##### Table of Contents



UNITED STATES
 SECURITIES AND EXCHANGE
    COMMISSION
 WASHINGTON, DC 20549
     FORM 10-Q
  (Mark One)þ

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE
    SECURITIES EXCHANGE ACT OF 1934For the quarterly period ended
    July 29, 2006ORo

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)  OF
    THE SECURITIES EXCHANGE ACT OF 1934For the transition period from
    
    to   Commission file number
    001-09338
     MICHAELS STORES, INC.
   Delaware

75-1943604(State or other jurisdiction of
    incorporation or organization)

(I.R.S. employer
    identification number)   8000 Bent Branch Drive
 Irving, Texas 75063
 P.O. Box 619566
 DFW, Texas
    75261-9566
   (972) 409-1300
       þ o
  Rule 12b-2
 þ o o
  Rule 12b-2 o þ
    Shares Outstanding as ofTitle

September 5, 2006Common Stock, par value
    $.10 per share

133,326,492




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##### 



MICHAELS
    STORES, INC.FORM 10-Q
  
  Part IFINANCIAL
    INFORMATIONItem 1.


Financial
    StatementsConsolidated
    Balance Sheets at July 29, 2006, January 28, 2006, and
    July 30, 2005 (unaudited)


3Consolidated
    Statements of Income for the quarter and six months ended
    July 29, 2006 and July 30, 2005 (unaudited)


4Consolidated
    Statements of Cash Flows for the six months ended July 29,
    2006 and July 30, 2005 (unaudited)


5Notes to
    Consolidated Financial Statements (unaudited)


6Item 2.


Managements
    Discussion and Analysis of Financial Condition and Results of
    Operations


21Item 3.


Quantitative and
    Qualitative Disclosures About Market Risk


29Item 4.


Controls and
    Procedures


29Part IIOTHER
    INFORMATIONItem 1.


Legal
    Proceedings


31Item 1A.


Risk
    Factors


38Item 4.


Submission of
    Matters to a Vote of Security Holders


39Item 6.


Exhibits


40Signatures


41Certifications Pursuant to Section 302Certifications Pursuant to Section 302Certification Pursuant to Section 906   2




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##### Table of Contents



MICHAELS
    STORES, INC.
 Part IFINANCIAL INFORMATION
  Item 1.
    Financial
    Statements.  MICHAELS
    STORES, INC.CONSOLIDATED BALANCE SHEETS 
    (In thousands, except share data)
    (Unaudited)
  July 29,


January 28,


July 30,2006


2006


2005ASSETSCurrent assets:Cash and equivalents

$
379,320


$
452,449


$
182,909Merchandise inventories


874,286



784,032



944,572Prepaid expenses and other


46,594



44,042



39,010Deferred and prepaid income taxes


56,863



34,125



113,936Total current assets


1,357,063



1,314,648



1,280,427Property and equipment, at
    cost


1,073,595



1,011,201



963,201Less accumulated depreciation


(636,349
)


(586,382
)


(544,714
)437,246



424,819



418,487Goodwill


115,839



115,839



115,839Other assets


22,929



20,249



18,687138,768



136,088



134,526Total assets

$
1,933,077


$
1,875,555


$
1,833,440LIABILITIES AND
    STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable

$
272,886


$
193,595


$
248,645Accrued liabilities and other


249,691



282,499



232,385Income taxes payable






20,672



Total current liabilities


522,577



496,766



481,030Deferred income taxes






2,803



22,747Other long-term
    liabilities


89,173



88,637



86,898Total long-term liabilities


89,173



91,440



109,645611,750



588,206



590,675Commitments and
    contingenciesStockholders
    equity:Preferred Stock, $0.10 par
    value, 2,000,000 shares authorized; none issued










Common Stock, $0.10 par value,
    350,000,000 shares authorized; 135,906,124 shares
    issued and 133,139,724 shares outstanding at July 29,
    2006, 133,821,417 shares issued and 132,986,517 shares
    outstanding at January 28, 2006, and
    135,827,039 shares issued and outstanding at July 30,
    2005


13,591



13,382



13,583Additional paid-in capital


442,676



386,627



435,625Retained earnings


951,354



907,773



784,169Treasury Stock
    (2,766,400 shares at July 29, 2006,
    834,900 shares at January 28, 2006, and none at
    July 30, 2005)


(94,127
)


(27,944
)


Accumulated other comprehensive
    income


7,833



7,511



9,388Total stockholders equity


1,321,327



1,287,349



1,242,765Total liabilities and
    stockholders equity

$
1,933,077


$
1,875,555


$
1,833,440    3




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##### Table of Contents



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


Six Months EndedJuly 29,


July 30,


July 29,


July 30,2006


2005


2006


2005Net sales

$
768,264


$
745,493


$
1,600,745


$
1,566,509Cost of sales and occupancy expense


495,010



481,263



1,007,051



984,467Gross profit


273,254



264,230



593,694



582,042Selling, general, and
    administrative expense


242,180



223,104



483,916



450,998Store pre-opening costs


1,521



1,455



2,958



4,194Operating income


29,553



39,671



106,820



126,850Interest expense


252



15,500



424



20,589Other (income) and expense, net


(3,329
)


(2,370
)


(10,491
)


(5,050
)Income before income taxes and
    cumulative effect of accounting change


32,630



26,541



116,887



111,311Provision for income taxes


12,318



10,080



44,125



42,296Income before cumulative effect
    of accounting change


20,312



16,461



72,762



69,015Cumulative effect of accounting
    change, net of income tax of $54.2 million














88,488Net income (loss)

$
20,312


$
16,461


$
72,762


$
(19,473
)Basic earnings (loss) per
    common share:Income before cumulative effect of
    accounting change

$
0.15


$
0.12


$
0.55


$
0.51Cumulative effect of accounting
    change, net of income tax














(0.65
)Net income (loss)

$
0.15


$
0.12


$
0.55


$
(0.14
)Diluted earnings (loss) per
    common share:Income before cumulative effect of
    accounting change

$
0.15


$
0.12


$
0.54


$
0.50Cumulative effect of accounting
    change, net of income tax














(0.64
)Net income (loss)

$
0.15


$
0.12


$
0.54


$
(0.14
)Dividends declared per common share

$
0.12


$
0.10


$
0.22


$
0.17    4




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##### Table of Contents



MICHAELS
    STORES, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS 
    (In thousands)
    (Unaudited)
  Six Months EndedJuly 29,


July 30,2006


2005Operating activities:Net income (loss)

$
72,762


$
(19,473
)Adjustments:Depreciation


56,433



48,085Amortization


187



194Share-based compensation


10,867



10,646Tax benefits from stock options
    exercised


(16,065
)


(16,794
)Non-cash charge for the cumulative
    effect of accounting change






142,723Loss from early extinguishment of
    debt






12,133Other


168



325Changes in assets and liabilities:Merchandise inventories


(90,027
)


(151,050
)Prepaid expenses and other


(2,991
)


(12,397
)Deferred income taxes and other


(6,190
)


(8,899
)Accounts payable


50,560



(7,621
)Accrued liabilities and other


(8,707
)


4,125Income taxes payable


(27,329
)


(88,035
)Other long-term liabilities


1,845



11,584Net cash provided by (used in)
    operating activities


41,513



(74,454
)Investing activities:Additions to property and equipment


(69,549
)


(60,510
)Purchases of short-term investments






(226
)Sales of short-term investments






50,605Net proceeds from sales of
    property and equipment


8



Net cash used in investing
    activities


(69,541
)


(10,131
)Financing activities:Repayment of Senior Notes






(209,250
)Cash dividends paid to stockholders


(26,625
)


(32,670
)Repurchase of Common Stock


(66,182
)


(71,197
)Proceeds from stock options
    exercised


27,870



25,787Tax benefits from stock options
    exercised


16,065



16,794Proceeds from issuance of Common
    Stock and other


1,791



2,178Change in cash overdraft


1,980



Net cash used in financing
    activities


(45,101
)


(268,358
)Net decrease in cash and
    equivalents


(73,129
)


(352,943
)Cash and equivalents at
    beginning of period


452,449



535,852Cash and equivalents at end of
    period

$
379,320


$
182,909    5




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##### Table of Contents



MICHAELS
    STORES, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
    For the Six Months Ended July 29, 2006
    (Unaudited)
  Note 1.
    Basis of
    Presentation    Form 10-Q Regulation S-X.
  Form 10-K
        Note 2.
    Changes
    in Accounting  Form 10-K, Share-Based Payment Form 10-Q, Form 10-K.
 6




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##### Table of Contents



MICHAELS
    STORES, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  For the
    Six Months Ended July 29, 2006
 (Unaudited)
  Note 2.
    Changes
    in Accounting (Continued)     As Previously


WAC


SFAS No. 123(R)


AsReported


Adjustments


Adjustments


RestatedQuarter Ended July 30,
    2005Balance SheetMerchandise inventories

$
1,090,239


$
(145,690
)

$
23


$
944,572Deferred and prepaid income taxes


58,580



55,356







113,936Other assets


18,765







(78
)


18,687Deferred income taxes


26,848







(4,101
)


22,747Additional
    paid-in-capital


425,002







10,623



435,625Retained earnings


880,990



(90,221
)


(6,600
)


784,169Accumulated other comprehensive
    income


9,478



(90
)






9,388Six Months Ended July 30,
    2005Statement of Cash
    FlowsNet income


77,348



(90,221
)


(6,600
)


(19,473
)Share-based compensation expense










10,646



10,646Non-cash charge for the cumulative
    effect of accounting change






142,723







142,723Merchandise inventories


(153,844
)


2,794







(151,050
)Deferred income taxes and other


(4,853
)






(4,046
)


(8,899
)Income taxes payable


(32,737
)


(55,298
)






(88,035
)Tax benefits from stock options
    exercised (a reclassification from operating activities to
    financing activities)










(16,794
)


(16,794
)   7




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##### Table of Contents



MICHAELS
    STORES, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  For the
    Six Months Ended July 29, 2006
 (Unaudited)
  Note 3.
    Earnings
    per Share    Quarter Ended


Six Months EndedJuly 29,


July 30,


July 29,


July 30,2006


2005


2006


2005(In thousands, except per share data)Numerator:Income before cumulative effect of
    accounting change

$
20,312


$
16,461


$
72,762


$
69,015Cumulative effect of accounting
    change, net of income tax














88,488Net income (loss)

$
20,312


$
16,461


$
72,762


$
(19,473
)Denominator:Denominator for basic earnings per
    common shareweighted average shares


132,295



135,774



132,346



135,896Effect of dilutive securities:Employee stock options


2,236



2,634



2,104



2,563Denominator for diluted earnings
    per common shareweighted average shares adjusted for
    dilutive securities


134,531



138,408



134,450



138,459Basic earnings (loss) per
    common share:Income before cumulative effect of
    accounting change

$
0.15


$
0.12


$
0.55


$
0.51Cumulative effect of accounting
    change, net of income tax














(0.65
)Net income (loss)

$
0.15



0.12



0.55



(0.14
)Diluted earnings (loss) per
    common share:Income before cumulative effect of
    accounting change

$
0.15


$
0.12


$
0.54


$
0.50Cumulative effect of accounting
    change, net of income tax














(0.64
)Net income (loss)

$
0.15


$
0.12


$
0.54


$
(0.14
)    8




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##### Table of Contents



MICHAELS
    STORES, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  For the
    Six Months Ended July 29, 2006
 (Unaudited)
  Note 4.
    Share-Based
    Compensation    Note 5.
    Debt  91/4% Senior
    Notes due 2009
  1 4
  Credit
    Agreement
     9




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##### Table of Contents



MICHAELS
    STORES, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  For the
    Six Months Ended July 29, 2006
 (Unaudited)
  Note 6.
    Comprehensive
    Income (Loss)    Quarter Ended


Six Months EndedJuly 29,


July 30,


July 29,


July 30,2006


2005


2006


2005(In thousands)Net income (loss)

$
20,312


$
16,461


$
72,762


$
(19,473
)Other comprehensive income (loss):Foreign currency translation
    adjustment and other


(289
)


1,136



322



4,066Comprehensive income (loss)

$
20,023


$
17,597


$
73,084


$
(15,407
)    Note 7.
    Commitments
    and Contingencies  Shareholder
    Claims
  Fathergill
    Claim
    and/or
   10




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##### Table of Contents



MICHAELS
    STORES, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  For the
    Six Months Ended July 29, 2006
 (Unaudited)
  Note 7.
    Commitments
    and Contingencies (Continued)    Gottlieb
    and Schuman Claim
        Dutil
    Claim
   11




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##### Table of Contents



MICHAELS
    STORES, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  For the
    Six Months Ended July 29, 2006
 (Unaudited)
  Note 7.
    Commitments
    and Contingencies (Continued)   Hulliung
    Claim
  Rule 10b-5
  Rule 10b-5
  Ziolkowski
    Claim
  Rule 10b-5
 12




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##### Table of Contents



MICHAELS
    STORES, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  For the
    Six Months Ended July 29, 2006
 (Unaudited)
  Note 7.
    Commitments
    and Contingencies (Continued)   Massachusetts
    Laborers Annuity Fund Claim
  and/or Rule 14a-9
  Employee
    Class Action Claims
  Cotton
    Claim
    Clark
    Claim
   13




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##### Table of Contents



MICHAELS
    STORES, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  For the
    Six Months Ended July 29, 2006
 (Unaudited)
  Note 7.
    Commitments
    and Contingencies (Continued)    Morris
    Claim
    Olivas
    Claim
    Governmental
    Inquiries and Related Matters
  Non-U.S. Trust
    Inquiry
  non-U.S. trusts
   14




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##### Table of Contents



MICHAELS
    STORES, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  For the
    Six Months Ended July 29, 2006
 (Unaudited)
  Note 7.
    Commitments
    and Contingencies (Continued)   and/or non-U.S. trusts. and/or and/or non-U.S. trusts
  non-U.S. trusts, Rule 13d-3, non-U.S. trusts
  non-U.S. trusts
  non-U.S. trusts
  non-U.S. trusts,
 15




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##### Table of Contents



MICHAELS
    STORES, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  For the
    Six Months Ended July 29, 2006
 (Unaudited)
  Note 7.
    Commitments
    and Contingencies (Continued)   Stock
    Options Inquiry
    Internal
    Review of Stock Options Practices and Related
    Accounting
       16




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##### Table of Contents



MICHAELS
    STORES, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  For the
    Six Months Ended July 29, 2006
 (Unaudited)
  Note 7.
    Commitments
    and Contingencies (Continued)      Accounting for Stock Issued to
    Employees
  . Form 10-K
 17




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##### Table of Contents



MICHAELS
    STORES, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  For the
    Six Months Ended July 29, 2006
 (Unaudited)
  Note 7.
    Commitments
    and Contingencies (Continued)  Form 10-K
        General
    Note 8.
    Segments  Disclosures About Segments of an
    Enterprise and Related Information.
 18




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##### Table of Contents





MICHAELS
    STORES, INC.




NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS (Continued)




For the
    Six Months Ended July 29, 2006


(Unaudited)




|        |                         
|------- | ------------------------
|Note 8. | Segments
    (Continued)









|                                    |  |                |           |  |           |   |         |              |  |   |           | 
|----------------------------------- |  | -------------- | --------- |  | --------- | - | ------- | ------------ |  | - | --------- | 
|                                    |  |                |           |  | Operating |   |         |              | 
|                                    |  | Net Sales      |           |  | Income    |   |         | Total Assets | 
|                                    |  | (In thousands) |          
|                                   
|Quarter ended July 29,
    2006:    |  |                |           |  |           |   |         |              |  |   |           | 
|United States                       |  | $              | 717,959   |  |           | $ | 25,298  |              |  | $ | 1,852,823 | 
|Canada                              |  |                | 50,305    |  |           |   | 4,255   |              |  |   | 80,254    | 
|                                    |  |                |           |  |           |   |         |              |  |   |           | 
|Consolidated Total                  |  | $              | 768,264   |  |           | $ | 29,553  |              |  | $ | 1,933,077 | 
|                                    |  |                |           |  |           |   |         |              |  |   |           | 
|Quarter ended July 30,
    2005:    |  |                |           |  |           |   |         |              |  |   |           | 
|United States                       |  | $              | 703,288   |  |           | $ | 35,699  |              |  | $ | 1,765,332 | 
|Canada                              |  |                | 42,205    |  |           |   | 3,972   |              |  |   | 68,108    | 
|                                    |  |                |           |  |           |   |         |              |  |   |           | 
|Consolidated Total                  |  | $              | 745,493   |  |           | $ | 39,671  |              |  | $ | 1,833,440 | 
|                                    |  |                |           |  |           |   |         |              |  |   |           | 
|Six months ended July 29,
    2006: |  |                |           |  |           |   |         |              |  |   |           | 
|United States                       |  | $              | 1,496,315 |  |           | $ | 93,874  |              |  | $ | 1,852,823 | 
|Canada                              |  |                | 104,430   |  |           |   | 12,946  |              |  |   | 80,254    | 
|                                    |  |                |           |  |           |   |         |              |  |   |           | 
|Consolidated Total                  |  | $              | 1,600,745 |  |           | $ | 106,820 |              |  | $ | 1,933,077 | 
|                                    |  |                |           |  |           |   |         |              |  |   |           | 
|Six months ended July 30,
    2005: |  |                |           |  |           |   |         |              |  |   |           | 
|United States                       |  | $              | 1,480,188 |  |           | $ | 117,728 |              |  | $ | 1,765,332 | 
|Canada                              |  |                | 86,321    |  |           |   | 9,122   |              |  |   | 68,108    | 
|                                    |  |                |           |  |           |   |         |              |  |   |           | 
|Consolidated Total                  |  | $              | 1,566,509 |  |           | $ | 126,850 |              |  | $ | 1,833,440 | 
|                                    |  |                |           |  |           |   |         |              |  |   |           | 









|        |                    
|------- | -------------------
|Note 9. | Proposed
    Merger





19



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##### Table of Contents





MICHAELS
    STORES, INC.




NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS (Continued)




For the
    Six Months Ended July 29, 2006


(Unaudited)




|         |                                     
|-------- | ------------------------------------
|Note 10. | Recent
    Accounting Pronouncements



Accounting for Uncertainty in Income Taxesan
    interpretation of FASB Statement No. 109


20



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##### Table of Contents



Item 2.
    Managements
    Discussion and Analysis of Financial Condition and Results of
    Operations.    Disclosure
    Regarding Forward-Looking Information
  Form 10-Q. Form 10-Q, Form 10-K
  
    our ability to remain competitive in the areas of merchandise
    quality, price, breadth of selection, customer service, and
    convenience;
    our ability to anticipate
    and/or react
    to changes in customer demand and preferences for products and
    supplies used in creative activities and the related potential
    impact to merchandise inventories in categories that represent a
    significant portion of our business;
    changes in consumer confidence resulting in a reduction in
    consumer spending on items perceived to be discretionary;
    unexpected consumer responses to our promotional programs;
    unusual weather conditions;
    the execution and management of our store growth, including new
    concepts, the impact of new competitor stores in locations near
    our existing stores, and the availability of acceptable real
    estate locations for new store openings;
    the effective optimization and maintenance of our perpetual
    inventory and automated replenishment systems and related
    impacts to inventory levels;
    the identification and implementation of enhancements to our
    supply chain to enable us to distribute additional SKUs through
    our distribution centers;
    delays in the receipt of merchandise ordered from suppliers due
    to vendor payment delays associated with recently implemented
    systems or delays in connection with either the manufacture or
    shipment of such merchandise;
    transportation delays (including dock strikes and other work
    stoppages) and increases in transportation costs due to fuel
    surcharges and transportation regulations;
    restrictive actions by foreign governments or changes in United
    States laws and regulations affecting imports or domestic
    distribution;
    significant increases in inflation or commodity prices, such as
    petroleum, natural gas, electricity, steel, copper, and paper,
    which may adversely affect our costs, including cost of
    merchandise; 21




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##### Table of Contents




    significant increases in tariffs or duties levied on imports
    which may limit the availability of certain merchandise from our
    foreign suppliers;
    changes in political, economic, and social conditions;
    significant fluctuations in exchange rates;
    financial difficulties of any of our key vendors, suppliers, or
    insurance providers;
    the design and implementation of new management information
    systems as well as the maintenance and enhancement of existing
    systems, particularly in light of our continued store growth and
    the addition of new concepts;
    our ability to maintain the security of electronic and other
    confidential information;
    our ability to maintain effective internal controls over our
    newly implemented financial reporting system;
    our ability to comply with the terms and restrictions of our
    Credit Agreement;
    receipt of regulatory and shareholder approval for the merger
    with entities sponsored by Bain and Blackstone, lawsuits
    challenging the proposed merger, and disruptions in connection
    with the proposed merger, including potential diversion of
    managements attention and potential loss of employees or
    business partners;
    our ability to attract and retain qualified personnel to
    successfully execute our operating plans;
    the seasonality of the retail business; and
    other factors as set forth in our Annual Report on
    Form 10-K
    for the fiscal year ended January 28, 2006, particularly in
    Critical Accounting Policies and Estimates and
    Risk Factors, in this Quarterly Report on
    Form 10-Q
    under Risk Factors, and in our other Securities and
    Exchange Commission filings.  Form 10-Q
 22




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##### Table of Contents



General
      Quarter Ended


Six Months EndedJuly 29,


July 30,


July 29,


July 30,2006


2005


2006


2005Michaels stores:Retail stores open at beginning of
    period


899



857



885



844Retail stores opened during the
    period


7



13



24



27Retail stores opened (relocations)
    during the period


2



3



5



11Retail stores closed during the
    period


(1
)






(4
)


(1
)Retail stores closed (relocations)
    during the period


(2
)


(3
)


(5
)


(11
)Retail stores open at end of period


905



870



905



870Aaron Brothers
    stores:Retail stores open at beginning of
    period


165



165



166



164Retail stores opened during the
    period














1Retail stores closed during the
    period










(1
)


Retail stores open at end of period


165



165



165



165Recollections stores:Retail stores open at beginning of
    period


11



9



11



8Retail stores opened during the
    period






2







3Retail stores open at end of period


11



11



11



11Star Decorators Wholesale
    stores:Wholesale stores open at beginning
    of period


4



4



4



3Wholesale stores opened during the
    period














1Wholesale stores open at end of
    period


4



4



4



4Total store count at end of period


1,085



1,050



1,085



1,050Other operating data:Average inventory per Michaels
    store (in thousands)(1)

$
903


$
1,028


$
903


$
1,028Comparable store sales (decrease)
    increase(2)


(0.3
)%


4.2
%


(1.7
)%


6.1
%     (1)
    
    Average inventory per Michaels store calculation excludes our
    Aaron Brothers, Recollections, and Star Decorators Wholesale
    stores.(2)
    
    Comparable store sales (decrease) increase represents the
    decrease or increase in net sales for stores open the same
    number of months in the indicated period and the comparable
    period of the previous year, including stores that were
    relocated or expanded during either period. A store is deemed to
    become comparable in its 14th month of operation in order
    to eliminate grand opening sales distortions. A store
    temporarily closed more than 2 weeks due to a catastrophic
    event is not considered comparable during the month it closed.
    If a store is closed longer than 2 weeks but less than
    2 months, it becomes comparable in the month in which it
    reopens, subject to a mid-month convention. A store closed
    longer than 2 months becomes comparable in its
    14th month of operation after its reopening. 23




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##### Table of Contents



Results
    of Operations
    Quarter Ended


Six Months EndedJuly 29,


July 30,


July 29,


July 30,2006


2005


2006


2005Net sales


100.0
%


100.0
%


100.0
%


100.0
%Cost of sales and occupancy expense


64.4



64.6



62.9



62.8Gross profit


35.6



35.4



37.1



37.2Selling, general, and
    administrative expense


31.6



29.9



30.2



28.8Store pre-opening costs


0.2



0.2



0.2



0.3Operating income


3.8



5.3



6.7



8.1Interest expense






2.0







1.3Other (income) and expense, net


(0.4
)


(0.3
)


(0.6
)


(0.3
)Income before income taxes and
    cumulative effect of accounting change


4.2



3.6



7.3



7.1Provision for income taxes


1.6



1.4



2.8



2.7Income before cumulative effect
    of accounting change


2.6



2.2



4.5



4.4Cumulative effect of accounting
    change, net of income tax














5.6Net income


2.6
%


2.2
%


4.5
%


(1.2
)%   Quarter
    Ended July 29, 2006 Compared to the Quarter Ended
    July 30, 2005
  Net Sales 12-month
    Cost of Sales and Occupancy Expense
   24




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##### Table of Contents



Selling, General, and Administrative
    Expense
      Operating Income
  Interest Expense 1 4
  Other Income
  Provision for Income Taxes
  Net Income
  Six
    Months Ended July 29, 2006 Compared to the Six Months Ended
    July 30, 2005
  Net Sales
 25




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##### Table of Contents



Cost of Sales and Occupancy Expense
    Selling, General, and Administrative
    Expense
    Operating Income
  Interest Expense 1 4 .
  Other Income
  Provision for Income Taxes
  Cumulative Effect of Accounting Change
 26




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##### Table of Contents



Net Income
  Liquidity
    and Capital Resources
    day-to-day
  Cash Flow
    from Operating Activities
      Cash Flow
    used in Investing Activities
    Six Months EndedJuly 29,


July 30,2006(1)


2005(2)(In thousands)New and relocated stores and
    stores not yet opened

$
16,621


$
21,285Existing stores


30,205



16,482Distribution system expansion


7,197



4,112Information systems


13,582



11,973Corporate and other


1,944



6,658$
69,549


$
60,510     (1)
    
    In the first six months of fiscal 2006, we incurred capital
    expenditures related to the opening of 24 and the relocation of
    five Michaels stores. Capital expenditures for existing stores
    for the first six months of fiscal 2006 increased
    $13.7 million over the first six months of fiscal 2005
    primarily due to incremental expenditures associated with our
    store standardization/remodel program.(2)
    
    In the first six months of fiscal 2005, we incurred capital
    expenditures related to the opening of 27 Michaels, one
    Aaron Brothers, three Recollections, and one Star Decorators
    Wholesale store, and the relocation of 11 Michaels stores. 27




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##### Table of Contents



Cash Flow
    used in Financing Activities
      Shares





SharesAuthorized for


Shares


Available forRepurchase


Repurchased


RepurchaseDecember 5, 2000 repurchase
    plan (variable portion)


72,510



(72,509
)


1
(1)December 6, 2005 repurchase
    plan


5,000,000



(2,428,688
)


2,571,312
(2)5,072,510



(2,501,197
)


2,571,313     (1)
    
    Our Board of Directors provided that proceeds of the exercise of
    options under our 2001 General Stock Option Plan may be used to
    repurchase shares under the 2000 repurchase plan and that the
    maximum number of shares authorized to be repurchased under the
    2000 repurchase plan may be increased to the extent necessary to
    so use the proceeds from such option exercises. In fiscal years
    2005 and 2004, we repurchased and subsequently retired
    17,958 shares and 54,551 shares of our Common Stock,
    respectively, at average prices of $40.93 and $27.03 per
    share, respectively, using proceeds from exercises of stock
    options granted under the 2001 General Stock Option plan.(2)
    
    Through the first six months of fiscal 2006, we repurchased
    approximately 1.9 million shares of our Common Stock
    authorized to be repurchased under the December 2005 repurchase
    plan at an average price of $34.26 per share and, as a
    result, we had approximately 2.6 million shares available
    for repurchase under the plan as of July 29, 2006. We hold
    the repurchased shares as Treasury Stock.      Debt
  1 4
   28




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##### Table of Contents



Recent
    Accounting Pronouncements
  Accounting for Uncertainty in Income Taxesan
    interpretation of FASB Statement No. 109
  Recent
    Events
    Item 3.
    Quantitative
    and Qualitative Disclosures About Market Risk.    Item 4.
    Controls
    and Procedures.  Evaluation
    of Disclosure Controls and Procedures
  Rules 13a-15(e) 15d-15(e)
 29




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##### Table of Contents



Form 10-Q.
  Change in
    Internal Control Over Financial Reporting
  Rules 13a-15(f) 15d-15(f)
 30




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##### Table of Contents



MICHAELS
    STORES, INC.Part IIOTHER INFORMATION
  Item 1.
    Legal
    Proceedings.  Shareholder
    Claims
  Fathergill
    Claim
    and/or
    Gottlieb
    and Schuman Claim
   31




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##### Table of Contents



Dutil
    Claim
    Hulliung
    Claim
  Rule 10b-5
  Rule 10b-5
 32




---



##### Table of Contents







Ziolkowski
    Claim




Rule 10b-5




Massachusetts
    Laborers Annuity Fund Claim




and/or Rule 14a-9




Employee
    Class Action Claims




Cotton
    Claim




wholly-owned


33



---



##### Table of Contents







Clark
    Claim








Morris
    Claim








Olivas
    Claim








Governmental
    Inquiries and Related Matters




Non-U.S. Trust
    Inquiry




non-U.S. trusts


34



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##### Table of Contents



and/or non-U.S. trusts. and/or and/or non-U.S. trusts
  non-U.S. trusts, Rule 13d-3, non-U.S. trusts
  non-U.S. trusts
  non-U.S. trusts
  non-U.S. trusts,
 35




---



##### Table of Contents



Stock
    Options Inquiry
    Internal
    Review of Stock Options Practices and Related
    Accounting
         36




---



##### Table of Contents



Accounting for Stock Issued to
    Employees
  . Form 10-K Form 10-K
     37




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##### Table of Contents



General
    Item 1A.
    Risk
    Factors.  Form 10-K
  The proposed merger with entities sponsored by Bain and
    Blackstone is subject to certain closing conditions and is the
    subject of certain lawsuits that could result in the merger not
    being completed, which may in turn result in a decline in the
    price of Michaels Common Stock.
      Whether or not the merger with entities sponsored by Bain and
    Blackstone is completed, the announcement and pendency of the
    merger could cause disruptions in our operations, which could
    have an adverse effect on our business and financial results.
    
    Managements attention may be diverted to completion of the
    merger and away from execution of existing business plans, which
    could disrupt operations and have a material adverse effect on
    our operating results; and
    Perceived uncertainties as to our future direction may result in
    the loss of employees or business partners. 38




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##### Table of Contents



Item 4.
    Submission
    of Matters to a Vote of Security Holders.    Election
    of Directors
    Total VoteTotal Vote


Withheldfor Each


for EachDirector


DirectorCharles J. Wyly, Jr.


121,710,509



3,942,194Sam Wyly


121,567,127



4,085,576Richard E. Hanlon


93,449,075



32,203,628Richard C. Marcus


91,567,127



34,085,576Liz Minyard


120,954,034



4,698,669Cece Smith


123,889,881



1,762,822     Ratification
    of the Selection of Our Independent Auditors
    For


125,504,857Against


72,799Abstentions


75,047125,652,703  39




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##### Table of Contents



Item 6.
    Exhibits.    ExhibitNumber

Description of Exhibit2
.1

Agreement and Plan of Merger,
    dated as of June 30, 2006, among Bain Paste Mergerco, Inc.,
    Blackstone Paste Mergerco, Inc., Bain Paste Finco, LLC,
    Blackstone Paste Finco, LLC and Michaels Stores, Inc.
    (previously filed as Exhibit 2.1 to
    Form 8-K
    filed by Registrant on July 6, 2006, SEC File No.
    001-09338).2
.2

First Amendment to Agreement and
    Plan of Merger, dated as of September 1, 2006, among Bain
    Paste Mergerco, Inc., Blackstone Paste Mergerco, Inc., Bain
    Paste Finco, LLC, Blackstone Paste Finco, LLC and Michaels
    Stores, Inc. (previously filed as Exhibit 2.1 to
    Form 8-K
    filed by Registrant on September 5, 2006, SEC File No.
    001-09338).31
.1

Certifications of Jeffrey N. Boyer
    pursuant to §302 of the Sarbanes-Oxley Act of 2002 (filed
    herewith).31
.2

Certifications of Gregory A.
    Sandfort 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).  40




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##### Table of Contents



MICHAELS
    STORES, INC.
 SIGNATURES
      By:
    /s/  Jeffrey
    N. Boyer         41




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##### Table of Contents



INDEX TO
    EXHIBITS
  ExhibitNumber

Description of Exhibit2
.1

Agreement and Plan of Merger,
    dated as of June 30, 2006, among Bain Paste Mergerco, Inc.,
    Blackstone Paste Mergerco, Inc., Bain Paste Finco, LLC,
    Blackstone Paste Finco, LLC and Michaels Stores, Inc.
    (previously filed as Exhibit 2.1 to
    Form 8-K
    filed by Registrant on July 6, 2006, SEC File No.
    001-09338).2
.2

First Amendment to Agreement and
    Plan of Merger, dated as of September 1, 2006, among Bain
    Paste Mergerco, Inc., Blackstone Paste Mergerco, Inc., Bain
    Paste Finco, LLC, Blackstone Paste Finco, LLC and Michaels
    Stores, Inc. (previously filed as Exhibit 2.1 to
    Form 8-K
    filed by Registrant on September 5, 2006, SEC File No.
    001-09338).31
.1

Certifications of Jeffrey N. Boyer
    pursuant to §302 of the Sarbanes-Oxley Act of 2002 (filed
    herewith).31
.2

Certifications of Gregory A.
    Sandfort 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).