Table of Contents

 

 

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON,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 August 1, 2009** |
| ** **                                              | ** ** |
| **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**

 (Address of principal 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 by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the Registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days.*  Yes o No o

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T during thepreceding 12 months (or for such shorter period that the registrant wasrequired to submit and post such files). * Yes o No o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company. See the definitions of“large accelerated filer,” “accelerated filer” and “smaller reporting company”in Rule 12b-2 of the Exchange Act. 

 

| Large accelerated filer o                     |   | Accelerated filer o         |
|-----------------------------------------------|--------|-----------------------------|
| Non-accelerated filer x                       |   | Smaller reporting company o |
| (Do not check if a smaller reporting company) |   |                        |

 

Indicateby check mark whether the Registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).  Yes o No x

 

Asof August 31, 2009, 118,942,246 shares of the Registrant’s Common Stockwere outstanding.

 

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*TheRegistrant has filed all reports required to be filed by Section 13 or 15(d) ofthe Securities Exchange Act of 1934, but is not required to file such reportsunder such sections.

 

 

 

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Table of Contents

 

**MICHAELS STORES, INC.**

**FORM 10-Q**

 
| **Part I—FINANCIAL INFORMATION** | **3**                                                                                                                               |
|--------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------|
| **Item 1.**                           | **Financial Statements**                                                                                                            | **3** |
|                                       | Consolidated Balance Sheets at  August 1, 2009, January 31, 2009, and August 2, 2008  (unaudited)                    | **3** |
|                                       | Consolidated Statements of Operations for the quarter  and six months ended August 1, 2009 and August 2, 2008 (unaudited) | **4** |
|                                       | Consolidated  Statements of Cash Flows for the six months ended August 1, 2009 and  August 2, 2008 (unaudited)            | **5** |
|                                       | Notes to Consolidated Financial Statements (unaudited)                                                                              | **6** |
| **Item 2.**                           | **Management’s  Discussion and Analysis of Financial Condition and Results of Operations**                                     | **18** |
| **Item 3.**                           | **Quantitative  and Qualitative Disclosures About Market Risk**                                                                     | **24** |
| **Item 4.**                           | **Controls and  Procedures**                                                                                                        | **24** |
| **Part II—OTHER INFORMATION**    | **26**                                                                                                                              |
| **Item 1.**                           | **Legal Proceedings**                                                                                                               | **26** |
| **Item 5.**                           | **Other Information**                                                                                                               | **26** |
| **Item 6.**                           | **Exhibits**                                                                                                                        | **26** |
| **Signatures**                             | **27**                                                                                                                              |

 

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**Table of Contents**

 

**MICHAELS STORES, INC.**

**Part I—FINANCIAL INFORMATION**

 

**Item 1.  FinancialStatements.**

 

**MICHAELSSTORES, INC.**

**CONSOLIDATED BALANCE SHEETS**

**(Inmillions, except share data)**

**(Unaudited)**

 
| ** **                                                                                                                                                                                                                                                               | ** ** | **August 1,** | ** ** | **January 31,** | ** ** | **August 2,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|----------------------|------------|--------------------|------------|
| ** **                                                                                                                                                                                                                                                               | ** ** | **2009**           | ** ** | **2009**             | ** ** | **2008**           | ** ** |
| **ASSETS**                                                                                                                                                                                                                                                               |       |               |       |                 |       |               |       |
| **Current assets:**                                                                                                                                                                                                                                                      |       |               |       |                 |       |               |       |
| Cash  and equivalents                                                                                                                                                                                                                                                    |       | $                  | 36         |                 | $          | 33                 |       | $ | 45 |   |
| Merchandise  inventories                                                                                                                                                                                                                                                 |       | 950                |       | 900                  |       | 938                |       |
| Prepaid  expenses and other                                                                                                                                                                                                                                              |       | 75                 |       | 73                   |       | 71                 |       |
| Deferred  income taxes                                                                                                                                                                                                                                                   |       | 41                 |       | 41                   |       | 31                 |       |
| Income  tax receivable                                                                                                                                                                                                                                                   |       | 16                 |       | 2                    |       | 42                 |       |
| Total  current assets                                                                                                                                                                                                                                                    |       | 1,118              |       | 1,049                |       | 1,127              |       |
| **Property and equipment, at cost**                                                                                                                                                                                                                                      |       | 1,228              |       | 1,214                |       | 1,187              |       |
| Less  accumulated depreciation                                                                                                                                                                                                                                           |       | (883               | )          | (832                 | )          | (777               | )          |
|                                                                                                                                                                                                                                                                     |       | 345                |       | 382                  |       | 410                |       |
| **Goodwill**                                                                                                                                                                                                                                                             |       | 94                 |       | 94                   |       | 94                 |       |
| **Debt issuance costs, net of accumulated amortization of  $47, $39, and $30, respectively**                                                                                                                                                                             |       | 78                 |       | 86                   |       | 95                 |       |
| **Deferred income taxes**                                                                                                                                                                                                                                                |       | 14                 |       | 12                   |       | —             |       |
| **Other assets**                                                                                                                                                                                                                                                         |       | 26                 |       | 2                    |       | 2                  |       |
|                                                                                                                                                                                                                                                                     |       | 212                |       | 194                  |       | 191                |       |
| Total  assets                                                                                                                                                                                                                                                            |       | $                  | 1,675      |                 | $          | 1,625              |       | $ | 1,728 |   |
|                                                                                                                                                                                                                                                                     |       |               |       |                 |       |               |       |
| **LIABILITIES AND STOCKHOLDERS’  DEFICIT**                                                                                                                                                                                                                          |       |               |       |                 |       |               |       |
| **Current liabilities:**                                                                                                                                                                                                                                                 |       |               |       |                 |       |               |       |
| Accounts  payable                                                                                                                                                                                                                                                        |       | $                  | 216        |                 | $          | 230                |       | $ | 244 |   |
| Accrued  liabilities and other                                                                                                                                                                                                                                           |       | 288                |       | 275                  |       | 304                |       |
| Current  portion of long-term debt                                                                                                                                                                                                                                       |       | 198                |       | 173                  |       | 286                |       |
| Income  taxes payable                                                                                                                                                                                                                                                    |       | —             |       | 2                    |       | —             |       |
| Current  liabilities - discontinued operations                                                                                                                                                                                                                           |       | 1                  |       | 1                    |       | 2                  |       |
| Total  current liabilities                                                                                                                                                                                                                                               |       | 703                |       | 681                  |       | 836                |       |
| **Long-term debt**                                                                                                                                                                                                                                                       |       | 3,766              |       | 3,756                |       | 3,748              |       |
| **Deferred income taxes**                                                                                                                                                                                                                                                |       | —             |       | —               |       | 4                  |       |
| **Other long-term liabilities**                                                                                                                                                                                                                                          |       | 79                 |       | 74                   |       | 78                 |       |
| **Long-term liabilities - discontinued operations**                                                                                                                                                                                                                      |       | 1                  |       | 1                    |       | 1                  |       |
| Total  long-term liabilities                                                                                                                                                                                                                                             |       | 3,846              |       | 3,831                |       | 3,831              |       |
|                                                                                                                                                                                                                                                                     |       | 4,549              |       | 4,512                |       | 4,667              |       |
| **Commitments and contingencies**                                                                                                                                                                                                                                        |       |               |       |                 |       |               |       |
| **Stockholders’ deficit:**                                                                                                                                                                                                                                          |       |               |       |                 |       |               |       |
| Common  Stock, $0.10 par value, 220,000,000 shares authorized; 118,387,229 shares  issued and outstanding at August 1, 2009; 118,376,402 shares issued and  outstanding at January 31, 2009; 118,382,402 shares issued and  outstanding at August 2, 2008 |       | 12                 |       | 12                   |       | 12                 |       |
| Additional  paid-in capital                                                                                                                                                                                                                                              |       | 32                 |       | 27                   |       | 15                 |       |
| Accumulated  deficit                                                                                                                                                                                                                                                     |       | (2,925             | )          | (2,931               | )          | (2,976             | )          |
| Accumulated  other comprehensive income                                                                                                                                                                                                                                  |       | 7                  |       | 5                    |       | 10                 |       |
| Total  stockholders’ deficit                                                                                                                                                                                                                                        |       | (2,874             | )          | (2,887               | )          | (2,939             | )          |
| Total  liabilities and stockholders’ deficit                                                                                                                                                                                                                        |       | $                  | 1,675      |                 | $          | 1,625              |       | $ | 1,728 |   |

 

See accompanying notes to consolidated financialstatements.

 

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**MICHAELS STORES, INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Inmillions)**

**(Unaudited)**

 
| ** **                                    | ** ** | **Quarter Ended**  | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------|------------|--------------------|------------|----------------------|------------|
| ** **                                    | ** ** | **August 1,** | ** ** | **August 2,**   | ** ** | **August 1,** | ** ** | **August 2,** | ** ** |
| ** **                                    | ** ** | **2009**           | ** ** | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
| **Net sales**                                 |       | $                  | 807        |                 | $          | 796 |   | $ | 1,659 |   | $ | 1,643 |   |
| Cost  of sales and occupancy expense          |       | 521                |       | 518                  |       | 1,058 |   | 1,039 |   |
| **Gross profit**                              |       | 286                |       | 278                  |       | 601 |   | 604 |   |
| Selling,  general, and administrative expense |       | 232                |       | 246                  |       | 478 |   | 518 |   |
| Related  party expenses                       |       | 3                  |       | 4                    |       | 7 |   | 8 |   |
| Store  pre-opening costs                      |       | 1                  |       | 1                    |       | 2 |   | 3 |   |
| **Operating income**                          |       | 50                 |       | 27                   |       | 114 |   | 75 |   |
| Interest  expense                             |       | 62                 |       | 76                   |       | 125 |   | 154 |   |
| Other  (income) and expense, net              |       | (14                | )          | —               |       | (20 | ) | — |   |
| **Income (loss) before income taxes**         |       | 2                  |       | (49                  | )          | 9 |   | (79 | ) |
| Provision  (benefit) for income taxes         |       | —             |       | (19                  | )          | 3 |   | (29 | ) |
| **Net income (loss)**                         |       | $                  | 2          |                 | $          | (30 | ) | $ | 6 |   | $ | (50 | ) |

 

See accompanyingnotes to consolidated financial statements.

 

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**MICHAELSSTORES, INC.**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Inmillions)**

**(Unaudited)**

 
| ** **                                           | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------|------------|----------------------|------------|
| ** **                                           | ** ** | **August 1,**   | ** ** | **August 2,** | ** ** |
| ** **                                           | ** ** | **2009**             | ** ** | **2008** | ** ** |
| **Operating activities:**                            |       |                 |       |   |   |
| Net  income (loss)                                   |       | $                    | 6          |   | $ | (50 | ) |
| Adjustments:                                         |       |                 |       |   |   |
| Depreciation  and amortization                       |       | 58                   |       | 63 |   |
| Share-based  compensation                            |       | 4                    |       | 4 |   |
| Deferred  financing costs amortization               |       | 8                    |       | 8 |   |
| Accretion  of subordinated discount notes            |       | 22                   |       | 19 |   |
| Change  in fair value of interest rate cap           |       | (15                  | )          | — |   |
| Changes  in assets and liabilities:                  |       |                 |       |   |   |
| Merchandise  inventories                             |       | (43                  | )          | (94 | ) |
| Prepaid  expenses and other                          |       | (5                   | )          | — |   |
| Deferred  income taxes and other                     |       | (8                   | )          | 2 |   |
| Accounts  payable                                    |       | 7                    |       | 18 |   |
| Accrued  interest                                    |       | 1                    |       | (34 | ) |
| Accrued  liabilities and other                       |       | 7                    |       | 6 |   |
| Income  taxes receivable                             |       | (17                  | )          | (37 | ) |
| Other  long-term liabilities                         |       | 5                    |       | (3 | ) |
| Net  cash provided by (used in) operating activities |       | 30                   |       | (98 | ) |
|                                                 |       |                 |       |   |   |
| **Investing activities:**                            |       |                 |       |   |   |
| Additions  to property and equipment                 |       | (17                  | )          | (39 | ) |
| Net  cash used in investing activities               |       | (17                  | )          | (39 | ) |
|                                                 |       |                 |       |   |   |
| **Financing activities:**                            |       |                 |       |   |   |
| Borrowings  on asset-based revolving credit facility |       | 441                  |       | 506 |   |
| Payments  on asset-based revolving credit facility   |       | (415                 | )          | (341 | ) |
| Repayments  on senior secured term loan facility     |       | (12                  | )          | (12 | ) |
| Repurchase  of new Common Stock                      |       | —               |       | (1 | ) |
| Payments  of capital leases                          |       | —               |       | (4 | ) |
| Change  in cash overdraft                            |       | (23                  | )          | 6 |   |
| Other                                                |       | (1                   | )          | (1 | ) |
| Net  cash (used in) provided by financing activities |       | (10                  | )          | 153 |   |
|                                                 |       |                 |       |   |   |
| **Net increase in cash and equivalents**             |       | 3                    |       | 16 |   |
| **Cash and equivalents at beginning of period**      |       | 33                   |       | 29 |   |
| **Cash and equivalents at end of period**            |       | $                    | 36         |   | $ | 45 |   |
|                                                 |       |                 |       |   |   |
| **Supplemental Cash Flow Information:**              |       |                 |       |   |   |
| Cash  paid for interest                              |       | $                    | 93         |   | $ | 160 |   |
| Cash  paid for income taxes                          |       | $                    | 19         |   | $ | 11 |   |

** **

See accompanying notes to consolidated financialstatements.

 

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**MICHAELS STORES, INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**For the Six Months Ended August 1, 2009**

**(Unaudited)**

 

**Note 1.  Summaryof Significant 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 the “Company”, “us,”“we,” “our,” and all similar expressions are references to Michaels Stores, Inc.and our consolidated, wholly-owned subsidiaries, unless otherwise expresslystated or the 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.  Therefore, thesefinancial statements should be read in conjunction with our Annual Report on Form 10-Kfor the fiscal year ended January 31, 2009. We have evaluated allsubsequent events through the issuance of the financial statements, whichoccurred on September 4, 2009.

 

The balance sheet at January 31,2009 has been derived from the audited financial statements at that date butdoes not include all of the information and notes required by generallyaccepted accounting principles for complete financial statements. For furtherinformation, refer to the consolidated financial statements and notes theretoincluded in our Annual Report on Form 10-K for the fiscal year ended January 31,2009.

 

In the opinion ofmanagement, all adjustments (consisting of normal recurring accruals and otheritems, as disclosed) considered necessary for a fair presentation have beenincluded.

 

Because of the seasonalnature of our business, the results of operations for the three and six monthsended August 1, 2009 are not indicative of the results to be expected forthe entire year.

 

We report on the basis ofa 52 or 53-week fiscal year, which ends on the Saturday closest to January 31.All references herein to “fiscal 2009” relate to the 52 weeks ending January 30,2010, and all references to “fiscal 2008” relate to the 52 weeks ended January 31,2009. In addition, all references herein to “the second quarter of fiscal 2009”relate to the 13 weeks ended August 1, 2009 and all references to “thesecond quarter of fiscal 2008” relate to the 13 weeks ended August 2,2008.  Finally, all references to “thesix months ended August 1, 2009” relate to the 26 weeks ended August 1,2009, and “the six months ended August 2, 2008” relate to the 26 weeksended August 2, 2008.

 

*Recent Accounting Pronouncements*

** **

In September 2006,the Financial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards (“SFAS”) No. 157, *Fair Value Measurements*,which is intended to increase consistency and comparability in fair valuemeasurements by defining fair value, establishing a framework for measuringfair value and expanding disclosures about fair value measurements.  SFAS 157 was originally effective forfinancial statements issued for fiscal years beginning after November 15,2007, and interim periods within those fiscal years.  In November 2007, the FASB placed a oneyear deferral for the implementation of SFAS 157 for nonfinancial assets andliabilities; however, SFAS 157 is effective for fiscal years beginning after November 15,2007 for financial assets and liabilities, as well as for any other assets andliabilities that are carried at fair value on a recurring basis in financialstatements.  On February 3, 2008, weadopted the provisions of SFAS 157 related to financial assets and liabilitiesand on February 1, 2009, we adopted the provisions related to nonfinancialassets and liabilities that are not required or permitted to be measured atfair value on a recurring basis. These adoptions had no impact on ourconsolidated financial statements.   SeeNote 6 for further information regarding fair value measurements. Additionally,in April 2009, the FASB issued FASB Staff Position (“FSP”) No. FAS107-1 and APB 28-1, *Interim Disclosures AboutFair Value of Financial Instruments,* which collectively provideadditional guidance and require additional disclosure regarding determining andreporting fair values for certain assets and liabilities. We adopted FSP FAS107-1 in the second quarter of fiscal 2009 as reflected in Note 3.

 

 

 

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In December 2007,the FASB issued SFAS No. 141 (revised 2007), *Business Combinations*(“SFAS 141R”). SFAS 141R replaces SFASNo. 141, *Business Combinations*.The statement retains the purchase method of accounting used in businesscombinations, but replaces SFAS 141 by establishing principles and requirementsfor the recognition and measurement of assets, liabilities and goodwill,including the requirement that most transaction costs and restructuring costsbe expensed. In addition, the statement requires disclosures to enable users toevaluate the nature and financial effects of the business combination. SFAS141R is effective for business combinations for which the acquisition date ison or after the beginning of the first annual reporting period beginning on orafter December 15, 2008. We will apply the provisions of SFAS 141R to anybusiness combinations occurring on or after February 1, 2009.

 

In March 2008, theFASB issued SFAS No. 161, *Disclosuresabout Derivative Instruments and Hedging Activities — an amendment of FASBStatement No. 133*. SFAS 161 requires qualitative disclosuresabout objectives and strategies for using derivatives, quantitative data aboutthe fair value of and gains and losses on derivative contracts, and details ofcredit-risk-related contingent features in hedged positions. The statement alsorequires enhanced disclosures regarding how and why entities use derivativeinstruments, how derivative instruments and related hedged items are accountedfor in accordance with SFAS 133 and its related interpretation, and howderivative instruments and related hedged items affect entity’s financialposition, financial performance, and cash flows. SFAS 161 is effective forfiscal years and interim periods beginning after November 15, 2008. Weadopted the new disclosure requirements of SFAS 161 in the first quarter of2009 as reflected in Note 5.

 

In May 2009, theFASB issued SFAS No. 165, *Subsequent Events*.SFAS 165 is intended to establish general standards of accounting for anddisclosure of events that occur after the balance sheet date but before thefinancial statements are issued or available to be issued. This standard setsforth the period after the balance sheet date during which management of areporting entity should evaluate events or transactions that may occur forpotential recognition or disclosure in the financial statements, thecircumstances under which an entity should recognize events or transactionsoccurring after the balance sheet date in its financial statements, and thedisclosures that an entity should make about events or transactions thatoccurred after the balance sheet date. SFAS 165 is effective for fiscal yearsand interim periods ending after June 15, 2009. We adopted SFAS 165 duringthe second quarter of fiscal 2009, but the impact of the adoption will dependon the nature and the extent of transactions that occur subsequent to ourinterim and annual reporting periods.

 

In June 2009, theFASB issued SFAS No. 168, *FASB Accounting StandardsCodification and the Hierarchy of Generally Accepted Accounting Principles — areplacement of FASB Statement No. 162.*SFAS 168 establishes theFASB Accounting Standards Codification (the “Codification”) as the source ofauthoritative accounting principles recognized by the FASB to be applied bynon-governmental entities in the preparation of financial statements inconformity with generally accepted accounting principles. Rules andinterpretive releases of the SEC under authority of federal securities laws arealso sources of authoritative guidance for SEC registrants. All guidancecontained in the Codification carries an equal level of authority. The U.S.GAAP hierarchy will be modified to include two levels of GAAP: authoritativeand nonauthoritative. SFAS 168 is effective for financial statements issued forinterim and annual periods ended after September 15, 2009. The adoption ofSFAS 168 is not expected to have a material impact on our consolidatedfinancial statements.

 

**Note 2.  Share-BasedCompensation**

 

The 2006 Equity Incentive Plan (“2006Plan”) provides for the grant of share-based awards exercisable for up to 14.2million shares of Common Stock. On June 3, 2009, the Company announced  an offer to exchange certain employee stockoptions issued under the 2006 Plan (“Exchange Offer”) for new stock optionsgranted on a one-for-one basis.  On July 2,2009, 8.0 million stock options outstanding were exchanged based on thefollowing terms:

 

(1) outstanding vested or unvestedoptions to purchase shares of Common Stock that had an exercise price per shareof $30.00, $37.50, $45.00 or $52.50 for an equal number of new options topurchase shares of Common Stock with an exercise price equal to $7.50 and a newfive-year vesting schedule that commenced on July 2, 2009 and aneight-year term; and

 

(2) outstanding options that had anexercise price per share of $15.00 and $22.50 were exchanged for an equalnumber of new options with the same exercise price. A portion of the newoptions will be vested based on the period of time that the exchanged optionshad been held in relation to the total term of the option and have identicalterms and conditions to the previously issued options, and the remainingoptions have a new five-year vesting schedule that commenced on July 2,2009 and an eight-year term.

 

The fair value for options granted underSFAS No. 123(R) was estimated at the date of grant using theBlack-Scholes-Merton option valuation model. Prior year assumptions are notreflected due to all options being cancelled as part of the Exchange Offer andnew options granted. The following assumptions were used to estimate the fairvalue of options granted during the quarter ended August 1, 2009:

 

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| **Assumptions****(1)**                             | ** ** | ** **    | ** ** |
|----------------------------------------------------|------------|---------------|------------|
| Risk-free  interest rates (2)                      |       | 2.4% - 3.3%   |       |
| Expected  dividend yield                           |       | 0.0%          |       |
| Expected  volatility rates of our Common Stock (3) |       | 44.3% - 45.9% |       |
| Expected  life of options (in years) (4)           |       | 5.5 - 8.0     |       |
| Weighted  average fair value of options granted    |       | $             | 0.93       |   |
|                                                    |            |               |            |  |

 

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(1)         Forfeitures were estimated based onhistorical experience and anticipated events.

 

(2)         Based on constant maturity interest ratesfor U.S. Treasury instruments with terms consistent with the expected lives ofthe awards.

 

(3)         We considered both the historicalvolatility as well as implied volatilities from the exchange-traded options onthe common stock from a peer group of companies.

 

(4)         Expected lives were based on an analysisof historical exercise and post-vesting employment termination behavior.

 

Asof August 1, 2009, there were 632,511 shares of restricted stockoutstanding, 10.4 million share-based awards outstanding and up to 3.2 millionshares of Common Stock remaining available for grant under the 2006 Plan. Thetable below sets forth a summary of stock option activity and other summarydata for the six months ended August 1, 2009.

 
| ** **                                     | ** ** | **Number of   Shares  (in millions)** | ** ** | **Weighted-Average   Exercise Price** | ** ** | **Weighted-Average   Remaining  Contractual Term   (in years)** | ** ** |
|------------------------------------------------|------------|---------------------------------------|------------|---------------------------------------|------------|-----------------------------------------------------------------|------------|
|                                           |       |                                  |       |                                  |       |                                                            |       |
| Outstanding  at January 31, 2009          |       | 10.1                                  |       | $                                     | 26.25      |                                                            |       |   |
| Grants  (1)                                    |       | 10.8                                  |       | 15.50                                 |       |                                                            |       |
| Canceled/Forfeited  (1)                        |       | (10.5                                 | )          | 26.25                                 |       |                                                            |       |
| Outstanding  at August 1, 2009            |       | 10.4                                  |       | $                                     | 15.03      |                                                            | 7.5        |   |
| Vested  and Exercisable at August 1, 2009 |       | 1.8                                   |       | $                                     | 18.75      |                                                            | 6.0        |   |

 

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(1)          The number of options granted and canceled/forfeitedincludes options granted and canceled in connection with the Exchange Offer.

 

As of August 1,2009, the total fair value of vested options, subsequent to the Exchange Offer,was $1.4 million. As of August 1, 2009, there were 8.5 million nonvestedoptions with a weighted average fair value of $0.96 per share.

 

Share-based compensationexpense was $2.1 million and $0.9 million for the second quarter of fiscal 2009and 2008, respectively, and $4.2 million and $3.8 million for the six monthsended August 1, 2009 and August 2, 2008, respectively.  As a result of the Exchange Offer,share-based compensation expense for fiscal 2009 is expected to decline by $0.5million, of which $0.1 million was recognized during the 2nd quarter.  Share-based compensation expense is expectedto increase by $3.5 million over the life of the options granted from theExchange Offer.

 

As of August 1,2009, compensation cost not yet recognized related to nonvested awards totaled$23.4 million and is expected to be recognized over a weighted average periodof 4.9 years. To the extent the actual forfeiture rate is different from whatwe have anticipated, share-based compensation related to these awards will bedifferent from our expectations.

 

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**Note 3.  Debt**

 

Ouroutstanding debt is detailed in the table below.  We were in compliance with the terms andconditions of all debt agreements for all periods presented.

 
| ** **                             | ** ** | **August 1, 2009** | ** ** | **January 31, 2009** | ** ** | **August 2, 2008** | ** ** | **Interest Rate** | ** ** |
|----------------------------------------|------------|-------------------------|------------|---------------------------|------------|-------------------------|------------|-------------------|------------|
| ** **                             | ** ** | ** **              | ** ** | **(in millions)**         | ** ** | ** **              | ** ** | ** **        | ** ** |
|                                   |       |                    |       |                      |       |                    |       |              |       |
| Senior  notes                          |       | $                       | 750        |                      | $          | 750                     |       | $                 | 750        |   | 10.000 | % |
| Senior  subordinated notes             |       | 400                     |       | 400                       |       | 400                     |       | 11.375            | %          |
| Subordinated  discount notes           |       | 354                     |       | 332                       |       | 312                     |       | 13.000            | %          |
| Senior  secured term loan              |       | 2,285                   |       | 2,297                     |       | 2,309                   |       | Variable          |       |
| Asset-based  revolving credit facility |       | 174                     |       | 148                       |       | 262                     |       | Variable          |       |
| Other                                  |       | 1                       |       | 2                         |       | 1                       |       | Variable          |       |
|                                   |       |                    |       |                      |       |                    |       |              |       |
| Total  debt                            |       | 3,964                   |       | 3,929                     |       | 4,034                   |       |              |       |
|                                   |       |                    |       |                      |       |                    |       |              |       |
| Less  current portion                  |       | 198                     |       | 173                       |       | 286                     |       |              |       |
|                                   |       |                    |       |                      |       |                    |       |              |       |
| Long-term  debt                        |       | $                       | 3,766      |                      | $          | 3,756                   |       | $                 | 3,748      |   |   |   |

 

*Asset-based revolving creditfacility*

 

Oursenior secured asset-based revolving credit facility, which we entered into on October 31,2006, with Banc of America, N.A. and other lenders (the “Asset-based revolvingcredit facility”) provides senior secured financing of up to $1.0 billion,subject to a borrowing base as described in our Annual Report on Form 10-K.As of August 1, 2009, the borrowing base was $749 million, of which we hadunused standby letters of credit of $49 million and $526 million of unusedavailability.

 

*Senior secured term loan facility*

 

Borrowingsunder our senior secured term loan facility, which we entered into on October 31,2006, with Deutsche Bank A.G. New York Branch, and other lenders, (the “Seniorsecured term loan facility”) bear interest at a rate per annum equal to, at ouroption, either (a) a base rate determined by reference to the higher of (1) theprime rate of Deutsche Bank and (2) the federal funds effective rateplus 1⁄2 of 1% or (b) a LIBOR rate, subject to certain adjustments, ineach case plus an applicable margin. The applicable margin is subject todownward adjustment based on the ratings threshold set forth in the Seniorsecured term loan facility agreement. At August 1, 2009, the margin was1.25% with respect to base rate borrowings and 2.25% with respect to LIBORborrowings.

 

Thetable below provides the carrying and fair values of our Senior andSubordinated term loan and notes. The fair value of these debt instruments wasdetermined based on quoted market prices.

 
| ** **                   | ** ** | **Carrying Value** | ** ** | **Fair Value** | ** ** |
|------------------------------|------------|--------------------|------------|----------------|------------|
| ** **                   | ** ** | **(in millions)**  | ** ** |
| Senior  Secured Term Loan    |       | $                  | 2,285      |           | $          | 1,868 |   |
| Senior  Notes                |       | 750                |       | 698            |       |
| Senior  Subordinated Notes   |       | 400                |       | 316            |       |
| Subordinated  Discount Notes |       | 354                |       | 142            |       |
|                              |            |                    |            |                |            |  |  |

 

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**Note 4.  Comprehensive (Loss)Income**

 

Ourcomprehensive (loss) income, net of related tax, is as follows:

 
| ** **                                         | ** ** | **Quarter Ended**       | ** ** | **Six Months Ended**    | ** ** |
|----------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                         | ** ** | **August 1, 2009** | ** ** | **August 2, 2008** | ** ** | **August 1, 2009** | ** ** | **August 2, 2008** | ** ** |
| ** **                                         | ** ** | **(in millions)**       | ** ** |
|                                               |       |                    |       |                    |       |   |   |   |   |
| Net  income (loss)                                 |       | $                       | 2          |                    | $          | (30 | ) | $ | 6 |   | $ | (50 | ) |
| Other  comprehensive income (loss):                |       |                    |       |                    |       |   |   |   |   |
| Derivative  gain                                   |       | 1                       |       | 2                       |       | 3 |   | 2 |   |
| Foreign  currency translation adjustment and other |       | (4                      | )          | (1                      | )          | (5 | ) | (2 | ) |
| Comprehensive  (loss) income                       |       | $                       | (1         | )                       | $          | (29 | ) | $ | 4 |   | $ | (50 | ) |

 

**Note 5.  DerivativeInstruments**

 

Weare exposed to fluctuations in interest rates on our Senior secured term loan.During the first quarter of fiscal 2009, we purchased an interest rate cap tomitigate the effects of interest rate fluctuations. The objective of the cap isto hedge the variability of cash flows associated with our interest payments onour Senior secured term loan that result from fluctuations in the three-monthLIBOR rate and does not qualify for hedge accounting under SFAS 133. The caplimits our interest exposure on a notional value of $2.0 billion to the lesserof the three-month LIBOR rate or 7.0%. The term of the cap extends to the first quarter of fiscal 2015. Thefair value of the cap as of August 1, 2009 was $24 million and is includedin Other assets on the Consolidated Balance Sheet. The change in fair value ofthe cap for the quarter and six months ended August 1, 2009, was $11million and $15 million, respectively, and is recorded in Other (income) andexpense, net in the Consolidated Statement of Operations.

 

**Note 6.  Fair Value Measurements**

 

Asdefined in SFAS No. 157, fair value is the price that would be received tosell an asset or paid to transfer a liability in an orderly transaction betweenmarket participants at the measurement date.  SFAS No. 157establishes a three-level valuation hierarchy for fair value measurements.These valuation techniques are based upon observable and unobservable inputs.Observable inputs reflect market data obtained from independent sources, whileunobservable inputs reflect our market assumptions. These two types of inputscreate the following fair value hierarchy:

 

·                  Level 1 — Quoted prices for *identical*instruments in active markets;

·                  Level 2 — Quoted prices for *similar*instruments in active markets; quoted prices for identical orsimilar instruments in markets that are not active; and model-derivedvaluations whose significant inputs are observable; and

·                  Level 3 — Instruments whose significant inputs are *unobservable.*

 

The following table presents net financial assets (liabilities)accounted for at fair value on a recurring basis as of August 1, 2009 (inmillions):

 
| ** **         | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
|--------------------|------------|-------------|------------|-------------|------------|-------------|------------|-----------|------------|
| Cash  equivalents  |       | $           | 4          |        | $          | —      |       | $         | —     |   | $ | 4 |   |
| Interest  Rate Cap |       | —      |       | 24          |       | —      |       | 24        |       |
|                    |            |             |            |             |            |             |            |           |            |  |  |  |  |

 

Cashequivalents consist ofhighly liquid investments, with a maturity of 90 days or less at the date ofpurchase, including U.S. Treasury bills, various government obligations, andmoney market funds.  We carry cashequivalents at cost, which approximates fair value.

 

Derivatives in Level 2are measured based on a variety of pricing factors, which include the marketprice of the derivative instrument available in the dealer-market, which havebeen corroborated with market data. See Note 5 for additional information onour derivative instruments.

 

We generally apply fairvalue techniques on a non-recurring basis for the establishment of potentialimpairment loss related to goodwill pursuant to SFAS 142 and determining thefair value of long-lived assets pursuant to SFAS 144.

 

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**Note 7.  Commitmentsand Contingencies**

 

Weare involved in ongoing legal and regulatory proceedings.  There were no material changes to ourdisclosures of commitments and contingencies from our Annual Report on Form 10-Kfor the fiscal year ended January 31, 2009 and our Quarterly Report on Form 10-Qfor the quarterly period ended May 2, 2009.

 

**Note 8.  Segments**

 

We consider our Michaelsand Aaron Brothers operations to be our operating segments for purposes ofdetermining reportable segments 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 havesimilar economic characteristics and meet the aggregation criteria set forth inparagraph 17 of SFAS No. 131. Therefore, we combine both operatingsegments into one reporting segment.

 

Our chief operatingdecision makers evaluate historical operating performance, plan and forecastfuture periods’ operating performance based on earnings before interest, incometaxes, depreciation and amortization (“EBITDA”).  In addition, an element of base incentivecompensation targets for certain management personnel are based on EBITDA. Areconciliation of EBITDA to income (loss) before income taxes is presentedbelow.

 
| ** **                         | ** ** | **Quarter Ended**       | ** ** | **Six Months Ended**    | ** ** |
|------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                         | ** ** | **August 1, 2009** | ** ** | **August 2, 2008** | ** ** | **August 1, 2009** | ** ** | **August 2, 2008** | ** ** |
| ** **                         | ** ** | **(in millions)**       | ** ** |
|                               |       |                    |       |                    |       |   |   |   |   |
| Income  (loss) before income taxes |       | $                       | 2          |                    | $          | (49 | ) | $ | 9 |   | $ | (79 | ) |
| Interest  expense                  |       | 62                      |       | 76                      |       | 125 |   | 154 |   |
| Depreciation  and amortization     |       | 28                      |       | 32                      |       | 58 |   | 63 |   |
| EBITDA                             |       | $                       | 92         |                    | $          | 59 |   | $ | 192 |   | $ | 138 |   |

 

Oursales and assets by country are as follows:

 
| ** **                                | ** ** | **Net Sales**     | ** ** | **Total Assets** | ** ** |
|-------------------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                                | ** ** | **(in millions)** | ** ** |
| **Quarter ended August 1, 2009:**    |       |              |       |             |       |
| United  States                            |       | $                 | 744        |             | $          | 1,578 |   |
| Canada                                    |       | 63                |       | 97               |       |
| Consolidated  Total                       |       | $                 | 807        |             | $          | 1,675 |   |
|                                      |       |              |       |             |       |
| **Quarter ended August 2, 2008:**    |       |              |       |             |       |
| United  States                            |       | $                 | 731        |             | $          | 1,616 |   |
| Canada                                    |       | 65                |       | 112              |       |
| Consolidated  Total                       |       | $                 | 796        |             | $          | 1,728 |   |
|                                      |       |              |       |             |       |
| **Six Months ended August 1, 2009:** |       |              |       |             |       |
| United  States                            |       | $                 | 1,536      |             | $          | 1,578 |   |
| Canada                                    |       | 123               |       | 97               |       |
| Consolidated  Total                       |       | $                 | 1,659      |             | $          | 1,675 |   |
|                                      |       |              |       |             |       |
| **Six Months ended August 2, 2008:** |       |              |       |             |       |
| United  States                            |       | $                 | 1,509      |             | $          | 1,616 |   |
| Canada                                    |       | 134               |       | 112              |       |
| Consolidated  Total                       |       | $                 | 1,643      |             | $          | 1,728 |   |

 

We present assets based on their physical,geographic location.  Certain assetslocated in the United States are also used to support our Canadian operations,but we do not allocate these assets to Canada.

 

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**Note 9.  RelatedParty Transactions**

 

Aspreviously disclosed, on October 31, 2006, substantially all of the CommonStock of Michaels Stores, Inc. was acquired through a merger transaction(the “Merger”) by affiliates of Bain Capital Partners, LLC and The BlackstoneGroup. We pay annual management fees to Bain Capital Partners, LLC and TheBlackstone Group (collectively, together with their applicable affiliates, the“Sponsors”) and Highfields Capital Management LP in the amount of $12 millionand $1 million, respectively. We recognized $3 million of expense related toannual management fees during the second quarter of fiscal 2009 and fiscal2008, and $7 million during the six months ended August 1, 2009 and August 2,2008. These expenses are included in related party expenses on the ConsolidatedStatements of Operations.

 

BainCapital owns a majority ownership stake in an external vendor we utilize toprint our circular advertisements. Payments associated with this vendor during the second quarter of eachof fiscal 2009 and fiscal 2008 were $6 million, and $14 million and $16 millionfor the six months ended August 1, 2009 and August 2, 2008,respectively.  These expenses areincluded in selling, general and administrative expense on the ConsolidatedStatements of Operations.

 

BainCapital owns a majority ownership stake in an external vendor we utilize fornon-merchandise supplies. Payments associated with this vendor during thesecond quarter of fiscal 2008 were $1 million. Payments for the six monthsended August 1, 2009 and August 2, 2008 were $1 million and $2million, respectively. These expenses are included in selling, general and administrativeexpense on the Consolidated Statements of Operations.

 

TheBlackstone Group owns a majority ownership stake in an external vendor weutilize to count our store inventory. Payments associated with this vendorduring the second quarter of fiscal 2009 and 2008 were $2 million and $1million, respectively. Payments for the six months ended August 1, 2009and August 2, 2008 were $4 million and $3 million, respectively.  These expenses are included in selling,general and administrative expense on the Consolidated Statements ofOperations.

 

Duringfiscal 2008, we began utilizing an external vendor for waste managementservices that is partially owned by The Blackstone Group. Payments associatedwith this vendor during the second quarter of fiscal 2009 and fiscal 2008 were$2 million and $1 million, respectively, and $4 million and $1 million for thesix months ended August 1, 2009 and August 2, 2008, respectively.These expenses are included in selling, general and administrative expense onthe Consolidated Statements of Operations.

 

During the first quarterof fiscal 2008, The Blackstone Group acquired an ownership stake in an externalvendor we utilize for all of the candy-type items in our stores.  Payments associated with this vendor during thesecond quarter of fiscal 2009 and fiscal 2008 were $6 million and $4 million,respectively, and $9 million and $8 million for the six monthsended August 1, 2009 and August 2, 2008, respectively. These expenses are recognized in costof sales as the sales are incurred.

 

The Blackstone Group ownsa partial ownership stake in an external vendor we utilize for newspaperadvertisements. Payments associated with this vendor were$1 million during each of the six months ended August 1, 2009 and August 2,2008. These expenses are included in selling, general and administrativeexpense on the Consolidated Statements of Operations.

 

Ourcurrent directors are affiliates of Bain Capital or The Blackstone Group.  As such, some or all of our directors mayhave an indirect material interest in payments with respect to debt securitiesof the Company that have been purchased by affiliates of Bain Capital and TheBlackstone Group.  Such affiliatesbeneficially own approximately $239 million face amount of ourSubordinated Discount Notes due 2016.

 

TheCompany periodically provides officers of Michaels Stores, Inc. and itssubsidiaries the opportunity to purchase shares of our Common Stock. There wereno shares sold to officers during first six months of each of fiscal 2009 and fiscal2008.  Also, during the second quarter offiscal 2008 and the six months ended August 2, 2008, we repurchased100,000 and 105,334 shares, respectively, from officers who are no longer withthe Company.  There have been no sharesrepurchased during the first six months of fiscal 2009.

 

Inconnection with the consummation of the Merger, the Company entered into aSeparation Agreement with each of Charles Wyly and Sam Wyly, executive officersand directors of the Company prior to the Merger.  Under the Separation Agreements, each ofCharles Wyly and Sam Wyly received a lump sum payment of $3.0 million inexchange for his agreement to adhere to certain non-competition,non-solicitation and confidentiality restrictions. We amortized theseSeparation Agreements over the two year period ended October 31, 2008.These expenses are included in related party expenses on the ConsolidatedStatements of Operations.

 

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**Note 10.   Condensed Consolidating FinancialInformation**

 

All obligations ofMichaels Stores, Inc. under the Senior notes, Senior subordinated notes,Subordinated discount notes, Senior secured term loan, and Asset-basedrevolving credit facility are guaranteed by each of our subsidiaries other thanAaron Brothers Card Services, LLC and Canada Artistree, Inc. As of August 1,2009, the financial statements of Aaron Brothers Card Services, LLC and CanadaArtistree, Inc. were immaterial.

 

The following condensedconsolidating financial information represents the financial information ofMichaels Stores, Inc. and its wholly-owned subsidiary guarantors, preparedon the equity basis of accounting.  The information is presented inaccordance with the requirements of Rule 3-10 under the SEC’s RegulationS-X.  The financial information may not necessarily be indicative ofresults of operations, cash flows, or financial position had the subsidiaryguarantors operated as independent entities.

 

**Supplemental Condensed Consolidating Balance Sheet**

 
| ** **                                                 | ** ** | **August 1, 2009** | ** ** |
|------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                 | ** ** | **Parent  Company**     | ** ** | **Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| ** **                                                 | ** ** | **(in millions)**       | ** ** |
| **ASSETS**                                                 | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Current assets:**                                        |       |                    |       |   |   |   |   |   |   |
| Cash  and equivalents                                      |       | $                       | 29         |   | $ | 7 |   | $ | — |   | $ | 36 |   |
| Merchandise  inventories                                   |       | 633                     |       | 317 |   | — |   | 950 |   |
| Intercompany  receivables                                  |       | —                  |       | 515 |   | (515 | ) | — |   |
| Other                                                      |       | 81                      |       | 51 |   | — |   | 132 |   |
| Total  current assets                                      |       | 743                     |       | 890 |   | (515 | ) | 1,118 |   |
| **Property and equipment, net**                            |       | 257                     |       | 88 |   | — |   | 345 |   |
| **Goodwill, net**                                          |       | 94                      |       | — |   | — |   | 94 |   |
| **Investment in subsidiaries**                             |       | 655                     |       | — |   | (655 | ) | — |   |
| **Other assets**                                           |       | 96                      |       | 22 |   | — |   | 118 |   |
| Total  assets                                              |       | $                       | 1,845      |   | $ | 1,000 |   | $ | (1,170 | ) | $ | 1,675 |   |
|                                                       |       |                    |       |   |   |   |   |   |   |
| **LIABILITIES AND STOCKHOLDERS’ (DEFICIT)  EQUITY**   |       |                    |       |   |   |   |   |   |   |
| **Current liabilities:**                                   |       |                    |       |   |   |   |   |   |   |
| Accounts  payable                                          |       | $                       | 13         |   | $ | 203 |   | $ | — |   | $ | 216 |   |
| Accrued  liabilities and other                             |       | 207                     |       | 81 |   | — |   | 288 |   |
| Current  portion of long-term debt                         |       | 198                     |       | — |   | — |   | 198 |   |
| Intercompany  payable                                      |       | 515                     |       | — |   | (515 | ) | — |   |
| Other                                                      |       | (34                     | )          | 35 |   | — |   | 1 |   |
| Total  current liabilities                                 |       | 899                     |       | 319 |   | (515 | ) | 703 |   |
| **Long-term debt**                                         |       | 3,766                   |       | — |   | — |   | 3,766 |   |
| **Other long-term liabilities**                            |       | 54                      |       | 26 |   | — |   | 80 |   |
| **Total stockholders’ (deficit) equity**              |       | (2,874                  | )          | 655 |   | (655 | ) | (2,874 | ) |
| Total  liabilities and stockholders’ (deficit) equity |       | $                       | 1,845      |   | $ | 1,000 |   | $ | (1,170 | ) | $ | 1,675 |   |

 

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**Supplemental Condensed Consolidating Balance Sheet**

 
| ** **                                                 | ** ** | **January 31, 2009** | ** ** |
|------------------------------------------------------------|------------|---------------------------|------------|
| ** **                                                 | ** ** | **Parent  Company**       | ** ** | **Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| ** **                                                 | ** ** | **(in millions)**         | ** ** |
| **ASSETS**                                                 | ** ** | ** **                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Current assets:**                                        |       |                      |       |   |   |   |   |   |   |
| Cash  and equivalents                                      |       | $                         | 26         |   | $ | 7 |   | $ | — |   | $ | 33 |   |
| Merchandise  inventories                                   |       | 627                       |       | 273 |   | — |   | 900 |   |
| Intercompany  receivables                                  |       | —                    |       | 387 |   | (387 | ) | — |   |
| Other                                                      |       | 62                        |       | 54 |   | — |   | 116 |   |
| Total  current assets                                      |       | 715                       |       | 721 |   | (387 | ) | 1,049 |   |
| **Property and equipment, net**                            |       | 284                       |       | 98 |   | — |   | 382 |   |
| **Goodwill, net**                                          |       | 94                        |       | — |   | — |   | 94 |   |
| **Investment in subsidiaries**                             |       | 488                       |       | — |   | (488 | ) | — |   |
| **Other assets**                                           |       | 80                        |       | 20 |   | — |   | 100 |   |
| Total  assets                                              |       | $                         | 1,661      |   | $ | 839 |   | $ | (875 | ) | $ | 1,625 |   |
|                                                       |       |                      |       |   |   |   |   |   |   |
| **LIABILITIES AND STOCKHOLDERS’ (DEFICIT)  EQUITY**   |       |                      |       |   |   |   |   |   |   |
| **Current liabilities:**                                   |       |                      |       |   |   |   |   |   |   |
| Accounts  payable                                          |       | $                         | 15         |   | $ | 215 |   | $ | — |   | $ | 230 |   |
| Accrued  liabilities and other                             |       | 200                       |       | 75 |   | — |   | 275 |   |
| Current  portion of long-term debt                         |       | 173                       |       | — |   | — |   | 173 |   |
| Intercompany  payable                                      |       | 387                       |       | — |   | (387 | ) | — |   |
| Other                                                      |       | (32                       | )          | 35 |   | — |   | 3 |   |
| Total  current liabilities                                 |       | 743                       |       | 325 |   | (387 | ) | 681 |   |
| **Long-term debt**                                         |       | 3,756                     |       | — |   | — |   | 3,756 |   |
| **Other long-term liabilities**                            |       | 49                        |       | 26 |   | — |   | 75 |   |
| **Total stockholders’ (deficit) equity**              |       | (2,887                    | )          | 488 |   | (488 | ) | (2,887 | ) |
| Total  liabilities and stockholders’ (deficit) equity |       | $                         | 1,661      |   | $ | 839 |   | $ | (875 | ) | $ | 1,625 |   |

 

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**Supplemental Condensed Consolidating Balance Sheet**

 
| ** **                                                 | ** ** | **August 2, 2008** | ** ** |
|------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                 | ** ** | **Parent  Company**     | ** ** | **Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| ** **                                                 | ** ** | **(in millions)**       | ** ** |
| **ASSETS**                                                 | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Current assets:**                                        |       |                    |       |   |   |   |   |   |   |
| Cash  and equivalents                                      |       | $                       | 32         |   | $ | 13 |   | $ | — |   | $ | 45 |   |
| Merchandise  inventories                                   |       | 665                     |       | 273 |   | — |   | 938 |   |
| Intercompany  receivables                                  |       | —                  |       | 374 |   | (374 | ) | — |   |
| Other                                                      |       | 95                      |       | 49 |   | — |   | 144 |   |
| Total  current assets                                      |       | 792                     |       | 709 |   | (374 | ) | 1,127 |   |
| **Property and equipment, net**                            |       | 294                     |       | 116 |   | — |   | 410 |   |
| **Goodwill, net**                                          |       | 94                      |       | — |   | — |   | 94 |   |
| **Investment in subsidiaries**                             |       | 474                     |       | — |   | (474 | ) | — |   |
| **Other assets**                                           |       | 82                      |       | 15 |   | — |   | 97 |   |
| Total  assets                                              |       | $                       | 1,736      |   | $ | 840 |   | $ | (848 | ) | $ | 1,728 |   |
|                                                       |       |                    |       |   |   |   |   |   |   |
| **LIABILITIES AND STOCKHOLDERS’ (DEFICIT)  EQUITY**   |       |                    |       |   |   |   |   |   |   |
| **Current liabilities:**                                   |       |                    |       |   |   |   |   |   |   |
| Accounts  payable                                          |       | $                       | 18         |   | $ | 226 |   | $ | — |   | $ | 244 |   |
| Accrued  liabilities and other                             |       | 225                     |       | 79 |   | — |   | 304 |   |
| Current  portion of long-term debt                         |       | 286                     |       | — |   | — |   | 286 |   |
| Intercompany  payable                                      |       | 374                     |       | — |   | (374 | ) | — |   |
| Other                                                      |       | (38                     | )          | 40 |   | — |   | 2 |   |
| Total  current liabilities                                 |       | 865                     |       | 345 |   | (374 | ) | 836 |   |
| **Long-term debt**                                         |       | 3,748                   |       | — |   | — |   | 3,748 |   |
| **Other long-term liabilities**                            |       | 62                      |       | 21 |   | — |   | 83 |   |
| **Total stockholders’ (deficit) equity**              |       | (2,939                  | )          | 474 |   | (474 | ) | (2,939 | ) |
| Total  liabilities and stockholders’ (deficit) equity |       | $                       | 1,736      |   | $ | 840 |   | $ | (848 | ) | $ | 1,728 |   |

 

**Supplemental Condensed Consolidating Statement of Operations**

 
| ** **                                    | ** ** | **Quarter Ended August 1, 2009** | ** ** |
|-----------------------------------------------|------------|---------------------------------------|------------|
| ** **                                    | ** ** | **Parent  Company**                   | ** ** | **Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| ** **                                    | ** ** | **(in millions)**                     | ** ** |
| ** **                                    | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Net sales**                                 |       | $                                     | 707        |   | $ | 471 |   | $ | (371 | ) | $ | 807 |   |
| Cost  of sales and occupancy expense          |       | 498                                   |       | 394 |   | (371 | ) | 521 |   |
| **Gross profit**                              |       | 209                                   |       | 77 |   | — |   | 286 |   |
| Selling,  general, and administrative expense |       | 202                                   |       | 30 |   | — |   | 232 |   |
| Related  party expenses                       |       | 3                                     |       | — |   | — |   | 3 |   |
| Store  pre-opening costs                      |       | 1                                     |       | — |   | — |   | 1 |   |
| **Operating income**                          |       | 3                                     |       | 47 |   | — |   | 50 |   |
| Interest  expense                             |       | 62                                    |       | — |   | — |   | 62 |   |
| Other  (income) and expense, net              |       | (11                                   | )          | (3 | ) | — |   | (14 | ) |
| Intercompany  charges (income)                |       | 16                                    |       | (16 | ) | — |   | — |   |
| Equity  in earnings of subsidiaries           |       | 66                                    |       | — |   | (66 | ) | — |   |
| **Income before income taxes**                |       | 2                                     |       | 66 |   | (66 | ) | 2 |   |
| Provision  for income taxes                   |       | —                                |       | 13 |   | (13 | ) | — |   |
| **Net income**                                |       | $                                     | 2          |   | $ | 53 |   | $ | (53 | ) | $ | 2 |   |

 

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**Supplemental Condensed Consolidating Statement of Operations**

 
| ** **                                    | ** ** | **Quarter Ended August 2, 2008** | ** ** |
|-----------------------------------------------|------------|---------------------------------------|------------|
| ** **                                    | ** ** | **Parent  Company**                   | ** ** | **Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| ** **                                    | ** ** | **(in millions)**                     | ** ** |
| ** **                                    | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Net sales**                                 |       | $                                     | 689        |   | $ | 492 |   | $ | (385 | ) | $ | 796 |   |
| Cost  of sales and occupancy expense          |       | 488                                   |       | 415 |   | (385 | ) | 518 |   |
| **Gross profit**                              |       | 201                                   |       | 77 |   | — |   | 278 |   |
| Selling,  general, and administrative expense |       | 211                                   |       | 35 |   | — |   | 246 |   |
| Related  party expenses                       |       | 4                                     |       | — |   | — |   | 4 |   |
| Store  pre-opening costs                      |       | 1                                     |       | — |   | — |   | 1 |   |
| **Operating (loss) income**                   |       | (15                                   | )          | 42 |   | — |   | 27 |   |
| Interest  expense                             |       | 76                                    |       | — |   | — |   | 76 |   |
| Other  (income) and expense, net              |       | —                                |       | — |   | — |   | — |   |
| Intercompany  charges (income)                |       | 18                                    |       | (18 | ) | — |   | — |   |
| Equity  in earnings of subsidiaries           |       | 60                                    |       | — |   | (60 | ) | — |   |
| **(Loss) income before income taxes**         |       | (49                                   | )          | 60 |   | (60 | ) | (49 | ) |
| (Benefit)  provision for income taxes         |       | (19                                   | )          | 23 |   | (23 | ) | (19 | ) |
| **Net (loss) income**                         |       | $                                     | (30        | ) | $ | 37 |   | $ | (37 | ) | $ | (30 | ) |

 

**Supplemental Condensed Consolidating Statement of Operations**

 
| ** **                                    | ** ** | **Six Months Ended August 1, 2009** | ** ** |
|-----------------------------------------------|------------|------------------------------------------|------------|
| ** **                                    | ** ** | **Parent  Company**                      | ** ** | **Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| ** **                                    | ** ** | **(in millions)**                        | ** ** |
| ** **                                    | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Net sales**                                 |       | $                                        | 1,468      |   | $ | 950 |   | $ | (759 | ) | $ | 1,659 |   |
| Cost  of sales and occupancy expense          |       | 1,021                                    |       | 796 |   | (759 | ) | 1,058 |   |
| **Gross profit**                              |       | 447                                      |       | 154 |   | — |   | 601 |   |
| Selling,  general, and administrative expense |       | 418                                      |       | 60 |   | — |   | 478 |   |
| Related  party expenses                       |       | 7                                        |       | — |   | — |   | 7 |   |
| Store  pre-opening costs                      |       | 2                                        |       | — |   | — |   | 2 |   |
| **Operating income**                          |       | 20                                       |       | 94 |   | — |   | 114 |   |
| Interest  expense                             |       | 125                                      |       | — |   | — |   | 125 |   |
| Other  (income) and expense, net              |       | (15                                      | )          | (5 | ) | — |   | (20 | ) |
| Intercompany  charges (income)                |       | 33                                       |       | (33 | ) | — |   | — |   |
| Equity  in earnings of subsidiaries           |       | 132                                      |       | — |   | (132 | ) | — |   |
| **Income before income taxes**                |       | 9                                        |       | 132 |   | (132 | ) | 9 |   |
| Provision  for income taxes                   |       | 3                                        |       | 48 |   | (48 | ) | 3 |   |
| **Net income**                                |       | $                                        | 6          |   | $ | 84 |   | $ | (84 | ) | $ | 6 |   |

 

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**Supplemental Condensed Consolidating Statement of Operations**

 
| ** **                                    | ** ** | **Six Months Ended August 2, 2008** | ** ** |
|-----------------------------------------------|------------|------------------------------------------|------------|
| ** **                                    | ** ** | **Parent  Company**                      | ** ** | **Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| ** **                                    | ** ** | **(in millions)**                        | ** ** |
| ** **                                    | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Net sales**                                 |       | $                                        | 1,431      |   | $ | 936 |   | $ | (724 | ) | $ | 1,643 |   |
| Cost  of sales and occupancy expense          |       | 992                                      |       | 771 |   | (724 | ) | 1,039 |   |
| **Gross profit**                              |       | 439                                      |       | 165 |   | — |   | 604 |   |
| Selling,  general, and administrative expense |       | 452                                      |       | 66 |   | — |   | 518 |   |
| Related  party expenses                       |       | 8                                        |       | — |   | — |   | 8 |   |
| Store  pre-opening costs                      |       | 2                                        |       | 1 |   | — |   | 3 |   |
| **Operating (loss) income**                   |       | (23                                      | )          | 98 |   | — |   | 75 |   |
| Interest  expense                             |       | 154                                      |       | — |   | — |   | 154 |   |
| Other  (income) and expense, net              |       | —                                   |       | — |   | — |   | — |   |
| Intercompany  charges (income)                |       | 35                                       |       | (35 | ) | — |   | — |   |
| Equity  in earnings of subsidiaries           |       | 133                                      |       | — |   | (133 | ) | — |   |
| **(Loss) income before income taxes**         |       | (79                                      | )          | 133 |   | (133 | ) | (79 | ) |
| (Benefit)  provision for income taxes         |       | (29                                      | )          | 49 |   | (49 | ) | (29 | ) |
| **Net (loss) income**                         |       | $                                        | (50        | ) | $ | 84 |   | $ | (84 | ) | $ | (50 | ) |

 

**Supplemental Condensed Statement of Cash Flows**

 
| ** **                                 |   | **Six Months Ended August 1, 2009** |       |
|--------------------------------------------|--------|------------------------------------------|------------|
| ** **                                 |   | **Parent  Company**                      | ** ** | **Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** |   |
| ** **                                 |   | **(in millions)**                        |       |
| **Operating activities:**                  |   |                                     |       |   |   |   |   |   |   |
| Net  cash provided by operating activities |   | $                                        | 29         |   | $ | 58 |   | $ | (57 | ) | $ | 30 |   |
|                                       |   |                                     |       |   |   |   |   |   |   |
| **Investing activities:**                  |   |                                     |       |   |   |   |   |   |   |
| Cash  paid for property and equipment      |   | (16                                      | )          | (1 | ) | — |   | (17 | ) |
| Net  cash used in investing activities     |   | (16                                      | )          | (1 | ) | — |   | (17 | ) |
|                                       |   |                                     |       |   |   |   |   |   |   |
| **Financing activities:**                  |   |                                     |       |   |   |   |   |   |   |
| Net  borrowings of long-term debt          |   | 14                                       |       | — |   | — |   | 14 |   |
| Intercompany  dividends                    |   | —                                   |       | (57 | ) | 57 |   | — |   |
| Other  financing activities                |   | (24                                      | )          | — |   | — |   | (24 | ) |
| Net  cash used in financing activities     |   | (10                                      | )          | (57 | ) | 57 |   | (10 | ) |
|                                       |   |                                     |       |   |   |   |   |   |   |
| **Increase in cash and equivalents**       |   | 3                                        |       | — |   | — |   | 3 |   |
| **Beginning cash and cash equivalents**    |   | 26                                       |       | 7 |   | — |   | 33 |   |
| **Ending cash and cash equivalents**       |   | $                                        | 29         |   | $ | 7 |   | $ | — |   | $ | 36 |   |

 

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**Supplemental Condensed Statement of Cash Flows**

 
| ** **                                           | ** ** | **Six Months Ended August 2, 2008** | ** ** |
|------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                           | ** ** | **Parent  Company**                      | ** ** | **Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| ** **                                           | ** ** | **(in millions)**                        | ** ** |
| ** **                                           | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Operating Activities:**                            | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net  cash (used in) provided by operating activities |       | $                                        | (114       | ) | $ | 86 |   | $ | (70 | ) | $ | (98 | ) |
|                                                 |       |                                     |       |   |   |   |   |   |   |
| **Investing Activities:**                            |       |                                     |       |   |   |   |   |   |   |
| Cash  paid for property and equipment                |       | (33                                      | )          | (6 | ) | — |   | (39 | ) |
| Net  cash used in investing activities               |       | (33                                      | )          | (6 | ) | — |   | (39 | ) |
|                                                 |       |                                     |       |   |   |   |   |   |   |
| **Financing Activities:**                            |       |                                     |       |   |   |   |   |   |   |
| Net  borrowings of long-term debt                    |       | 153                                      |       | — |   | — |   | 153 |   |
| Intercompany  dividends                              |       | —                                   |       | (70 | ) | 70 |   | — |   |
| Other  financing activities                          |       | —                                   |       | — |   | — |   | — |   |
| Net  cash provided by (used in) financing activities |       | 153                                      |       | (70 | ) | 70 |   | 153 |   |
| ** **                                           | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Increase in cash and equivalents**                 |       | 6                                        |       | 10 |   | — |   | 16 |   |
| **Beginning cash and cash equivalents**              |       | 26                                       |       | 3 |   | — |   | 29 |   |
| **Ending cash and equivalents**                      |       | $                                        | 32         |   | $ | 13 |   | $ | — |   | $ | 45 |   |

 

**Note 11. Subsequent Event**

** **

On August 20, 2009,the Company entered into a Third Amendment to Credit Agreement (the “ThirdAmendment”) to the Company’s $2.4 billion senior secured term loan facilitywith Deutsche Bank AG New York Branch, as administrative agent, and the otherlenders party thereto (the “Term Loan Credit Facility”). The Third Amendmentamends the Term Loan Credit Facility to permit the issuance or incurrence of indebtednessfor the purpose of the repayment of existing term loans under the Term LoanCredit Facility, which new indebtedness could take the form of additional termloans under the Term Loan Credit Facility or secured or unsecured bonds orother loans.

 

**Item 2.  Management’s Discussion andAnalysis of Financial Condition and****Results of Operations.**

 

Allexpressions of  the “Company,” “us,”“we,” “our,” and all similar expressions are references to Michaels Stores, Inc.and its consolidated wholly-owned subsidiaries, unless otherwise expresslystated or the context otherwise requires.

 

**DisclosureRegarding Forward-Looking Information**

 

Thefollowing discussion should be read in conjunction with our consolidatedfinancial statements and related notes included elsewhere in this QuarterlyReport on Form 10-Q. The following discussion, as well as other portionsof this Quarterly Report on Form 10-Q, contains forward-looking statementsthat reflect our plans, estimates, and beliefs. Any statements contained herein(including, but not limited to, statements to the effect that Michaels or itsmanagement “anticipates,” “plans,” “estimates,” “expects,” “believes,” andother similar expressions) that are not statements of historical fact should beconsidered forward-looking statements and should be read in conjunction withour consolidated financial statements and related notes in our Annual Report onForm 10-K for the fiscal year ended January 31, 2009. Suchforward-looking statements are based upon management’s current knowledge andassumptions about future events and involve risks and uncertainties that couldcause actual results, performance or achievements to be materially differentfrom anticipated results, prospects, performance or achievements expressed orimplied by such forward-looking statements. Such risks and uncertaintiesinclude, but are not limited to:

 

·                  risks related to general economicconditions and the current financial crisis; if the worldwide economic downturn continues or deterioratesfurther, it could continue to adversely affect consumer confidence and retailspending, decreasing demand for our merchandise and adversely impact ourresults of operations, cash flows and financial condition;

 

·                  risks related to our substantial indebtedness, as our**leverage could adversely affect ourability to raise additional capital to fund our operations, limit our abilityto react to changes in the economy or our industry, expose us to interest raterisk to the extent of our variable rate debt and prevent us from meeting ourobligations under our notes and credit facilities;

 

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·                  restrictions in our debt agreements that limit ourflexibility in operating our business, as our senior secured credit facilitiesand the indentures governing our notes contain various covenants that limit ourability to engage in specified types of transactions and require that wemaintain specified financial ratios upon the occurrence of certain events;

 

·                  our ability to open new stores, as our growth depends on ourstrategy of increasing our number of stores and if  we are unable tocontinue this strategy, our ability to increase our sales, profitability, andcash flow could be impaired;

 

·                  how well we manage our business;

 

·                  changes in customer demand could materially adversely affectour sales, operating results, and cash flow;

 

·                  unexpected or unfavorable consumer responses to ourpromotional or merchandising programs could materially adversely affect oursales, operating results, and cash flow;

 

·                  changes in newspaper subscriptionrates may result in reduced exposure to our circular advertisements andadversely affect our sales, operating results and cash flow;

 

·                  improvements to our supply chain may not be fullysuccessful;

 

·                  our suppliers may fail us;

 

·                  our reliance on foreign suppliers increases our risk ofobtaining adequate, timely, and cost-effective product supplies;

 

·                  risks associated with the vendorsfrom whom our products are sourced, including our vendors’ ability to financetheir own operations, could materially adversely affect our revenue and grossprofit;

 

·                  product recalls and/or product liability, aswell as changes in product safety andother consumer protection laws, may adversely impact our operations,merchandise offerings, reputation and financial position;

 

·                  significant increases in inflation or commodity prices suchas petroleum, natural gas, electricity, steel and paper may adversely affectour costs, including cost of merchandise;

 

·                  we are co-sourcing certain of ourinformation technology, accounts payable, payroll and accounting functions, andmay co-source other administrative functions, making us more dependentupon third parties;

 

·                  our information systems may prove inadequate;

 

·                  we may fail to optimize or adequately maintain ourperpetual inventory and automated replenishment systems;

 

·                  failure to adequately maintain the security of ourelectronic and other confidential information could materially adversely affectour financial condition and operating results;

 

·                  if the Employee Free Choice Act, orsimilar legislation, is adopted, it would be easier for our associates toobtain union representation and our businesses could be impacted as a result;

 

·                  a weak fourth quarter would materially adversely affect ouroperating results;

 

·                  competition could negatively impact our operations; and

 

·                  the interests of our controlling stockholdersmay conflict with the interests of our creditors.

 

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For more details on factors that maycause actual results to differ materially from such forward-looking statements,please see Item 1A. Risk Factors of our Annual Report on Form 10-Kfor the fiscal year ended January 31, 2009, and other reports from time totime filed with or furnished to the SEC. We do not intend to, and undertake noobligation to, update or revise any forward-looking statement.

 

**General**

 

Wecontinue to develop a fully integrated pricing and promotion strategy and mayrefine our existing strategy in future periods. A significant component of our pricing and promotion strategy involveschanges in the breadth and depth of our promotional programs. Sales declinesdue to the current soft macroeconomic and retail environments could adverselyaffect operations due to a deleveraging of operating expenses.  As a result, our historical trends may not beindicative of future results.

 

Wereport on the basis of a 52 or 53-week fiscal year, which ends on the Saturdayclosest to January 31. All references herein to “fiscal 2009” relate tothe 52 weeks ending January 30, 2010 and all references to “fiscal2008” relate to the 52 weeks ended January 31, 2009. In addition, allreferences herein to “the second quarter of fiscal 2009” relate to the 13 weeksended August 1, 2009 and all references to “the second quarter of fiscal2008” relate to the 13 weeks ended August 2, 2008.  Finally, all references to “the six monthsended August 1, 2009” relate to the 26 weeks ended August 1, 2009,and “the six months ended August 2, 2008” relate to the 26 weeks ended August 2,2008, respectively.

 

The following table setsforth certain of our unaudited operating data:

 
| ** **                                               | ** ** | **Quarter Ended**  | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------|------------|--------------------|------------|----------------------|------------|
| ** **                                               | ** ** | **August 1,** | ** ** | **August 2,**   | ** ** | **August 1,** | ** ** | **August 2,** | ** ** |
| ** **                                               | ** ** | **2009**           | ** ** | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
| **Michaels stores:**                                     |       |               |       |                 |       |   |   |   |   |
| Retail  stores open at beginning of period               |       | 1,020              |       | 980                  |       | 1,009 |   | 963 |   |
| Retail  stores opened during the period                  |       | 3                  |       | 11                   |       | 14 |   | 28 |   |
| Retail  stores opened (relocations) during the period    |       | —             |       | 3                    |       | 4 |   | 6 |   |
| Retail  stores closed during the period                  |       | —             |       | —               |       | — |   | — |   |
| Retail  stores closed (relocations) during the period    |       | —             |       | (3                   | )          | (4 | ) | (6 | ) |
| Retail  stores open at end of period                     |       | 1,023              |       | 991                  |       | 1,023 |   | 991 |   |
|                                                     |       |               |       |                 |       |   |   |   |   |
| **Aaron Brothers stores:**                               |       |               |       |                 |       |   |   |   |   |
| Retail  stores open at beginning of period               |       | 156                |       | 164                  |       | 161 |   | 166 |   |
| Retail  stores opened during the period                  |       | —             |       | —               |       | — |   | — |   |
| Retail  stores opened (relocations) during the period    |       | —             |       | 1                    |       | — |   | 1 |   |
| Retail  stores closed during the period                  |       | (1                 | )          | —               |       | (6 | ) | (2 | ) |
| Retail  stores closed (relocations) during the period    |       | —             |       | (1                   | )          | — |   | (1 | ) |
| Retail  stores open at end of period                     |       | 155                |       | 164                  |       | 155 |   | 164 |   |
|                                                     |       |               |       |                 |       |   |   |   |   |
| Total  store count at end of period                      |       | 1,178              |       | 1,155                |       | 1,178 |   | 1,155 |   |
|                                                     |       |               |       |                 |       |   |   |   |   |
| **Other operating data:**                                |       |               |       |                 |       |   |   |   |   |
| Average  inventory per Michaels store (in thousands) (1) |       | $                  | 889        |                 | $          | 899 |   | $ | 889 |   | $ | 899 |   |
| Comparable  store sales (2)                              |       | (0.8               | )%         | (2.6                 | )%         | (1.4 | )% | (2.8 | )% |
|                                                          |            |                    |            |                      |            |  |  |  |  |  |  |  |  |

 

----

| (1)    | Average inventory per  Michaels store calculation excludes our Aaron Brothers stores.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| (2)    | Comparable store sales  decrease represents the decrease 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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**Resultsof Operations**

 

Thefollowing table sets forth the percentage relationship to net sales of eachline item of our unaudited consolidated statements of operations. This tableshould be read in conjunction with the following discussion and with ourconsolidated financial statements, including the related notes, containedherein.

 
| ** **                                    | ** ** | **Quarter Ended**  | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------|------------|--------------------|------------|----------------------|------------|
| ** **                                    | ** ** | **August 1,** | ** ** | **August 2,**   | ** ** | **August 1,** | ** ** | **August 2,** | ** ** |
| ** **                                    | ** ** | **2009**           | ** ** | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
| **Net sales**                                 |       | 100.0              | %          | 100.0                | %          | 100.0 | % | 100.0 | % |
| Cost  of sales and occupancy expense          |       | 64.6               |       | 65.1                 |       | 63.8 |   | 63.2 |   |
| **Gross profit**                              |       | 35.4               |       | 34.9                 |       | 36.2 |   | 36.8 |   |
| Selling,  general, and administrative expense |       | 28.7               |       | 30.9                 |       | 28.8 |   | 31.5 |   |
| Related  party expenses                       |       | 0.4                |       | 0.5                  |       | 0.4 |   | 0.5 |   |
| Store  pre-opening costs                      |       | 0.1                |       | 0.1                  |       | 0.1 |   | 0.2 |   |
| **Operating income**                          |       | 6.2                |       | 3.4                  |       | 6.9 |   | 4.6 |   |
| Interest  expense                             |       | 7.8                |       | 9.5                  |       | 7.5 |   | 9.4 |   |
| Other  (income) and expense, net              |       | (1.8               | )          | —               |       | (1.2 | ) | — |   |
| **Income (loss) before income taxes**         |       | 0.2                |       | (6.1                 | )          | 0.6 |   | (4.8 | ) |
| Income  tax provision (benefit)               |       | —             |       | (2.3                 | )          | 0.2 |   | (1.8 | ) |
| **Net  income (loss)**                        |       | 0.2                | %          | (3.8                 | )%         | 0.4 | % | (3.0 | )% |

 

*QuarterEnded August 1, 2009 Compared to the Quarter Ended August 2, 2008*

 

*Net Sales*—Net sales increased for thesecond quarter of fiscal 2009 by $11 million, or 1.4%, over the secondquarter of fiscal 2008. Comparable store sales decreased 0.8% primarily due toa decrease in the average ticket of 7.0%, partially offset by an increase incustomer transactions of 6.2%. The fluctuation in the exchange rates betweenthe United States and Canadian dollars adversely impacted the average ticket by100 basis points. The decrease in comparable store sales was more than offsetby non-comparable new stores.  Sales at43 Michaels stores that were opened during the 13-month period ended August 1,2009, provided incremental revenue of $18 million.

 

Wecontinue to evaluate all options available to us for our Aaron Brothersconcept, which range from refining the concept to possible storerationalization.  Certain of theseoptions, if enacted, may result in material charges to our consolidatedstatement of operations in future periods.

 

*Cost of Sales and Occupancy Expense*—Cost of salesand occupancy expense increased $3 million or 0.6% to $521 million in the secondquarter of 2009 from $518 million in the second quarter of 2008 primarily dueto a 1.4% increase in sales, principally as a result of sales from new stores.As a percentage of net sales, cost of sales and occupancy expense decreasedapproximately 50 basis points driven by a merchandise margin improvement of 20basis points related to profit optimization and a 30 basis point reduction inoccupancy costs due to lower utilities and amortization expense.

 

*Selling, General, and Administrative Expense*—Selling,general, and administrative expense was $232 or 28.7% of net sales, in thesecond quarter of fiscal 2009 compared to $246 million, or 30.9% of net sales,in the second quarter of fiscal 2008. Selling, general, and administrativeexpense decreased $14 million or 220 basis points primarily due to lowerpayroll, severance expense and depreciation expense.  Additionally, prior year amounts include consultingexpenses for studies related to consumer insights and other strategicinitiatives.

* *

*Related Party Expenses*— Related party expenseswere $3 million and $4 million in the second quarter of fiscal 2009 and fiscal2008, respectively.  These costs consistprimarily of approximately $3 million of management fees and associatedexpenses paid to our Sponsors and Highfields Capital Management L.P. (“Highfields”).  Also included in the related party expensesin fiscal 2008 is approximately $1 million of amortization expense related tothe Separation Agreements as more fully described in Note 9 to the consolidatedfinancial statements.

 

*Interest Expense*—Interest expense for thequarter decreased $14 million to $62 million as a result of a lower averageinterest rate related to our variable-rate debt and lower average debt levels.

 

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*Other(Income) and Expense, net*—Other income in the second quarter of fiscal2009 related primarily to an $11 million favorable change in the fair value ofthe interest rate cap as more fully described in Note 5 to the consolidatedfinancial statements and $4 million related to foreign exchange gains.

* *

*Provision (Benefit) for Income Taxes*—The effectivetax rate was 19.5% for the second quarter of fiscal 2009 and 38.6% for thesecond quarter of fiscal 2008.  As aresult of our low income base, our effective rate is highly sensitive tochanges caused by permanent differences (i.e. differences between book incomeand tax income that are not expected to reverse in future periods).

 

*Six MonthsEnded August 1, 2009 Compared to the Six Months Ended August 2, 2008*

 

*Net Sales*—Net sales increased for thefirst six months of fiscal 2009 by $16 million, or 1.0%, over the firstsix months of fiscal 2008. Comparable store sales decreased 1.4% primarily dueto a decrease in the average ticket of 5.2% and an adverse impact of 0.2%related to deferred custom framing revenue, partially offset by an increase incustomer transactions of 4.0%. The fluctuation in the exchange rates betweenthe United States and Canadian dollars adversely impacted the average ticket by130 basis points. The decrease in comparable store sales was more than offsetby non-comparable new stores.  Sales atour new stores that were opened during the 13-month period ended August 1,2009, provided incremental revenue of $40 million.

 

*Cost of Sales and Occupancy Expense*—Cost of salesand occupancy expense increased $19 million or 1.8% to $1,058 million for thefirst six months of fiscal 2009 from $1,039 million for the first six months offiscal 2008 primarily due to sales from new stores. As a percentage of netsales, cost of sales and occupancy expense increased approximately 60 basispoints primarily driven by a merchandise margin decline of 50 basis pointsrelated to higher promotional and clearance sales as we move through oldproduct in preparation of new product and merchandise resets. Occupancy costsincreased 10 basis points related to the decreased leverage of fixed costs.

 

*Selling, General, and Administrative Expense*—Selling,general, and administrative expense was $478 million, or 28.8% of net sales,for the first six months of fiscal 2009 compared to $518 million, or 31.5%of net sales, for the first six months of fiscal 2008. Selling, general andadministrative expense decreased $40 million, or 270 basis points, primarilydue to a reduction inpayroll and bonus expense, severance expense, and depreciation expense.Additionally, prior year amounts include consulting expenses for studies relatedto consumer insights and other strategic initiatives.

 

*Related Party Expenses*—Related party expenses were$7 million and $8 million for the first six months of fiscal 2009 and fiscal2008, respectively, consisting primarily of $7 million of management fees andassociated expenses paid to our Sponsors and Highfields.  Also included in the related party expensesin fiscal 2008 is approximately $1 million of amortization expense related tothe Separation Agreements as more fully described in Note 9 to the consolidatedfinancial statements.

 

*Interest Expense*—Interest expense decreased$29 million in the six months ended August 1, 2009 compared to the sixmonths ended August 2, 2008, primarily due to a lower average interestrate on our variable-rate debt and lower average debt levels.

 

*Other(Income) and Expense, net*—Other income for the first six months offiscal 2009 related primarily to a $15 million favorable change in the fairvalue of the interest rate cap as more fully described in Note 5 to the consolidatedfinancial statements and $5 million related to foreign exchange gains.

* *

*Provision (Benefit) for Income Taxes*—The effectivetax rate was 36.6% for the first six months of fiscal 2009 and 36.9% for thefirst six months of fiscal 2008. We expect the effective tax rate for fiscal2009 to range from 38% to 43%.

 

**Liquidityand Capital Resources**

 

Werequire cash principally for day-to-day operations, to finance capitalinvestments, inventory for new stores, and inventory replenishment for existingstores, to service our outstanding debt, and seasonal working capitalneeds.  We and our subsidiaries,affiliates, and significant shareholders may from time to time seek to retireor purchase our outstanding debt (including publicly issued debt) through cashpurchases and/or exchanges, in open market purchases, privately negotiatedtransactions, by tender offer or otherwise. Such repurchases or exchanges, if any, will depend on prevailing marketconditions, liquidity requirements, contractual restrictions and otherfactors.  We expect that our availablecash, cash flow generated from operating activities, and funds available underour Asset-based revolving credit facility will be sufficient to fund plannedcapital expenditures, working capital requirements, debt repayments, debtservice requirements and future growth for the foreseeable future.

 

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*Cash Flowfrom Operating Activities*

 

Cashflow provided by operating activities during the first six months of fiscal2009 was $30 million compared to cash used in operating activities of $98million during the first six months of fiscal 2008. The $128 million change wasprimarily due to an increase in net income, a smaller increase in merchandiseinventories, and a favorable impact from accrued interest.  The change in accrued interest is primarilyattributable to the timing of payments and a lower average interest rate.

 

Averageinventory per Michaels store (including supporting distribution centers)decreased 1.1% from $899,000 at August 2, 2008 to $889,000 at August 1,2009 primarily due to lower freight costs. We anticipate average inventory perMichaels store at the end of fiscal 2009 to be down compared to the end offiscal 2008.

 

*Cash Flowused in Investing Activities*

 

Cashflow used in investing activities was primarily the result of the followingcapital expenditure activities:

 
| ** **                                              | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------------|------------|----------------------|------------|
| ** **                                              | ** ** | **August 1,**   | ** ** | **August 2,** | ** ** |
| ** **                                              | ** ** | **2009**             | ** ** | **2008** | ** ** |
| ** **                                              | ** ** | **(in millions)**    | ** ** |
| New  and relocated stores and stores not yet opened (1) |       | $                    | 7          |   | $ | 15 |   |
| Existing  stores                                        |       | 5                    |       | 7 |   |
| Distribution  system expansion                          |       | 1                    |       | 2 |   |
| Information  systems                                    |       | 4                    |       | 14 |   |
| Corporate  and other                                    |       | —               |       | 1 |   |
|                                                    |       | $                    | 17         |   | $ | 39 |   |

 

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(1)          In thefirst six months of fiscal 2009, we incurred capital expenditures related tothe opening of 14 Michaels in addition to the relocation of four Michaelsstores. In the first six months of fiscal 2008, we incurred capitalexpenditures related to the opening of 28 Michaels stores in addition to therelocation of six Michaels stores and one Aaron Brothers store.

 

*Cash Flowprovided by Financing Activities*

 

Cashflow from financing activities are related primarily to borrowings andrepayments under our Asset-based revolving credit facility.  The borrowed amounts were used to financeinventory purchases and capital expenditures. The Asset-based revolving credit facility provides senior secured financingof up to $1.0 billion, subject to a borrowing base. As of August 1, 2009,the borrowing base was $749 million with $526 million of unused availability.

 

**RecentAccounting Pronouncements**

 

In September 2006,the Financial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards (“SFAS”) No. 157, *Fair Value Measurements*,which is intended to increase consistency and comparability in fair valuemeasurements by defining fair value, establishing a framework for measuringfair value and expanding disclosures about fair value measurements.  SFAS 157 was originally effective forfinancial statements issued for fiscal years beginning after November 15,2007, and interim periods within those fiscal years.  In November 2007, the FASB placed a oneyear deferral for the implementation of SFAS 157 for nonfinancial assets andliabilities; however, SFAS 157 is effective for fiscal years beginning after November 15,2007 for financial assets and liabilities, as well as for any other assets andliabilities that are carried at fair value on a recurring basis in financialstatements.  On February 3, 2008, weadopted the provisions of SFAS 157 related to financial assets and liabilitiesand on February 1, 2009, we adopted the provisions related to nonfinancialassets and liabilities that are not required or permitted to be measured atfair value on a recurring basis. These adoptions had no impact on ourconsolidated financial statements.   SeeNote 6 for further information regarding fair value measurements. Additionally,in April 2009, the FASB issued FASB Staff Position (“FSP”) No. FAS107-1 and APB 28-1, *Interim Disclosures AboutFair Value of Financial Instruments,* which collectively provideadditional guidance and require additional disclosure regarding determining andreporting fair values for certain assets and liabilities. We adopted FSP FAS107-1 in the second quarter of fiscal 2009 as reflected in Note 3.

 

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In December 2007,the FASB issued SFAS No. 141 (revised 2007), *Business Combinations*(“SFAS 141R”). SFAS 141R replaces SFASNo. 141, *Business Combinations*.The statement retains the purchase method of accounting used in businesscombinations, but replaces SFAS 141 by establishing principles and requirementsfor the recognition and measurement of assets, liabilities and goodwill,including the requirement that most transaction costs and restructuring costsbe expensed. In addition, the statement requires disclosures to enable users toevaluate the nature and financial effects of the business combination. SFAS141R is effective for business combinations for which the acquisition date ison or after the beginning of the first annual reporting period beginning on orafter December 15, 2008. We will apply the provisions of SFAS 141R to anybusiness combinations occurring on or after February 1, 2009.

 

In March 2008, theFASB issued SFAS No. 161, *Disclosuresabout Derivative Instruments and Hedging Activities — an amendment of FASBStatement No. 133*. SFAS 161 requires qualitative disclosuresabout objectives and strategies for using derivatives, quantitative data aboutthe fair value of and gains and losses on derivative contracts, and details ofcredit-risk-related contingent features in hedged positions. The statement alsorequires enhanced disclosures regarding how and why entities use derivativeinstruments, how derivative instruments and related hedged items are accountedfor in accordance with SFAS 133 and its related interpretation, and howderivative instruments and related hedged items affect entity’s financialposition, financial performance, and cash flows. SFAS 161 is effective forfiscal years and interim periods beginning after November 15, 2008. Weadopted the new disclosure requirements of SFAS 161 in the first quarter of2009 as reflected in Note 5.

 

In May 2009, theFASB issued SFAS No. 165, *Subsequent Events*.SFAS 165 is intended to establish general standards of accounting for anddisclosure of events that occur after the balance sheet date but before thefinancial statements are issued or available to be issued. This standard setsforth the period after the balance sheet date during which management of areporting entity should evaluate events or transactions that may occur forpotential recognition or disclosure in the financial statements, thecircumstances under which an entity should recognize events or transactionsoccurring after the balance sheet date in its financial statements, and thedisclosures that an entity should make about events or transactions thatoccurred after the balance sheet date. SFAS 165 is effective for fiscal yearsand interim periods ending after June 15, 2009. We adopted SFAS 165 duringthe second quarter of fiscal 2009, but the impact of the adoption will dependon the nature and the extent of transactions that occur subsequent to ourinterim and annual reporting periods.

 

In June 2009, theFASB issued SFAS No. 168, *FASB Accounting StandardsCodification and the Hierarchy of Generally Accepted Accounting Principles — areplacement of FASB Statement No. 162.*SFAS 168 establishes theFASB Accounting Standards Codification (the “Codification”) as the source ofauthoritative accounting principles recognized by the FASB to be applied by non-governmentalentities in the preparation of financial statements in conformity withgenerally accepted accounting principles. Rules and interpretive releasesof the SEC under authority of federal securities laws are also sources ofauthoritative guidance for SEC registrants. All guidance contained in theCodification carries an equal level of authority. The U.S. GAAP hierarchy willbe modified to include two levels of GAAP: authoritative and nonauthoritative.SFAS 168 is effective for financial statements issued for interim and annualperiods ended after September 15, 2009. The adoption of SFAS 168 is notexpected to have a material impact on our consolidated financial statements.

 

**Item 3.  Quantitative and QualitativeDisclosures About Market Risk.**

 

Duringthe first quarter of fiscal 2009, we purchased an interest rate cap to hedgethe variability of cash flows associated with our interest payments on ourSenior secured term loan that result from fluctuations in the three-month LIBORrate. The cap limits our interest exposure on a notional value of $2.0 billionto the lesser of the three-month LIBOR rate or 7.0%.  The term of the cap is from April 15,2009 through April 15, 2015. The fair value of the cap as of August 1,2009 was $24 million and is included in Other assets on the ConsolidatedBalance Sheet. The change in fair value of the cap for the quarter and sixmonths ended August 1, 2009, was $11 million and $15 million,respectively, and is recorded in Other (income) and expense, net in theConsolidated Statement of Operations.

** **

**Item 4.  Controls and Procedures.**

 

*Evaluationof Disclosure Controls and Procedures*

 

Wemaintain a set of disclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) promulgated by the SEC under the Securities Exchange Act of1934). An evaluation was carried out under the supervision and with theparticipation of our management, including our Chief Executive Officer and ourChief Financial Officer, of the effectiveness of our disclosure controls andprocedures as of the end of the period covered by this Quarterly Report on Form 10-Q.Based on that evaluation, our Chief Executive Officer and our Chief FinancialOfficer concluded that our disclosure controls and procedures are effective toprovide reasonable assurance that information required to be disclosed in thereports that we file or submit under the Securities Exchange Act of 1934 isrecorded, processed, summarized, and reported within the time periods specifiedin SEC rules and forms. Such controls and procedures are designed toensure that information we are required to disclose in our reports isaccumulated and communicated to our management, including our principalexecutive officer and principal financial officer, to allow timely disclosuredecisions. We note that the design of any system of controls is based, in part,upon certain assumptions about the likelihood of future events, and there canbe no assurance that any design will succeed in achieving its stated goalsunder all potential future conditions.

 

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*Change inInternal Control Over Financial Reporting*

 

Therehas not been any change in our internal control over financial reporting (asdefined in Rules 13a-15(f) and 15d-15(f) as promulgated by theSEC under the Securities Exchange Act of 1934) during the quarter coveredby this Quarterly Report on Form 10-Q that materially affected, or isreasonably likely to materially affect, our internal control over financialreporting.

 

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**MICHAELSSTORES, INC.**

**Part II—OTHERINFORMATION**

 

**Item 1.  LegalProceedings.**

 

Informationregarding legal proceedings is incorporated herein by reference from Note 7 toour Consolidated Financial Statements.

 

**Item 5.  OtherInformation.**

** **

EffectiveSeptember 4, 2009, Shelley G. Broader separated from employment asPresident and Chief Operating Officer with Michaels Stores, Inc.

 

**Item 6.  Exhibits.**

** **

(a) Exhibits:

 
| **Exhibit  Number** | ** ** | **Description of Exhibit**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|---------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1                |       | Amended  form of Stock Option Agreement under Michaels Stores, Inc. 2006  Equity Incentive Plan (filed herewith).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.2                |       | Third  Amendment to Credit Agreement, dated as of August 20, 2009, 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 Registrant’s Current Report on  Form 8-K filed August 21, 2009). |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 31.1                |       | Certifications  of John B. Menzer pursuant to §302 of the Sarbanes-Oxley Act of 2002 (filed  herewith).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 31.2                |       | Certifications  of Elaine D. Crowley 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).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |

 

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**MICHAELSSTORES, INC.**

**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the Registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 
|                                | MICHAELS  STORES, INC. |
|-------------------------------------|------------------------|
|                                |                   |   |
|                                | By:                    | /s/ Elaine  D. Crowley |
|                                |                   | Elaine  D. Crowley |
|                                |                   | Executive  Vice President - Chief  Financial Officer |
|                                |                   | (Principal  Financial Officer) |
| ** **                          | ** **             | ** ** |
| Dated: September 4,  2009 | ** **             | ** ** |

 

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**INDEX TO EXHIBITS**

 
| **Exhibit  Number** | ** ** | **Description of Exhibit**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|---------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1                |       | Amended  form of Stock Option Agreement under Michaels Stores, Inc. 2006  Equity Incentive Plan (filed herewith).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.2                |       | Third  Amendment to Credit Agreement, dated as of August 20, 2009, 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 Registrant’s Current Report on  Form 8-K filed August 21, 2009). |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 31.1                |       | Certifications  of John B. Menzer pursuant to §302 of the Sarbanes-Oxley Act of 2002 (filed  herewith).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 31.2                |       | Certifications  of Elaine D. Crowley 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).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |

 

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