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UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWASHINGTON, DC 20549

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FORM 10-Q

(Mark One)

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

For the quarterly period ended August 3, 2002

OR

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

For the transition period from  to

Commission file number 001-09338

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

Delaware(State or other jurisdiction of
incorporation or organization)

75-1943604(I.R.S. employer
identification number)


8000 Bent Branch Drive
Irving, Texas 75063
P.O. Box 619566
DFW, Texas 75261-9566(Address of principal executive offices, including zip code)

(972) 409-1300(Registrant's telephone number, including area code)

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

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

Title

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

67,084,314


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MICHAELS STORES, INC.
FORM 10-Q

Part IFINANCIAL INFORMATION



|Item 1.                   |                                                                                                              | Financial Statements                                                                 
|------------------------- | ------------------------------------------------------------------------------------------------------------ | -------------------------------------------------------------------------------------
|                          | Consolidated Balance Sheets at August 3, 2002 (unaudited) and February 2, 2002                              
|                          | Consolidated Statements of Income for the quarter ended August 3, 2002 and August 4, 2001 (unaudited)       
|                          | Consolidated Statements of Income for the six months ended August 3, 2002 and August 4, 2001 (unaudited)    
|                          | Consolidated Statements of Cash Flows for the six months ended August 3, 2002 and August 4, 2001 (unaudited)
|                          | Notes to Consolidated Financial Statements (unaudited)                                                      
|Item 2.                   |                                                                                                              | Management's Discussion and Analysis of Financial Condition and Results of Operations
|Item 3.                   |                                                                                                              | Quantitative and Qualitative Disclosures About Market Risk                           
|Item 4.                   |                                                                                                              | Controls and Procedures                                                              
|Part IIOTHER INFORMATION
|Item 1.                   |                                                                                                              | Legal Proceedings                                                                    
|Item 4.                   |                                                                                                              | Submission of Matters to a Vote of Security Holders                                  
|Item 6.                   |                                                                                                              | Exhibits and Reports on Form 8-K                                                     
|Signatures               
|Certifications           



2

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MICHAELS STORES, INC.    Part IFINANCIAL INFORMATION

Item 1. Financial Statements.

MICHAELS STORES, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

|                                           |                                                                                                                                                                | August 3,
2002              |           | February 2,
2002 |          
|------------------------------------------ | -------------------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------- | --------- | ---------------- | ---------
|
|ASSETS                                     |                                                                                                                                                                |                             |           |                  |          
|Current assets:                            |                                                                                                                                                                |                             |           |                  |          
|                                           | Cash and equivalents                                                                                                                                           |                             | $         | 16,528           |          
|                                           | Merchandise inventories                                                                                                                                        |                             |           | 959,702          |          
|                                           | Prepaid expenses and other                                                                                                                                     |                             |           | 20,103           |          
|                                           | Deferred and prepaid income taxes                                                                                                                              |                             |           | 27,008           |          
|                                           |                                                                                                                                                                |                             |           |                  |          
|                                           |                                                                                                                                                                | Total current assets        |           |                  | 1,023,341
|                                           |                                                                                                                                                                |                             |           |                  |          
|Property and equipment, at cost            |                                                                                                                                                                |                             | 691,181   |                  |          
|Less accumulated depreciation              |                                                                                                                                                                |                             | (320,510  | )                |          
|                                           |                                                                                                                                                                |                             |           |                  |          
|                                           |                                                                                                                                                                |                             | 370,671   |                  |          
|                                           |                                                                                                                                                                |                             |           |                  |          
|Goodwill, net                              |                                                                                                                                                                |                             | 115,839   |                  |          
|Other assets                               |                                                                                                                                                                |                             | 10,369    |                  |          
|                                           |                                                                                                                                                                |                             |           |                  |          
|                                           |                                                                                                                                                                |                             | 126,208   |                  |          
|                                           |                                                                                                                                                                |                             |           |                  |          
|Total assets                               |                                                                                                                                                                | $                           | 1,520,220 |                  | $        
|                                           |                                                                                                                                                                |                             |           |                  |          
|LIABILITIES AND STOCKHOLDERS' EQUITY       |                                                                                                                                                                |                             |           |                  |          
|Current liabilities:                       |                                                                                                                                                                |                             |           |                  |          
|                                           | Accounts payable                                                                                                                                               |                             | $         | 210,770          |          
|                                           | Accrued liabilities and other                                                                                                                                  |                             |           | 174,779          |          
|                                           | Borrowings under the Credit Agreement                                                                                                                          |                             |           | 20,400           |          
|                                           | Income taxes payable                                                                                                                                           |                             |           |                 |          
|                                           |                                                                                                                                                                |                             |           |                  |          
|                                           |                                                                                                                                                                | Total current liabilities   |           |                  | 405,949  
|                                           |                                                                                                                                                                |                             |           |                  |          
|91/4% Senior Notes due 2009                |                                                                                                                                                                |                             | 200,000   |                  |          
|Deferred income taxes                      |                                                                                                                                                                |                             | 15,542    |                  |          
|Other long-term liabilities                |                                                                                                                                                                |                             | 26,567    |                  |          
|                                           |                                                                                                                                                                |                             |           |                  |          
|                                           |                                                                                                                                                                | Total long-term liabilities |           |                  | 242,109  
|                                           |                                                                                                                                                                |                             |           |                  |          
|                                           |                                                                                                                                                                |                             | 648,058   |                  |          
|                                           |                                                                                                                                                                |                             |           |                  |          
|Commitments and contingencies              |                                                                                                                                                                |                             |           |                  |          
|Stockholders' equity:                      |                                                                                                                                                                |                             |           |                  |          
|                                           | Common Stock, $0.10 par value, 150,000,000 shares authorized; shares issued and outstanding of 66,080,973 at August 3, 2002 and 65,697,393 at February 2, 2002 |                             |           | 6,608            |          
|                                           | Additional paid-in capital                                                                                                                                     |                             |           | 464,776          |          
|                                           | Retained earnings                                                                                                                                              |                             |           | 400,778          |          
|                                           |                                                                                                                                                                |                             |           |                  |          
|                                           |                                                                                                                                                                | Total stockholders' equity  |           |                  | 872,162  
|                                           |                                                                                                                                                                |                             |           |                  |          
|Total liabilities and stockholders' equity |                                                                                                                                                                | $                           | 1,520,220 |                  | $        
|                                           |                                                                                                                                                                |                             |           |                  |          

See accompanying notes to consolidated financial statements.

3

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MICHAELS STORES, INC.

CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share data)

(Unaudited)

|                                             |         | Quarter Ended |        
|-------------------------------------------- | ------- | ------------- | -------
|
|Net sales                                    |         | $             | 576,580
|Cost of sales and occupancy expense          |         |               | 368,351
|                                             |         |               |        
|Gross profit                                 |         |               | 208,229
|Selling, general, and administrative expense |         |               | 165,027
|Store pre-opening costs                      |         |               | 2,123  
|                                             |         |               |        
|Operating income                             |         |               | 41,079 
|Interest expense                             |         |               | 5,145  
|Other (income) and expense, net              |         |               | (429   
|                                             |         |               |        
|Income before income taxes                   |         |               | 36,363 
|Provision for income taxes                   |         |               | 14,909 
|                                             |         |               |        
|Net income                                   |         | $             | 21,454 
|                                             |         |               |        
|Earnings per common share:                   |         |               |        
|                                             | Basic   |               | $      
|                                             |         |               |        
|                                             | Diluted |               | $      
|                                             |         |               |        

See
accompanying notes to consolidated financial statements.

4

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MICHAELS STORES, INC.

CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share data)

(Unaudited)

|                                             |         | Six Months Ended |          
|-------------------------------------------- | ------- | ---------------- | ---------
|
|Net sales                                    |         | $                | 1,179,800
|Cost of sales and occupancy expense          |         |                  | 765,202  
|                                             |         |                  |          
|Gross profit                                 |         |                  | 414,598  
|Selling, general, and administrative expense |         |                  | 330,430  
|Store pre-opening costs                      |         |                  | 3,807    
|Litigation settlement                        |         |                  |         
|                                             |         |                  |          
|Operating income                             |         |                  | 80,361   
|Interest expense                             |         |                  | 10,229   
|Other (income) and expense, net              |         |                  | (1,283   
|                                             |         |                  |          
|Income before income taxes                   |         |                  | 71,415   
|Provision for income taxes                   |         |                  | 29,280   
|                                             |         |                  |          
|Net income                                   |         | $                | 42,135   
|                                             |         |                  |          
|Earnings per common share:                   |         |                  |          
|                                             | Basic   |                  | $        
|                                             |         |                  |          
|                                             | Diluted |                  | $        
|                                             |         |                  |          

See
accompanying notes to consolidated financial statements.

5

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

|                                                |                                                       | Six Months Ended                  |                                            
|----------------------------------------------- | ----------------------------------------------------- | --------------------------------- | -------------------------------------------
|
|Operating activities:                           |                                                       |                                   |                                            
|                                                | Net income                                            |                                   | $                                          
|                                                | Adjustments:                                          |                                   |                                            
|                                                |                                                       | Depreciation                      |                                            
|                                                |                                                       | Amortization                      |                                            
|                                                |                                                       | Other                             |                                            
|                                                |                                                       | Change in assets and liabilities: |                                            
|                                                |                                                       |                                   | Merchandise inventories                    
|                                                |                                                       |                                   | Prepaid expenses and other                 
|                                                |                                                       |                                   | Deferred and prepaid income taxes and other
|                                                |                                                       |                                   | Accounts payable                           
|                                                |                                                       |                                   | Income taxes payable                       
|                                                |                                                       |                                   | Accrued liabilities and other              
|                                                |                                                       |                                   |                                            
|                                                |                                                       |                                   |                                            
|                                                |                                                       |                                   |                                            
|                                                |                                                       |                                   |                                            
|                                                |                                                       |                                   |                                            
|Investing activities:                           |                                                       |                                   |                                            
|                                                | Additions to property and equipment                   |                                   |                                            
|                                                | Proceeds from sale/leaseback transaction              |                                   |                                            
|                                                | Net proceeds from sales of property and equipment     |                                   |                                            
|                                                |                                                       |                                   |                                            
|                                                |                                                       |                                   |                                            
|                                                |                                                       |                                   |                                            
|Financing activities:                           |                                                       |                                   |                                            
|                                                | Net borrowings under the Credit Agreement             |                                   |                                            
|                                                | Proceeds from issuance of 91/4% Senior Notes due 2009 |                                   |                                            
|                                                | Repurchase of Common Stock                            |                                   |                                            
|                                                | Proceeds from stock options exercised                 |                                   |                                            
|                                                | Proceeds from issuance of Common Stock and other      |                                   |                                            
|                                                | Payment of other long-term liabilities                |                                   |                                            
|                                                |                                                       |                                   |                                            
|                                                |                                                       |                                   |                                            
|                                                |                                                       |                                   |                                            
|Net (decrease) increase in cash and equivalents |                                                       |                                   | (176,497                                   
|Cash and equivalents at beginning of period     |                                                       |                                   | 193,025                                    
|                                                |                                                       |                                   |                                            
|Cash and equivalents at end of period           |                                                       | $                                 | 16,528                                     
|                                                |                                                       |                                   |                                            

See
accompanying notes to consolidated financial statements.

6

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MICHAELS STORES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the Six Months Ended August 3, 2002

(Unaudited)

Note 1. Basis of Presentation

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

The
accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by generally
accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals and other items, as disclosed) considered
necessary for a fair presentation have been included. Because of the seasonal nature of our business, the results of operations for the quarter and six months ended August 3, 2002 are not
indicative of the results to be expected for the entire year.

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

All
references herein to "fiscal 2002" relate to the 52 weeks ending February 1, 2003 and all references to "fiscal 2001" relate to the 52 weeks ended February 2, 2002. In
addition, all references herein to "the second quarter of fiscal 2002" and "the first six months of fiscal 2002" relate to the 13 and 26 weeks ended August 3, 2002, respectively, and all
references to "the second quarter of fiscal 2001" and "the first six months of fiscal 2001" relate to the 13 and 26 weeks ended August 4, 2001, respectively.

Note 2. Common Stock and Earnings per Share

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

7

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

Quarter Ended

Six Months EndedAugust 3,
2002

August 4,
2001

August 3,
2002

August 4,
2001(In thousands, except per share data)Numerator:Net income

$
21,454

$
4,673

$
42,135

$
11,962Denominator:Denominator for basic earnings per common share-weighted average shares


66,355


64,582


66,157


64,163Effect of dilutive securities:Employee stock options


4,236


1,770


4,226


1,540Denominator for diluted earnings per common share-weighted average shares adjusted for dilutive securities


70,591


66,352


70,383


65,703Earnings per common share:Basic

$
0.32

$
0.07

$
0.64

$
0.19Diluted

$
0.30

$
0.07

$
0.60

$
0.18


Our
purchase and subsequent retirement of 392,100 shares of our Common Stock in the second quarter of fiscal 2002 reduced the number of weighted average shares outstanding by 24,330
shares for the second quarter of fiscal 2002 and 12,165 shares for the first six months of fiscal 2002.

Note 3. Senior Notes

In July 2001, we issued $200 million in principal amount of 91/4% Senior Notes due July 1, 2009 in a private placement under
Securities and Exchange Commission Rule 144A to a limited number of qualified institutional buyers. The Senior Notes due 2009 are unsecured and interest thereon is payable
semi-annually on each January 1 and July 1, beginning on January 1, 2002. In August 2001, as required by the contract with the purchasers of the Senior Notes
due 2009, we made an offer to exchange all of the privately placed Senior Notes due 2009 for an equal principal amount of Senior Notes due 2009 having substantially identical terms, the sale of which
was registered under the Securities Act of 1933. As of October 1, 2001, all of the privately placed Senior Notes due 2009 were exchanged for the Senior Notes due 2009 having substantially
identical terms.

Note 4. Credit Agreement

Effective May 1, 2001, we signed a new $200 million unsecured revolving bank credit facility with Fleet National Bank and other lending
institutions, which replaced the previous $100 million unsecured revolving bank credit facility. The Credit Agreement had an original term of three years (with a maturity extension for one
additional year available under certain conditions) and contains a

8

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$25 million competitive bid feature and a $70 million letter of credit sub-facility. Effective May 24, 2002, pursuant to the terms of the Credit Agreement, our
lenders agreed to extend the term of the Credit Agreement from April 30, 2004 to April 30, 2005.

We
are in compliance with all terms and conditions of the Credit Agreement. Borrowings outstanding under the Credit Agreement were $20.4 million as of August 3, 2002 with
no borrowings outstanding as of August 4, 2001. Borrowings available under the Credit Agreement are reduced by the aggregate amount of letters of credit outstanding under the Credit Agreement
($16.7 million as of August 3, 2002). In the first six months of fiscal 2002, borrowings under the Credit Agreement were outstanding for five days, with average outstanding borrowings of
$16.4 million and a weighted average interest rate of 4.75%.

Note 5. Legal Proceedings

Raniwala Proceeding

On May 2, 2000, Taiyeb Raniwala, a former assistant manager of a Michaels store, filed a purported class action complaint against us, on behalf of Michaels
stores' former and current assistant store managers. The Raniwala Complaint was filed in the Alameda County Superior Court, California and alleged that we violated various California laws by
erroneously treating Michaels stores' assistant store managers as "exempt" employees who were not entitled to overtime compensation. Based on these allegations, the Raniwala Complaint asserted that
we: (1) violated various California Wage Orders; (2) violated Section 17200 of the California Business and Professions Code; and (3) engaged in conversion. The Raniwala
Complaint sought back wages, interest, penalties, and attorneys' fees.

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

Collins Proceeding

On April 16, 1999, Suzanne Collins, a former assistant manager of our subsidiary, Aaron Brothers, Inc., filed a class action complaint against Aaron
Brothers on behalf of Aaron Brothers' former store managers, assistant store managers, and managers-in-training. The Collins Complaint was filed in the Los Angeles County
Superior Court, California and alleged that Aaron Brothers violated various California laws by erroneously treating its store managers, assistant store managers, and
managers-in-training as "exempt" employees who were not entitled to overtime compensation. Based on these allegations, the Collins Complaint asserted that Aaron Brothers:
(1) violated various California Labor Codes; (2) violated Section 17200 of the California Business and Professions Code; and (3) engaged in conversion. The Collins
Complaint sought back wages, interest, penalties, punitive damages, and attorneys' fees.

9

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On
March 15, 2002, Aaron Brothers negotiated a definitive settlement of the purported class action with Collins, subject to final court approval. The Court granted preliminary
approval of the settlement on March 29, 2002. As a result, Aaron Brothers recorded a litigation settlement charge of $5.0 million in the fourth quarter of fiscal 2001, covering all
claims, attorneys' fees, and estimated payroll taxes. On June 12, 2002, the Court approved the settlement and the judgment was entered. The appeal period expired on August 12, 2002. No
appeals were filed with the Court. The settlement payments were delivered to the settlement administrator on August 16, 2002 for distribution.

General

We are a defendant from time to time in lawsuits incidental to our business. Based on currently available information, we believe that resolution of all known
contingencies is uncertain, and there can be no assurance that future costs of such litigation would not be material to our financial position or results of operations.

Note 6. Recent Accounting Pronouncements

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

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

10

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

Quarter Ended

Six Months EndedAugust 3,
2002

August 4,
2001

August 3,
2002

August 4,
2001(In thousands, except per share data)Net income as reported

$
21,454

$
4,673

$
42,135

$
11,962Add back:Goodwill amortization, net of income taxes





553





1,106Pro forma net income

$
21,454

$
5,226

$
42,135

$
13,068Pro forma earnings per common share:Basic

$
0.32

$
0.08

$
0.64

$
0.20Diluted

$
0.30

$
0.08

$
0.60

$
0.20


11

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

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

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

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

General

All references herein to "fiscal 2002" relate to the 52 weeks ending February 1, 2003 and all references to "fiscal 2001" relate to the 52 weeks ended
February 2, 2002. In addition, all references herein to "the second quarter of fiscal 2002" and "the first six months of fiscal 2002" relate to the 13 and 26 weeks ended August 3, 2002,
respectively, and all references to "the second quarter of fiscal 2001" and "the first six months of fiscal 2001" relate to the 13 and 26 weeks ended August 4, 2001, respectively.

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

Quarter Ended

Six Months EndedAugust 3,
2002

August 4,
2001

August 3,
2002

August 4,
2001Michaels stores:Retail stores open at end of period


729


657


729


657Retail stores opened during the period


18


13


37


29Retail stores closed during the period


2





3


Retail stores relocated during the period


1


3


9


7Aaron Brothers stores:Retail stores open at end of period


147


128


147


128Retail stores opened during the period


7


5


10


9Retail stores closed during the period


2





2


Retail stores relocated during the period


1





1


Star Wholesale store:Wholesale store open at end of period


1


1


1


1Other operating data:EBITDA(1)

$
62,291

$
30,851

$
121,136

$
63,481Adjusted EBITDA(2)


62,291


30,504


121,136


67,634Working capital


617,392


674,311


617,392


674,311Comparable store sales increase(3)


9
%

1
%

7
%

2
%




12

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(Notes from table on preceding page)

Results of Operations

The following table sets forth the percentage relationship to net sales of each line item of our unaudited consolidated statements of income. This table should be
read in conjunction with the following discussion and with our consolidated financial statements, including the related notes, contained herein.

|                                             |  | Quarter Ended |   | Six Months Ended |  
|-------------------------------------------- |  | ------------- | - | ---------------- | -
|
|Net sales                                    |  | 100.0         | % | 100.0            | %
|Cost of sales and occupancy expense          |  | 63.9          |   | 67.2             |  
|                                             |  |               |   |                  |  
|Gross profit                                 |  | 36.1          |   | 32.8             |  
|Selling, general, and administrative expense |  | 28.6          |   | 29.6             |  
|Store pre-opening costs                      |  | 0.4           |   | 0.4              |  
|Litigation settlement                        |  |              |   |                 |  
|                                             |  |               |   |                  |  
|Operating income                             |  | 7.1           |   | 2.8              |  
|Interest expense                             |  | 0.9           |   | 1.2              |  
|Other (income) and expense, net              |  | (0.1          | ) | (0.0             | )
|                                             |  |               |   |                  |  
|Income before income taxes                   |  | 6.3           |   | 1.6              |  
|Provision for income taxes                   |  | 2.6           |   | 0.6              |  
|                                             |  |               |   |                  |  
|Net income                                   |  | 3.7           | % | 1.0              | %
|                                             |  |               |   |                  |  

13

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Quarter Ended August 3, 2002 Compared to the Quarter Ended August 4, 2001

Net sales for the second quarter of fiscal 2002 increased $90.5 million, or 19%, over the second quarter of fiscal 2001. At the end of the second quarter
of fiscal 2002, we operated 729 Michaels and 147 Aaron Brothers retail stores. The results for the second quarter of fiscal 2002 included sales from 83 Michaels and 21 Aaron Brothers retail stores
that were opened during the 12-month period ended August 3, 2002, more than offsetting lost sales from the closure of 11 Michaels and two Aaron Brothers stores. Sales at the new
stores (net of closures) during the second quarter of fiscal 2002 accounted for $47.9 million of the increase in net sales. Comparable store sales increased 9% in the second quarter of fiscal
2002 compared to the second quarter of fiscal 2001, which contributed $40.9 million to the net sales increase. The improvement in comparable store sales was due to a strong performance in our
core categories of books, general crafts, ribbon, apparel crafts, art supplies, seasonal, kids crafts, and party. Going forward, we expect to achieve comparable store sales increases for the remainder
of fiscal 2002,
taken as a whole. Our ability to continue to generate comparable store sales increases is dependent, in part, on our ability to continue to maintain store in-stock positions on the
top-selling items, to properly allocate seasonal merchandise to our stores, and to be successful in our sales promotion efforts.

Cost
of sales and occupancy expense, as a percentage of net sales, for the second quarter of fiscal 2002 was 63.9%, a decrease of 3.3% compared to the second quarter of fiscal 2001. This
decrease was primarily attributable to improved merchandise margins and a leveraging of store occupancy expense on higher average net sales per store compared to the second quarter of fiscal 2001.

In
addition, in the second quarter of fiscal 2002, we fully utilized the $14.8 million markdown reserve originally recorded in the fourth quarter of fiscal 2001 to offset the
liquidation of certain merchandise that did not conform to each store's specific plan-o-gram SKU program.

Selling,
general, and administrative expense was $165.0 million, or 28.6% of net sales, in the second quarter of fiscal 2002 compared with $143.9 million, or 29.6% of net
sales, in the second quarter of fiscal 2001, which includes an adjustment of $347,000 to reduce the one-time charge recorded in the first quarter of fiscal 2001 related to senior executive
severance. Excluding this severance adjustment, selling, general, and administrative expense was $144.2 million, or 29.7% of net sales, in the second quarter of fiscal 2001. The decrease as a
percentage of net sales to 28.6% in the second quarter of fiscal 2002 from 29.7% in the second quarter of fiscal 2001 was due in part to a decrease in store payroll and related expenses, on a
percentage of net sales basis, resulting from higher average net sales per store in the second quarter of fiscal 2002 compared with the second quarter of fiscal 2001. In addition, net advertising
expense decreased, as a percentage of net sales, in the second quarter of fiscal 2002 as a result of a leveraging of advertising expense on higher average net sales per store and higher
co-op advertising income compared to the second quarter of fiscal 2001. Furthermore, as a result of our adoption of the provisions of SFAS No. 142 in the first quarter of fiscal
2002, amortization expense decreased $921,000 in the second quarter of fiscal 2002 compared with the second quarter of fiscal 2001.

Store
pre-opening costs remained relatively constant at 0.4% of net sales for both the second quarter of fiscal 2002 and the second quarter of fiscal 2001. In the second
quarter of fiscal 2002, we opened or relocated 19 Michaels and eight Aaron Brothers stores compared to 16 Michaels and five Aaron Brothers stores opened or relocated in the second quarter of fiscal
2001.

Operating
income increased 203% to $41.1 million, or 7.1% of net sales, in the second quarter of fiscal 2002 from $13.5 million, or 2.8% of net sales, in the second quarter
of fiscal 2001. Operating income for the second quarter of fiscal 2001 includes a $347,000 adjustment related to senior executive severance. Excluding the effects of the severance adjustment in the
second quarter of fiscal 2001, operating income increased 211% from $13.2 million, or 2.7% of net sales, in the second quarter of fiscal 2001.

14

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Interest
expense (net of interest income) decreased to $4.8 million, or 0.8% of net sales, in the second quarter of fiscal 2002 from $5.6 million, or 1.1% of net sales, in
the second quarter of fiscal 2001, due in part to lower interest expense in the second quarter of fiscal 2002 on outstanding borrowings against the Credit Agreement. Borrowings were outstanding under
the Credit Agreement for five days in the second quarter of fiscal 2002 compared to 61 days in the second quarter of fiscal 2001. In addition, interest expense for the second quarter of fiscal
2001 includes non-recurring incremental interest expense of $1.5 million incurred while the Senior Notes due 2009 and the Senior Notes due 2006 were both outstanding for a
29-day period during the second quarter of fiscal 2001.

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

Net
income for the second quarter of fiscal 2002 was $21.5 million, or $0.30 per diluted share, compared to $4.7 million, or $0.07 per diluted share, for the second quarter
of fiscal 2001. Excluding the effects of the severance adjustment and the incremental interest expense, net income for the second quarter of fiscal 2001 was $5.4 million, or $0.08 per diluted
share.

First Six Months Ended August 3, 2002 Compared to the First Six Months Ended August 4, 2001

Net sales for the first six months of fiscal 2002 increased $169.0 million, or 17%, over the first six months of fiscal 2001. Sales at the new stores (net
of closures) during the first six months of fiscal 2002 accounted for $99.2 million of the increase in net sales. Comparable store sales increased 7% in the first six months of fiscal 2002
compared to the first six months of fiscal 2001, which contributed $66.9 million to the net sales increase. The improvement in comparable store sales was due to a strong performance in our core
categories of books, apparel crafts, art supplies, ribbon, general crafts, kids crafts, and party.

Cost
of sales and occupancy expense, as a percentage of net sales, for the first six months of fiscal 2002 was 64.9%, a decrease of 1.8% compared to the first six months of fiscal 2001.
This decrease was primarily attributable to improved merchandise margins and a leveraging of store occupancy expense on higher average net sales per store compared to the first six months of fiscal
2001.

In
addition, in the second quarter of fiscal 2002, we fully utilized the $14.8 million markdown reserve originally recorded in the fourth quarter of fiscal 2001 to offset the
liquidation of certain merchandise that did not conform to each store's specific plan-o-gram SKU program.

Selling,
general, and administrative expense was $330.4 million, or 28.0% of net sales, in the first six months of fiscal 2002 compared with $300.3 million, or 29.7% of net
sales, in the first six months of
fiscal 2001, which includes one-time costs of approximately $1.0 million related to senior executive severance. Excluding this one-time severance charge, selling,
general, and administrative expense was $299.3 million, or 29.6% of net sales, in the first six months of fiscal 2001. The decrease as a percentage of net sales to 28.0% in the first six months
of fiscal 2002 from 29.6% in the first six months of fiscal 2001 was due in part to a decrease in store and corporate payroll and related expenses, on a percentage of net sales basis, resulting from
higher average net sales per store in the first six months of fiscal 2002 compared with the first six months of fiscal 2001. In addition, net advertising expense decreased, as a percentage of net
sales, in the first six months of fiscal 2002 as a result of a leveraging of advertising expense on higher average net sales per store and higher co-op advertising income compared to the
first six months of fiscal 2001. Furthermore, as a result of our adoption of the provisions of SFAS No. 142 in the first quarter of fiscal 2002, amortization expense decreased
$1.8 million in the first six months of fiscal 2002 compared with the first six months of fiscal 2001.

Store
pre-opening costs remained relatively constant as a percentage of net sales for both the first six months of fiscal 2002 and the first six months of fiscal 2001. In the
first six months of fiscal 2002,

15

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we opened or relocated 46 Michaels and 11 Aaron Brothers stores compared to 36 Michaels and nine Aaron Brothers stores opened or relocated in the first six months of fiscal 2001.

On
June 6, 2001, we negotiated a tentative settlement of the purported class action with one of our former assistant managers, Taiyeb Raniwala. As a result, we recorded a
litigation settlement charge of $3.2 million in the first quarter of fiscal 2001, covering all claims, attorneys' fees, and estimated payroll taxes. The settlement, in exchange for a full
release of claims, received final approval from the court on November 20, 2001, and distribution of the settlement proceeds was made on January 19, 2002.

Operating
income increased 171% to $80.4 million, or 6.8% of net sales, in the first six months of fiscal 2002 from $29.6 million, or 2.9% of net sales, in the first six
months of fiscal 2001. Operating income for the first six months of fiscal 2001 was negatively impacted by one-time severance costs of $1.0 million and the litigation settlement
charge of $3.2 million. Excluding the effects of the one-time severance charge and the litigation settlement charge in the first six months of fiscal 2001, operating income
increased 138% from $33.8 million, or 3.3% of net sales, in the first six months of fiscal 2001.

Interest
expense (net of interest income) decreased to $9.0 million, or 0.8% of net sales, in the first six months of fiscal 2002 from $9.2 million, or 0.9% of net sales,
in the first six months of fiscal 2001 due in part to lower interest expense in the first six months of fiscal 2002 on outstanding borrowings against the Credit Agreement. Borrowings were outstanding
under the Credit Agreement for five days in the first six months of fiscal 2002 compared to 140 days in the first six months of fiscal 2001. In addition, interest income was higher in the first
six months of fiscal 2002 as a result of larger invested cash balances compared to the first six months of fiscal 2001. These decreases were partially offset by higher interest expense on the
$200 million of 91/4% Senior Notes due July 1, 2009, which were issued in July 2001, compared to the $125 million of 107/8% Senior Notes due
2006, which were redeemed in August 2001.

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

Net
income for the first six months of fiscal 2002 was $42.1 million, or $0.60 per diluted share, compared to $12.0 million, or $0.18 per diluted share, for the first six
months of fiscal 2001. Excluding the effects of the one-time severance charge, the litigation settlement charge, and the incremental interest expense, net income for the first six months
of fiscal 2001 was $15.3 million, or $0.23 per diluted share.

Liquidity and Capital Resources

Changes in Cash and Equivalents

Cash flow used in operating activities during the first six months of fiscal 2002 was $124.9 million, compared to $101.5 million during the first
six months of fiscal 2001. The increase in cash used in operating activities of $23.4 million in the first six months of fiscal 2002 compared to the first six months of fiscal 2001 was
primarily attributable to an increase in the change in merchandise inventories net of the change in accounts payable of $17.5 million and an increase in the change in income taxes payable and
accrued liabilities of $45.1 million, partially offset by an increase in net income of $30.2 million. Inventories per Michaels store of $1.262 million at August 3, 2002
increased 8.4% from $1.164 million at August 4, 2001. We anticipate average inventory per Michaels store to increase 5% to 7% by the end of fiscal 2002.

Cash
flow used in investing activities in the first six months of fiscal 2002 was $71.3 million compared to $20.7 million in the first six months of fiscal 2001. Cash flow
used in investing activities in the first six months of fiscal 2002 was due in part to capital expenditures related to the completion of our new Hazleton, Pennsylvania distribution center, the
expansion of our Lancaster, California

16

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distribution center, and the opening of 37 Michaels and 10 Aaron Brothers stores and the relocation of nine Michaels stores and one Aaron Brothers store in the first six months of fiscal 2002.

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

Six Months EndedAugust 3,
2002

August 4,
2001(In thousands)New and relocated stores and stores not yet opened

$
21,865

$
25,935Existing stores


12,676


11,338Distribution system expansion


24,652


1,943Information systems


9,156


5,527Corporate and other


3,013


2,93871,362


47,681Proceeds from sale/leaseback transaction





(26,886
)$
71,362

$
20,795


We
anticipate capital expenditures for fiscal 2002 to total approximately $147.0 million. In fiscal 2002, we plan to open approximately 65 Michaels and 13 Aaron Brothers stores.

Cash
flow provided by financing activities in the first six months of fiscal 2002 was $19.7 million compared to $207.8 million in the first six months of fiscal 2001. The
decrease in cash provided by financing activities was primarily due to the issuance of the 91/4% Senior Notes due 2009 in the second quarter of fiscal 2001 totaling
$194.5 million, net of expenses, compared to the repurchase and subsequent retirement of 392,100 shares of our Common Stock totaling $12.8 million in the second quarter of fiscal 2002.
This decrease in cash provided by financing activities was partially offset by borrowings under the Credit Agreement in the first six months of fiscal 2002 totaling $20.4 million. Proceeds from
the exercise of stock options were $11.6 million for approximately 751,000 shares of our Common Stock in the first six months of fiscal 2002 and $13.2 million for approximately
1.1 million shares of our Common Stock in the first six months of fiscal 2001.

Bank Credit Facility

Effective May 1, 2001, we signed a new $200 million unsecured revolving bank credit facility with Fleet National Bank and other lending
institutions, which replaced the previous $100 million unsecured revolving bank credit facility. The Credit Agreement had an original term of three years (with a maturity extension for one
additional year available under certain conditions) and contains a $25 million competitive bid feature and a $70 million letter of credit sub-facility. Effective
May 24, 2002, pursuant to the terms of the Credit Agreement, our lenders agreed to extend the term of the Credit Agreement from April 30, 2004 to April 30, 2005.

We
are in compliance with all terms and conditions of the Credit Agreement. Borrowings outstanding under the Credit Agreement were $20.4 million as of August 3, 2002, with
no borrowings outstanding as of August 4, 2001. Borrowings available under the Credit Agreement are reduced by the aggregate amount of letters of credit outstanding under the Credit Agreement
($16.7 million as of August 3, 2002). In the first six months of fiscal 2002, borrowings under the Credit Agreement were outstanding for five days, with average outstanding borrowings of
$16.4 million and a weighted average interest rate of 4.75%.

17

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General

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

In
July 2001, we issued $200 million in principal amount of the 91/4% Senior Notes due 2009 in a private placement under Securities and Exchange Commission
Rule 144A to a limited number of qualified institutional buyers. The Senior Notes due 2009 are unsecured and interest thereon is payable semi-annually on each January 1 and
July 1, beginning on January 1, 2002. In August 2001, as required by the contract with the purchasers of the Senior Notes due 2009, we made an offer to exchange all of the
privately placed Senior Notes due 2009 for an equal principal amount of Senior Notes due 2009 having substantially identical terms, the sale of which was registered under the Securities Act of 1933.
As of October 1, 2001, all of the privately placed Senior Notes due 2009 were exchanged for the Senior Notes due 2009 having substantially identical terms.

On
December 5, 2000, our Board of Directors authorized the repurchase of 2.0 million shares of our outstanding Common Stock. On September 11, 2002, our Board of
Directors approved the repurchase of up to an additional 1.0 million shares of our outstanding Common Stock. During the second quarter
of fiscal 2002, we repurchased and subsequently retired 392,100 shares of our Common Stock. As of August 3, 2002, we have repurchased and retired 1.44 million shares under this plan at
an average cost of $20.79 per share. As of September 11, 2002, we have approximately 1.56 million shares of our Common Stock available for repurchase. The repurchase plan also provides
that the proceeds of the exercise of options under our 2001 General Stock Option Plan may be used to repurchase shares under the repurchase plan and that the maximum number of shares authorized to be
repurchased under the repurchase plan will be increased to the extent necessary, if any, to so use the proceeds from such option exercises. Under the agreements governing our outstanding indebtedness,
we can only repurchase shares of our Common Stock if we maintain or comply with specified financial ratios and other covenants. We may also be restricted by regulations of the Securities and Exchange
Commission from making future repurchases during certain time periods.

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

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

We have market risk exposure arising from changes in interest rates. The interest rates on the Credit Agreement are repriced frequently, at market prices, which
would result in carrying amounts that approximate fair value. We had borrowings outstanding of $20.4 million under the Credit Agreement at August 3, 2002. In July 2001, we issued
$200 million of the Senior Notes due 2009 with a fixed interest rate of 91/4%. In August 2001, we used a portion of the proceeds from the Senior Notes due 2009 to redeem
the Senior Notes due 2006. Generally, the fair market value of our fixed interest rate long-term debt will increase as interest rates fall and decrease as interest rates rise. Our market
risk is described in more detail in our Annual Report on Form 10-K for the fiscal year ended February 2, 2002.

Item 4. Controls and Procedures

In the second quarter of fiscal 2002, there were no significant changes in internal controls or in other factors that could significantly affect these controls.

18

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MICHAELS STORES, INC.    Part IIOTHER INFORMATION

Item 1. Legal Proceedings.

Reference is made to Part I, Item 3. Legal Proceedings, of our Annual Report on Form 10-K for the fiscal year ended February 2,
2002, filed on April 12, 2002, and Part II, Item 1. Legal Proceedings, of our Quarterly Report on Form 10-Q for the period ended May 4, 2002, filed on
June 18, 2002, which reported during the fiscal year the legal proceedings referenced below.

Collins Proceeding

On April 16, 1999, Suzanne Collins, a former assistant manager of our subsidiary, Aaron Brothers, Inc., filed a class action complaint against Aaron
Brothers on behalf of Aaron Brothers' former store managers, assistant store managers, and managers-in-training. The Collins Complaint was filed in the Los Angeles County
Superior Court, California and alleged that Aaron Brothers violated various California laws by erroneously treating its store managers, assistant store managers, and
managers-in-training as "exempt" employees who were not entitled to overtime compensation. Based on these allegations, the Collins Complaint asserted that Aaron Brothers:
(1) violated various California Labor Codes; (2) violated Section 17200 of the California Business and Professions Code; and (3) engaged in conversion. The Collins
Complaint sought back wages, interest, penalties, punitive damages, and attorneys' fees.

On
March 15, 2002, Aaron Brothers negotiated a definitive settlement of the purported class action with Collins, subject to final court approval. The Court granted preliminary
approval of the settlement on March 29, 2002. As a result, Aaron Brothers recorded a litigation settlement charge of $5.0 million in the fourth quarter of fiscal 2001, covering all
claims, attorneys' fees, and estimated payroll taxes. On June 12, 2002, the Court approved the settlement and the judgment was entered. The appeal period expired on August 12, 2002. No
appeals were filed with the Court. The settlement payments were delivered to the settlement administrator on August 16, 2002 for distribution.

General

We are a defendant from time to time in lawsuits incidental to our business. Based on currently available information, we believe that resolution of all known
contingencies is uncertain, and there can be no assurance that future costs of such litigation would not be material to our financial position or results of operations.

19

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

Our 2002 Annual Meeting of Stockholders was held on June 20, 2002. The following item of business, as proposed in the Proxy Statement dated May 6,
2002, was presented to the stockholders:

Election of Directors

The six director nominees, information with respect to which was set forth in the Proxy Statement under the caption titled "Proposal for Election of Directors,"
were elected. The vote with respect to the election of these directors was as follows:

Total Vote
for Each
Director

Total Vote
Withheld
From Each
Director

Abstentions

Broker
Non-VotesCharles J. Wyly, Jr.

61,244,452

807,362



Sam Wyly

61,244,296

807,518



Richard E. Hanlon

61,238,149

813,665



Richard C. Marcus

61,238,340

813,474



Liz Minyard

61,809,589

242,225



Elizabeth A. VanStory

61,233,299

818,515






Each
elected director will serve until the next annual meeting of stockholders and until his or her successor is duly elected and qualified or until the earlier of his or her
resignation, death, or removal.

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



20

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MICHAELS STORES, INC.

SIGNATURES

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

|                          |  | MICHAELS STORES, INC. |  |                                                                                                                                      
|------------------------- |  | --------------------- |  | -------------------------------------------------------------------------------------------------------------------------------------
|                          |  | By:                   |  | /s/BRYAN M. DECORDOVABryan M. DeCordova Executive Vice PresidentChief Financial Officer
(Principal Financial and Accounting Officer)
|Dated: September 17, 2002 |  |                       |  |                                                                                                                                      
|                          |  |                       |  |                                                                                                                                      

21

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CERTIFICATIONS

I, R. Michael Rouleau, certify that:



|Date: September 17, 2002 |  | /s/R. MICHAEL ROULEAUR. Michael Rouleau President and Chief Executive Officer
|------------------------ |  | -----------------------------------------------------------------------------
|                         |  |                                                                              

22

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CERTIFICATIONS

I, Bryan M. DeCordova, certify that:



|Date: September 17, 2002 |  | /s/BRYAN M. DECORDOVABryan M. DeCordova Executive Vice President
Chief Financial Officer
|------------------------ |  | -----------------------------------------------------------------------------------------
|                         |  |                                                                                          

23

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INDEX TO EXHIBITS

|Exhibit
Number |  | Description of Exhibit                                                                                                                                                                  
|-------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.1           |  | Amendment to Employment Agreement between Michaels Stores, Inc. and R. Michael Rouleau, dated July 16, 2002 (filed herewith).                                                           
|10.2           |  | Agreement between Michaels Stores, Inc. and Bryan M. DeCordova, dated effective as of June 7, 2002 (filed herewith).                                                                    
|10.3           |  | Amendment to Agreement among Michaels Stores, Inc., Michaels Management Services, LP, and Bryan M. DeCordova, dated effective as of August 2, 2002 (filed herewith).                    
|10.4           |  | Michaels Stores, Inc. Amended and Restated 2001 Employee Stock Option Plan (previously filed as Exhibit 99.1 to Form 8-K, filed by Registrant on July 29, 2002, SEC File No. 001-09338).
|99.1           |  | Certification pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002 (filed herewith).                                                              
|               |  |                                                                                                                                                                                         

---