Financial Assets and Financial Liabilities*,which permits companies to measure certain financial instruments and otheritems at fair value (at specified measurement dates) that are not currentlyrequired to be measured at fair value. Any unrealized gains or lossesapplicable to those items measured at fair value shall be reported in earnings.The decision to apply fair value shall generally be made on an instrument byinstrument basis, is irrevocable, and is applied only to an entire instrument.The provisions of FAS 159 will be effective for us as of the beginning forfiscal 2008, with early adoption permitted.

**Item 3.  Quantitativeand Qualitative Disclosures About Market Risk.**

During the first quarterof fiscal 2007, we executed an interest rate collar to hedge our variability ofcash flows associated with our interest payments on our Senior secured termloan that result from fluctuations in the three-month LIBOR rate. The interestrate collar provided a fixed interest rate, with respect to the three-monthLIBOR rate, at a cap of 6.0% and a floor of 3.21% for a notional value of$1.755 billion from March 2, 2007 through May 10, 2007. We terminated theinterest rate collar on May 10, 2007 in connection with the repricing of theSenior secured term loan described in Note 4 to our consolidated financialstatements of this Quarterly Report on Form 10-Q. The termination of theinterest rate collar resulted in an immaterial loss recorded in the secondquarter of fiscal 2007.

**Item 4.  Controlsand Procedures.**

*Evaluation of Disclosure Controlsand Procedures*

We maintain a set ofdisclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) promulgated by the SEC under the Securities Exchange Act of 1934). Anevaluation was carried out under the supervision and with the participation ofour management, including our President and Chief Financial Officer and ourPresident and Chief Operating Officer, of the effectiveness of our disclosurecontrols and procedures as of the end of the period covered by this QuarterlyReport on Form 10-Q. Based on that evaluation, our President and ChiefFinancial Officer and our President and Chief Operating Officer concluded thatour disclosure controls and procedures are effective to provide reasonableassurance that information required to be disclosed in the reports that we fileor submit under the Securities Exchange Act of 1934 is recorded, processed,summarized, and reported within the time periods specified in SEC rules andforms. Such controls and procedures are designed to ensure that information weare required to disclose in our reports is accumulated and communicated to ourmanagement, including our principal executive officers and principal financialofficer, to allow timely disclosure decisions. We note that the design of anysystem of controls is based, in part, upon certain assumptions about thelikelihood of future events, and there can be no assurance that any design willsucceed in achieving its stated goals under all potential future conditions.

*Change in Internal Control OverFinancial Reporting*

During the first quarterof fiscal 2007, we corrected our method of accounting for merchandiseinventories under the retail inventory method, or RIM, for years prior tofiscal 2005 and restated our consolidated financial statements in our 2006Annual Report on Form 10-K for years prior to fiscal 2006. The correction ofour application of RIM in prior years and restatement of consolidated financialstatements constituted a material change in our internal control over financialreporting.  There were no other materialchanges in our internal control over financial reporting (as defined inRules 13a-15(f) and 15d-15(f) as promulgated by the SEC under theSecurities Exchange Act of 1934) during our most recently completed fiscalquarter that materially affected, or are reasonably likely to materiallyaffect, our internal control over financial reporting.

18

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**MICHAELSSTORES, INC.**

**Part II—OTHER INFORMATION**

**Item 1.  Legal Proceedings.**

Reference is made to the consolidated action describedunder “Part I. Item 3. Legal Proceedings — Shareholder Claims — FederalCourt Litigation” in our Annual Report on Form 10-K for fiscal2006.  In that action, on May 21, 2007the lead plaintiff, Massachusetts Laborers’ Annuity Fund, filed a motion forleave to file a first amended consolidated class action complaint (the “AmendedComplaint”).  As proposed, the AmendedComplaint names Michaels and certain of its current and former officers anddirectors as defendants.  The AmendedComplaint alleges that the defendants misrepresented and/or omitted materialfacts in Michaels’ annual proxy statements for 2004, 2005 and 2006, including,among others, failing to disclose: (a) Michaels’ and the defendants’ alleged option backdatingpractices, (b) information regarding transactions and holdings of MichaelsCommon Stock by certain trusts owned by or for the benefit of two of Michaels’former officers and directors and their family members; and (c) that Michaelsand the defendants had reported false financial statements as a result of thosepractices.  Further, the Amended Complaintmakes allegations regarding the Company’s financial restatement of periodsprior to 2006, as well as the recently completed merger with entitiesaffiliated with Bain Capital Partners LLC and The Blackstone Group.  In the Amended Complaint, the lead plaintiffasserts claims against all defendants for violations of Section 14(a) of theSecurities Exchange Act of 1934 and Rule 14a-9 promulgated thereunder, andSection 20(a) of the Securities Exchange Act of 1934.  The plaintiff seeks, among other relief, (a)an indeterminate amount of damages, (b) pre-judgment and post-judgmentinterest, (c) an award of attorneys fees and costs, and (d) equitable orinjunctive relief, including the rescission of stock option grants.

Weare involved in ongoing legal and regulatory proceedings. Other than theupdate described in the preceding paragraph, there were no material changes toour disclosures of commitments and contingencies from our Annual Report on Form10-K for fiscal 2006.

**Item 2.  UnregisteredSale of Equity Securities and Use of Proceeds**

On February 16, 2007,officers of Michaels Stores, Inc. and its subsidiaries purchased shares of ourCommon Stock at a price of $15 per share. We sold approximately $4.3 million,or 289,334 shares of our Common Stock to certain officers, and such sharesrepresent approximately 0.24% of the total outstanding shares of MichaelsStores, Inc. The sale was made pursuant to the exemption provided by Section4(2) of the Securities Act of 1933 and Regulation D of the rules of the SEC.  The purchasers were either accreditedinvestors under that regulation or unaccredited investors meeting thequantitative and knowledge and experience requirements of Rule 506 ofRegulation D. The proceeds from the sale of the Common Stock were used forgeneral corporate purposes.

During the first quarterof fiscal 2007, we also granted options for the purchase of up to 9.7 millionshares of our Common Stock to key employees pursuant to the sameexemption.  See Note 3 to our ConsolidatedFinancial Statements in this Quarterly Report on Form 10-Q.

**Item 4.  Submission of Matters to a Vote ofSecurity Holders.**

OnFebruary 15, 2007, approximately 93.6% of our shareholders, by written consent,approved the 2006 Equity Incentive Plan, with no votes against and 6.4%abstaining.

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**Item 6.  Exhibits.**

(a) Exhibits:
| Exhibit  Number | ** ** | **Description of Exhibit**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|-----------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1             |       | Amended and Restated Certificate of Incorporation of  Michaels Stores, Inc. (previously filed as Exhibit 3.1 to Form 10-K filed by  Registrant on May 3, 2007, SEC File No. 001-09338).                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 3.2             |       | Amended and Restated Bylaws of Michaels Stores, Inc.  (previously filed as Exhibit 3.2 to Form 8-K filed by Registrant on November  6, 2006, SEC File No. 001-09338).                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 4.1             |       | Senior Indenture, dated as of October 31, 2006,  among Michaels Stores, Inc., the guarantors named therein and Wells Fargo  Bank, National Association, as trustee (previously filed as Exhibit 4.1 to  Form 10-Q filed by Registrant on December 7, 2006, SEC File No. 001-09338).                                                                                                                                                                                                                                                                                                                                                        |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 4.2             |       | Senior Subordinated Indenture, dated as of October  31, 2006, among Michaels Stores, Inc., the guarantors named therein and Wells  Fargo Bank, National Association, as trustee (previously filed as Exhibit 4.2  to Form 10-Q filed by Registrant on December 7, 2006, SEC File No.  001-09338).                                                                                                                                                                                                                                                                                                                                          |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 4.3             |       | Subordinated Discount Indenture, dated as of October  31, 2006, among Michaels Stores, Inc., the guarantors named therein and Wells  Fargo Bank, National Association, as trustee (previously filed as Exhibit 4.3  to Form 10-Q filed by Registrant on December 7, 2006, SEC File No.  001-09338).                                                                                                                                                                                                                                                                                                                                        |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 4.4             |       | Registration Rights Agreement for the Senior Notes,  dated as of October 31, 2006, among Michaels Stores, Inc., the guarantors  named therein and Deutsche Bank Securities Inc., J.P. Morgan Securities Inc.,  Banc of America Securities LLC and Credit Suisse Securities (USA) LLC  (previously filed as Exhibit 4.4 to Form 10-Q filed by Registrant on December  7, 2006, SEC File No. 001-09338).                                                                                                                                                                                                                                     |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 4.5             |       | Registration Rights Agreement for the Senior  Subordinated Notes, dated as of October 31, 2006, among Michaels Stores,  Inc., the guarantors named therein and Deutsche Bank Securities Inc., J.P.  Morgan Securities Inc., Banc of America Securities LLC and Credit Suisse  Securities (USA) LLC (previously filed as Exhibit 4.5 to Form 10-Q filed by  Registrant on December 7, 2006, SEC File No. 001-09338).                                                                                                                                                                                                                        |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 4.6             |       | Registration Rights Agreement for the Subordinated  Discount Notes, dated as of October 31, 2006, among Michaels Stores, Inc.,  the guarantors named therein and Deutsche Bank Securities Inc., J.P. Morgan  Securities Inc., Banc of America Securities LLC and Credit Suisse Securities  (USA) LLC (previously filed as Exhibit 4.6 to Form 10-Q filed by Registrant  on December 7, 2006, SEC File No. 001-09338).                                                                                                                                                                                                                      |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 4.7             |       | Registration Rights Agreement, dated as of October  31, 2006, among Michaels Stores, Inc. and certain stockholders thereof  (previously filed as Exhibit 4.7 to Form 10-Q filed by Registrant on December  7, 2006, SEC File No. 001-09338).                                                                                                                                                                                                                                                                                                                                                                                               |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.1            |       | Second Amendment to Credit Agreement, dated as of  May 10, 2007, to the Credit Agreement, dated as of October 31, 2006, among  Michaels Stores, Inc., Deutsche Bank AG New York Branch, as administrative  agent, the other lenders named therein, JPMorgan Chase Bank, N.A., as  syndication agent, and Bank of America, N.A. and Credit Suisse, as  co-documentation agents, and Deutsche Bank Securities Inc., J.P. Morgan  Securities Inc. and Banc of America Securities LLC as co-lead arrangers and  joint bookrunners (previously filed as Exhibit 10.1 to Form 8-K filed by  Registrant on May 11, 2007, SEC File No. 001-09338). |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.2            |       | Employment Agreement dated June 4, 2007, between  Michaels Stores, Inc. and Brian C. Cornell (filed herewith).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.3            |       | Fiscal Year 2007 Bonus Plan for Chief Executive  Officer (filed herewith).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.4            |       | Restricted Stock Award Agreement dated June 4, 2007,  between Michaels Stores, Inc. and Brian C. Cornell (filed herewith).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.5            |       | Stock Option Agreement dated June 4, 2007, between  Michaels Stores, Inc. and Brian C. Cornell (filed herewith).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 31.1            |       | Certifications of Brian C. Cornell pursuant to §302  of the Sarbanes-Oxley Act of 2002 (filed herewith).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 31.2            |       | Certifications of Jeffrey N. Boyer pursuant to §302  of the Sarbanes-Oxley Act of 2002 (filed herewith).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 32.1            |       | Certification pursuant to 18 U.S.C. §1350, as  adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002 (filed herewith).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |

 

20

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**MICHAELSSTORES, INC.**

**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.
|        | MICHAELS STORES, INC. |
|--------|-----------------------|
|   |                  |   |
|   | By:                   | /s/  Jeffrey N. Boyer |   |
|   |                  | Jeffrey N. Boyer |
|   |                  | President and Chief Financial Officer |
|   |                  | (Principal Financial Officer) |

 

Dated: June 11,2007

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**INDEX TOEXHIBITS**
| Exhibit Number | ** ** | **Description of Exhibit**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|----------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1            |       | Amended and Restated Certificate of Incorporation of  Michaels Stores, Inc. (previously filed as Exhibit 3.1 to Form 10-K filed by  Registrant on May 3, 2007, SEC File No. 001-09338).                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|           |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 3.2            |       | Amended and Restated Bylaws of Michaels Stores, Inc.  (previously filed as Exhibit 3.2 to Form 8-K filed by Registrant on November  6, 2006, SEC File No. 001-09338).                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|           |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 4.1            |       | Senior Indenture, dated as of October 31, 2006,  among Michaels Stores, Inc., the guarantors named therein and Wells Fargo  Bank, National Association, as trustee (previously filed as Exhibit 4.1 to  Form 10-Q filed by Registrant on  December 7, 2006, SEC File No.  001-09338).                                                                                                                                                                                                                                                                                                                                            |
|           |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 4.2            |       | Senior Subordinated Indenture, dated as of October  31, 2006, among Michaels Stores, Inc., the guarantors named therein and Wells  Fargo Bank, National Association, as trustee (previously filed as Exhibit 4.2  to Form 10-Q filed by Registrant on December 7, 2006, SEC File No.  001-09338).                                                                                                                                                                                                                                                                                                                                          |
|           |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 4.3            |       | Subordinated Discount Indenture, dated as of October  31, 2006, among Michaels Stores, Inc., the guarantors named therein and Wells  Fargo Bank, National Association, as trustee (previously filed as Exhibit 4.3  to Form 10-Q filed by Registrant on December 7, 2006, SEC File No.  001-09338).                                                                                                                                                                                                                                                                                                                                        |
|           |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 4.4            |       | Registration Rights Agreement for the Senior Notes,  dated as of October 31, 2006, among Michaels Stores, Inc., the guarantors  named therein and Deutsche Bank Securities Inc., J.P. Morgan Securities Inc.,  Banc of America Securities LLC and Credit Suisse Securities (USA) LLC  (previously filed as Exhibit 4.4 to Form 10-Q filed by Registrant on December  7, 2006, SEC File No. 001-09338).                                                                                                                                                                                                                                     |
|           |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 4.5            |       | Registration Rights Agreement for the Senior  Subordinated Notes, dated as of October 31, 2006, among Michaels Stores,  Inc., the guarantors named therein and Deutsche Bank Securities Inc., J.P.  Morgan Securities Inc., Banc of America Securities LLC and Credit Suisse  Securities (USA) LLC (previously filed as Exhibit 4.5 to Form 10-Q filed by  Registrant on December 7, 2006, SEC File No. 001-09338).                                                                                                                                                                                                                        |
|           |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 4.6            |       | Registration Rights Agreement for the Subordinated  Discount Notes, dated as of October 31, 2006, among Michaels Stores, Inc.,  the guarantors named therein and Deutsche Bank Securities Inc., J.P. Morgan  Securities Inc., Banc of America Securities LLC and Credit Suisse Securities  (USA) LLC (previously filed as Exhibit 4.6 to Form 10-Q filed by Registrant  on December 7, 2006, SEC File No. 001-09338).                                                                                                                                                                                                                      |
|           |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 4.7            |       | Registration Rights Agreement, dated as of October  31, 2006, among Michaels Stores, Inc. and certain stockholders thereof  (previously filed as Exhibit 4.7 to Form 10-Q filed by Registrant on December  7, 2006, SEC File No. 001-09338).                                                                                                                                                                                                                                                                                                                                                                                               |
|           |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.1           |       | Second Amendment to Credit Agreement, dated as of  May 10, 2007, to the Credit Agreement, dated as of October 31, 2006, among  Michaels Stores, Inc., Deutsche Bank AG New York Branch, as administrative  agent, the other lenders named therein, JPMorgan Chase Bank, N.A., as  syndication agent, and Bank of America, N.A. and Credit Suisse, as  co-documentation agents, and Deutsche Bank Securities Inc., J.P. Morgan  Securities Inc. and Banc of America Securities LLC as co-lead arrangers and  joint bookrunners (previously filed as Exhibit 10.1 to Form 8-K filed by  Registrant on May 11, 2007, SEC File No. 001-09338). |
|           |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.2           |       | Employment Agreement dated June 4, 2007, between  Michaels Stores, Inc. and Brian C. Cornell (filed herewith).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|           |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.3           |       | Fiscal Year 2007 Bonus Plan for Chief Executive  Officer (filed herewith).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|           |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.4           |       | Restricted Stock Award Agreement dated June 4, 2007,  between Michaels Stores, Inc. and Brian C. Cornell (filed herewith).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|           |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.5           |       | Stock Option Agreement dated June 4, 2007, between  Michaels Stores, Inc. and Brian C. Cornell (filed herewith).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|           |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 31.1           |       | Certifications of Brian C. Cornell pursuant to §302  of the Sarbanes-Oxley Act of 2002 (filed herewith).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|           |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 31.2           |       | Certifications of Jeffrey N. Boyer pursuant to §302  of the Sarbanes-Oxley Act of 2002 (filed herewith).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|           |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 32.1           |       | Certification pursuant to 18 U.S.C. §1350, as  adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002 (filed herewith).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |

 

22

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