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UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

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FORM 10-Q

(Mark One)

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

For the quarterly period ended August 4, 2001

OR

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

For the transition period from  to

Commission file number 0-11822

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

Delaware(State or other jurisdiction of
incorporation or organization)

75-1943604(I.R.S. employer identification number)8000 Bent Branch Drive
Irving, Texas 75063
P.O. Box 619566
DFW, Texas 75261-9566(Address of principal executive offices, including zip code)(972) 409-1300(Registrant's telephone number, including area code)


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

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

Title

Shares Outstanding as of
September 11, 2001Common Stock, par value $.10 per share

32,428,724


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

|Item 1.                   |  | Financial Statements                                                                                        |  |   
|------------------------- |  | ----------------------------------------------------------------------------------------------------------- |  | --
|                          |  | Consolidated Balance Sheets at August 4, 2001 (unaudited) and February 3, 2001                              |  | 3 
|                          |  | Consolidated Statements of Income for the three months ended August 4, 2001 and July 29, 2000 (unaudited)   |  | 4 
|                          |  | Consolidated Statements of Income for the six months ended August 4, 2001 and July 29, 2000 (unaudited)     |  | 5 
|                          |  | Consolidated Statements of Cash Flows for the six months ended August 4, 2001 and July 29, 2000 (unaudited) |  | 6 
|                          |  | Notes to Consolidated Financial Statements (unaudited)                                                      |  | 7 
|Item 2.                   |  | Management's Discussion and Analysis of Financial Condition and Results of Operations                       |  | 12
|Item 3.                   |  | Quantitative and Qualitative Disclosures About Market Risk                                                  |  | 18
|Part IIOTHER INFORMATION
|Item 1.                   |  | Legal Proceedings                                                                                           |  | 19
|Item 6.                   |  | Exhibits and Reports on Form 8-K                                                                            |  | 20
|Signatures                |  | 21                                                                                                         

2

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Item 1. Financial Statements.

MICHAELS STORES, INC.    CONSOLIDATED BALANCE SHEETS    (In thousands, except share data)

|                                                          |                                                                                                                                                               | August 4,
2001             |           | February 3,
2001 |        
|--------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------- | -------------------------- | --------- | ---------------- | -------
|
|ASSETS                                                    |                                                                                                                                                               |                            |           |                 
|Current assets:                                           |                                                                                                                                                               |                            |           |                  |        
|                                                          | Cash and equivalents                                                                                                                                          |                            | $         | 113,737          |        
|                                                          | Merchandise inventories                                                                                                                                       |                            |           | 801,380          |        
|                                                          | Prepaid expenses and other                                                                                                                                    |                            |           | 17,595           |        
|                                                          | Deferred income taxes and income taxes receivable                                                                                                             |                            |           | 19,626           |        
|                                                          |                                                                                                                                                               |                            |           |                  |        
|                                                          |                                                                                                                                                               | Total current assets       |           |                  | 952,338
|                                                          |                                                                                                                                                               |                            |           |                  |        
|Property and equipment, at cost                           |                                                                                                                                                               |                            | 558,901   |                  |        
|Less accumulated depreciation                             |                                                                                                                                                               |                            | (267,148  | )                |        
|                                                          |                                                                                                                                                               |                            |           |                  |        
|                                                          |                                                                                                                                                               |                            | 291,753   |                  |        
|                                                          |                                                                                                                                                               |                            |           |                  |        
|Costs in excess of net assets of acquired operations, net |                                                                                                                                                               |                            | 119,371   |                  |        
|Other assets                                              |                                                                                                                                                               |                            | 9,005     |                  |        
|                                                          |                                                                                                                                                               |                            |           |                  |        
|                                                          |                                                                                                                                                               |                            | 128,376   |                  |        
|                                                          |                                                                                                                                                               |                            |           |                  |        
|Total assets                                              |                                                                                                                                                               | $                          | 1,372,467 |                  | $      
|                                                          |                                                                                                                                                               |                            |           |                  |        
|LIABILITIES AND STOCKHOLDERS' EQUITY                      |                                                                                                                                                               |                            |           |                 
|Current liabilities:                                      |                                                                                                                                                               |                            |           |                  |        
|                                                          | Accounts payable                                                                                                                                              |                            | $         | 135,571          |        
|                                                          | Accrued liabilities and other                                                                                                                                 |                            |           | 142,456          |        
|                                                          | Income taxes payable                                                                                                                                          |                            |           |                 |        
|                                                          |                                                                                                                                                               |                            |           |                  |        
|                                                          |                                                                                                                                                               | Total current liabilities  |           |                  | 278,027
|                                                          |                                                                                                                                                               |                            |           |                  |        
|91/4% Senior notes due 2009                               |                                                                                                                                                               |                            | 200,000   |                  |        
|107/8% Senior notes due 2006                              |                                                                                                                                                               |                            | 125,000   |                  |        
|Deferred income taxes                                     |                                                                                                                                                               |                            | 18,269    |                  |        
|Other long-term liabilities                               |                                                                                                                                                               |                            | 19,601    |                  |        
|                                                          |                                                                                                                                                               |                            |           |                  |        
|                                                          | Total long-term liabilities                                                                                                                                   |                            |           | 362,870          |        
|                                                          |                                                                                                                                                               |                            |           |                  |        
|                                                          |                                                                                                                                                               |                            | 640,897   |                  |        
|                                                          |                                                                                                                                                               |                            |           |                  |        
|Commitments and contingencies                             |                                                                                                                                                               |                            |           |                  |        
|Stockholders' equity:                                     |                                                                                                                                                               |                            |           |                  |        
|                                                          | Common stock, $.10 par value, 150,000,000 shares authorized; shares issued and outstanding of 32,390,340 at August 4, 2001 and 31,836,840 at February 3, 2001 |                            |           | 3,239            |        
|                                                          | Additional paid-in capital                                                                                                                                    |                            |           | 445,340          |        
|                                                          | Retained earnings                                                                                                                                             |                            |           | 282,991          |        
|                                                          |                                                                                                                                                               |                            |           |                  |        
|                                                          |                                                                                                                                                               | Total stockholders' equity |           |                  | 731,570
|                                                          |                                                                                                                                                               |                            |           |                  |        
|Total liabilities and stockholders' equity                |                                                                                                                                                               | $                          | 1,372,467 |                  | $      
|                                                          |                                                                                                                                                               |                            |           |                  |        

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)

|                                             |         | Three Months Ended |        
|-------------------------------------------- | ------- | ------------------ | -------
|
|Net sales                                    |         | $                  | 486,078
|Cost of sales and occupancy expense          |         |                    | 326,566
|                                             |         |                    |        
|Gross profit                                 |         |                    | 159,512
|Selling, general, and administrative expense |         |                    | 143,856
|Store pre-opening costs                      |         |                    | 2,109  
|                                             |         |                    |        
|Operating income                             |         |                    | 13,547 
|Interest expense                             |         |                    | 5,954  
|Other (income) and expense, net              |         |                    | (328   
|                                             |         |                    |        
|Income before income taxes                   |         |                    | 7,921  
|Provision for income taxes                   |         |                    | 3,248  
|                                             |         |                    |        
|Net income                                   |         | $                  | 4,673  
|                                             |         |                    |        
|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                                                                            |         | $                | 1,010,798
|Cost of sales and occupancy expense                                                  |         |                  | 674,005  
|                                                                                     |         |                  |          
|Gross profit                                                                         |         |                  | 336,793  
|Selling, general, and administrative expense                                         |         |                  | 300,284  
|Store pre-opening costs                                                              |         |                  | 3,725    
|Litigation settlement                                                                |         |                  | 3,153    
|                                                                                     |         |                  |          
|Operating income                                                                     |         |                  | 29,631   
|Interest expense                                                                     |         |                  | 9,732    
|Other (income) and expense, net                                                      |         |                  | (376     
|                                                                                     |         |                  |          
|Income before income taxes and cumulative effect of accounting change                |         |                  | 20,275   
|Provision for income taxes                                                           |         |                  | 8,313    
|                                                                                     |         |                  |          
|Income before cumulative effect of accounting change                                 |         |                  | 11,962   
|Cumulative effect of accounting change for revenue recognition, net of tax of $1,235 |         |                  |         
|                                                                                     |         |                  |          
|Net income                                                                           |         | $                | 11,962   
|                                                                                     |         |                  |          
|Earnings per common share excluding the cumulative effect of accounting change:      |         |                  |          
|                                                                                     | Basic   |                  | $        
|                                                                                     |         |                  |          
|                                                                                     | Diluted |                  | $        
|                                                                                     |         |                  |          
|Earnings per common share including the cumulative effect of accounting change:      |         |                  |          
|                                                                                     | Basic   |                  | $        
|                                                                                     |         |                  |          
|                                                                                     | Diluted |                  | $        
|                                                                                     |         |                  |          

See
accompanying notes to consolidated financial statements.

5

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

|                                            |                                                       | Six Months Ended                                          |                                
|------------------------------------------- | ----------------------------------------------------- | --------------------------------------------------------- | -------------------------------
|
|Operating activities:                       |                                                       |                                                           |                                
|                                            | Net income                                            |                                                           | $                              
|                                            | Adjustments:                                          |                                                           |                                
|                                            |                                                       | Depreciation                                              |                                
|                                            |                                                       | Amortization                                              |                                
|                                            |                                                       | Other                                                     |                                
|                                            |                                                       | Change in assets and liabilities, excluding acquisitions: |                                
|                                            |                                                       |                                                           | Merchandise inventories        
|                                            |                                                       |                                                           | Prepaid expenses and other     
|                                            |                                                       |                                                           | Deferred income taxes and other
|                                            |                                                       |                                                           | Accounts payable               
|                                            |                                                       |                                                           | Income taxes payable           
|                                            |                                                       |                                                           | Accrued liabilities and other  
|                                            |                                                       |                                                           |                                
|                                            |                                                       |                                                           |                                
|                                            |                                                       |                                                           |                                
|                                            |                                                       |                                                           |                                
|                                            |                                                       |                                                           |                                
|Investing activities:                       |                                                       |                                                           |                                
|                                            | Additions to property and equipment                   |                                                           |                                
|                                            | Proceeds from sale/leaseback transaction              |                                                           |                                
|                                            | Net proceeds from sales of property and equipment     |                                                           |                                
|                                            | Acquisitions                                          |                                                           |                                
|                                            |                                                       |                                                           |                                
|                                            |                                                       |                                                           |                                
|                                            |                                                       |                                                           |                                
|Financing activities:                       |                                                       |                                                           |                                
|                                            | Proceeds from issuance of 91/4% senior notes due 2009 |                                                           |                                
|                                            | Redemption of convertible subordinated notes          |                                                           |                                
|                                            | Proceeds from stock options exercised                 |                                                           |                                
|                                            | Proceeds from issuance of common stock and other      |                                                           |                                
|                                            | Payment of other long-term liabilities                |                                                           |                                
|                                            |                                                       |                                                           |                                
|                                            |                                                       |                                                           |                                
|                                            |                                                       |                                                           |                                
|Net increase in cash and equivalents        |                                                       |                                                           | 85,546                         
|Cash and equivalents at beginning of period |                                                       |                                                           | 28,191                         
|                                            |                                                       |                                                           |                                
|Cash and equivalents at end of period       |                                                       | $                                                         | 113,737                        
|                                            |                                                       |                                                           |                                

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 4, 2001        (Unaudited)

Note 1.  Basis of Presentation

The consolidated financial statements include the accounts of Michaels Stores, Inc. and its wholly-owned subsidiaries (collectively, the "Company"). All
significant intercompany accounts and transactions have been eliminated.

The
accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with
the instructions to
Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting
principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals and other items, as disclosed) considered necessary for a fair
presentation have been included. Because of the seasonal nature of the Company's business, the results of operations for the 13 and 26 weeks ended August 4, 2001 are not indicative of the
results to be expected for the entire year.

The
balance sheet at February 3, 2001 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by
generally accepted accounting principles for complete financial statements. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's
Annual Report on Form 10-K for the fiscal year ended February 3, 2001.

All
references herein to "fiscal 2001" relate to the 52 weeks ending February 2, 2002, and all references to "fiscal 2000" relate to the 53 weeks ended February 3, 2001.
In addition, all references herein to "the 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, and all
references to "the second quarter of fiscal 2000" and "the first six months of fiscal 2000" relate to the 13 and 26 weeks ended July 29, 2000, respectively.

Note 2.  Senior Notes

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

On
August 6, 2001 (the "Redemption Date"), the Company used a portion of the proceeds of the Senior Notes due 2009 offering described above to redeem its 107/8%
senior notes due June 15, 2006 (the "Senior Notes due 2006"), of which $125 million in aggregate principal amount was then outstanding. The redemption price was $1,054.38 per $1,000
principal amount of the Senior Notes due 2006, plus accrued interest to the Redemption Date. The Company anticipates incurring an extraordinary loss from the early extinguishment of debt in the amount
of $5.3 million, net of tax, in the third quarter of fiscal 2001.

7

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Note 3.  Change in Accounting Principle

Effective October 29, 2000, the Company changed its method of accounting for custom frame sales in accordance with guidance provided in the Securities
and Exchange Commission's Staff Accounting Bulletin No. 101,Revenue Recognition in Financial Statements. Historically, the Company has
recognized sales for custom frame orders at the time the customer placed the order. Under the new accounting method adopted retroactive to January 30, 2000, the Company now effectively
recognizes revenue for custom frame orders at the time of delivery. The cumulative effect of the change on fiscal years prior to fiscal 2000 resulted in a non-cash charge to income of
$1.9 million (after reduction for income taxes of $1.2 million), which is included in the results of operations for the first quarter of fiscal 2000. In addition, the Company has given
retroactive effect to this change in accounting principle by restatement of the Company's previously published financial statements for the first quarter and the first six months of fiscal 2000. The
effect of the change on the second quarter and the first six months
of fiscal 2000 was to reduce net sales by $4.3 million and $2.7 million, respectively, and reduce income before the cumulative effect of the accounting change by $1.1 million and
$727,000, respectively.

Note 4.  Earnings Per Share

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

|                                   |                                                                                                     | Three Months Ended     |   | Six Months Ended |    
|---------------------------------- | --------------------------------------------------------------------------------------------------- | ---------------------- | - | ---------------- | ---
|
|
|Numerator:                         |                                                                                                     |                        |   |                  |    
|                                   | Income before cumulative effect of accounting change                                                |                        | $ | 4,673            |    
|                                   | Cumulative effect of accounting change, net of tax                                                  |                        |   |                 |    
|                                   |                                                                                                     |                        |   |                  |    
|                                   | Net income                                                                                          |                        | $ | 4,673            |    
|                                   |                                                                                                     |                        |   |                  |    
|Denominator:                       |                                                                                                     |                        |   |                  |    
|                                   | Denominator for basic earnings per shareweighted average shares                                    |                        |   | 32,291           |    
|                                   | Effect of dilutive securities:                                                                      |                        |   |                  |    
|                                   |                                                                                                     | Employee stock options |   |                  | 885
|                                   |                                                                                                     |                        |   |                  |    
|                                   | Denominator for diluted earnings per shareweighted average shares adjusted for dilutive securities |                        |   | 33,176           |    
|                                   |                                                                                                     |                        |   |                  |    
|Basic earnings per common share:   |                                                                                                     |                        |   |                  |    
|                                   | Income before cumulative effect of accounting change                                                |                        | $ | 0.14             |    
|                                   | Cumulative effect of accounting change                                                              |                        |   |                 |    
|                                   |                                                                                                     |                        |   |                  |    
|                                   | Net income                                                                                          |                        | $ | 0.14             |    
|                                   |                                                                                                     |                        |   |                  |    
|Diluted earnings per common share: |                                                                                                     |                        |   |                  |    
|                                   | Income before cumulative effect of accounting change                                                |                        | $ | 0.14             |    
|                                   | Cumulative effect of accounting change                                                              |                        |   |                 |    
|                                   |                                                                                                     |                        |   |                  |    
|                                   | Net income                                                                                          |                        | $ | 0.14             |    
|                                   |                                                                                                     |                        |   |                  |    

8

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Note 5.  Credit Agreement

Effective May 1, 2001, the Company completed a new $200 million unsecured bank credit facility with Fleet National Bank and other lending
institutions (the "Credit Agreement"), which replaced the
previous $100 million unsecured bank credit facility. The Credit Agreement has a term of three years (with a maturity extension for one additional year available under certain conditions) and
contains a $25 million competitive bid feature and a $70 million letter of credit sub-facility.

The
Credit Agreement contains certain financial covenants, including a balance sheet leverage ratio, a cash flow coverage ratio, a cash flow leverage ratio, and a capital expenditure
limitation. Interest on all borrowings varies based upon the type of borrowing, the fixed charge coverage ratio, and whether the Company elects to utilize the competitive bid feature available under
the Credit Agreement. If the competitive bid feature is not utilized, the interest rate on borrowings under the Credit Agreement is generally (a) the higher of (i) an annual rate of
interest announced from time to time by Fleet National Bank, as agent, as its "base rate" or (ii) one-half of one percent (1/2%) above the Federal Funds Effective
Rate or (b) the Eurodollar Rate, as defined by the Credit Agreement, plus an applicable margin based on our fixed charge coverage ratio. If the competitive bid feature is utilized, loans up to
$25 million may be made under the Credit Agreement at competitively bid interest rates offered by lending institutions participating in the facility, which may have the effect of decreasing the
amount of interest the Company would otherwise be obligated to pay on such borrowings. The Company is required to pay a facility fee from 0.2% to 0.35% per annum on the unused portion of the revolving
line of credit as well as letter of credit fees that vary depending on the fixed charge coverage ratio.

The
Company is in compliance with all terms and conditions of the Credit Agreement. No borrowings were outstanding under the Credit Agreement 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 ($8.7 million at August 4, 2001). Borrowings under
the Credit Agreement and the previous $100 million bank credit facility in the first six months of fiscal 2001 were outstanding for 140 days, with average outstanding borrowings of
$37.0 million and a weighted average interest rate of 6.20%.

Note 6.  Legal Proceedings

Raniwala Proceeding

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

9

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On July 20, 2000, Raniwala filed an amended complaint to correct certain deficiencies in the original Raniwala Complaint (the "Amended Raniwala Complaint"). On
September 25, 2000, the Company filed its answer to the Amended Raniwala Complaint.

On
June 6, 2001, the Company negotiated a tentative settlement of the purported class action with Raniwala. Pursuant to the terms of the settlement, in exchange for a full
release of claims, the Company is obligated to pay a maximum of $3.0 million, covering all claims and attorneys' fees, plus estimated payroll taxes of approximately $153,000, which amounts were
accrued in the first quarter of fiscal 2001. The specific terms of the settlement are currently being finalized between the parties and
must then be approved by the Alameda County Superior Court. While the Company believes that it is likely that the settlement will be approved, it can provide no assurance to that effect.

Collins Proceeding

On April 14, 1999, Suzanne Collins ("Collins"), a former assistant manager of the Company's subsidiary, Aaron Brothers, Inc. ("Aaron Brothers"),
filed a class action complaint (the "Collins Complaint") against Aaron Brothers on behalf of Aaron Brothers' former store managers, assistant store managers, and
managers-in-training. The Collins Complaint was filed in the Los Angeles County Superior Court, California and alleges that Aaron Brothers violated various California laws by
erroneously treating its store managers, assistant store managers, and managers-in-training as "exempt" employees who are not entitled to overtime compensation. Based on these
allegations, the Collins Complaint asserts that Aaron Brothers: (1) violated various California Labor Codes; (2) violated Section 17200 of the California Business and Professions
Code; and (3) engaged in conversion. The Collins Complaint seeks back wages, interest, penalties, punitive damages, and attorneys' fees.

On
June 25, 2001, Collins filed an amended complaint which expanded the purported class to include all current Aaron Brothers' salaried store managers, assistant store
managers, and managers-in-training based in California; added a new plaintiff as a class representative; and added two additional causes of action for injunctive and
declaratory relief.

The
court has set a hearing date during the fourth quarter of fiscal 2001 to determine whether the case should proceed as a class action lawsuit. A trial date has not yet been
scheduled.

The
case is currently in the discovery phase. There can be no assurance that Aaron Brothers will be successful in defending this litigation or that future operating results will not
be materially adversely affected by the final resolution of the lawsuit.

General

The Company is a defendant from time to time in lawsuits incidental to our business. Based on currently available information, the Company believes that
resolution of all known contingencies, including the litigation described above, is uncertain, and there can be no assurance that future costs of such litigation would not be material to its financial
position or results of operations.

10

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Note 7.  Recent Accounting Pronouncements

In June 2001, the Financial Accounting Standards Board (the "FASB") issued Statement of Financial Accounting Standards ("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. The Company will adopt these
provisions in the first quarter of fiscal 2002. Application of these non-amortization provisions in fiscal 2001 would have resulted in an increase in net income of $566,000, or $0.02 per
diluted share, in the second quarter of fiscal 2001 and $1.1 million, or $0.03 per diluted share, for the first six months of fiscal 2001. During fiscal 2002, the Company will perform the first
of the required impairment tests of goodwill and
indefinite lived intangible assets as of February 2, 2002 and has not yet determined what the effect of these tests will be. However, the Company believes the adoption of the provisions of SFAS
No. 141 and No. 142 will not have a materially adverse impact on the Company's operating results or financial position.

In
June 1998, the FASB issued SFAS No. 133,Accounting for Derivative Instruments and Hedging Activities, which requires
all derivatives to be recorded on the balance sheet at fair value and establishes accounting treatment for certain types of hedging activities. The Company adopted the requirements of SFAS
No. 133 beginning in fiscal 2001. The adoption of SFAS No. 133 had no material impact on the Company's operating results or financial position for the second quarter or the first six
months of fiscal 2001.

11

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

Certain statements contained in this discussion and analysis (or elsewhere in this Report), which are not historical facts, are forward
looking statements that involve risks and uncertainties, including, but not limited to, customer demand and trends in the arts and crafts industry, impact of competitors' locations, pricing, and
products, related inventory risks due to shifts in customer demand, impact of economic conditions, the availability of acceptable locations for new stores, difficulties implementing information system
technologies, supply constraints, results of financing efforts, effectiveness of advertising strategies, and other risks detailed in our Securities and Exchange Commission
filings.

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

General

All references herein to "fiscal 2001" relate to the 52 weeks ending February 2, 2002, and all references to "fiscal 2000" relate to the 53 weeks ended
February 3, 2001. In addition, all references herein to "the 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, and all references to "the second quarter of fiscal 2000" and "the first six months of fiscal 2000" relate to the 13 and 26 weeks ended July 29, 2000, respectively.

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

|                                           |  | Three Months Ended |         | Six Months Ended |  
|------------------------------------------ |  | ------------------ | ------- | ---------------- | -
|
|Michaels stores:                           |  |                    |         |                  |  
|Retail stores open at end of period        |  |                    | 657     |                  |  
|Retail stores opened during the period     |  |                    | 13      |                  |  
|Retail stores closed during the period     |  |                    |        |                  |  
|Retail stores relocated during the period  |  |                    | 3       |                  |  
|Aaron Brothers stores:                     |  |                    |         |                  |  
|Retail stores open at end of period        |  |                    | 128     |                  |  
|Retail stores opened during the period     |  |                    | 5       |                  |  
|Retail stores relocated during the period  |  |                    |        |                  |  
|Star Wholesale store:                      |  |                    |         |                  |  
|Wholesale store open at end of period      |  |                    | 1       |                  |  
|Wholesale store acquired during the period |  |                    |        |                  |  
|Other Operating Data:                      |  |                    |         |                  |  
|EBITDA(1)                                  |  | $                  | 30,851  |                  | $
|Adjusted EBITDA(2)                         |  |                    | 30,525  |                  |  
|Working capital                            |  |                    | 674,311 |                  |  
|Comparable store sales increase(3)         |  |                    | 1       | %                |  

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12

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Results of Operations

The following table sets forth the percentage relationship to net sales of each line item of our unaudited Consolidated Statements of Income. This table should
be read in conjunction with the following discussion and with our Consolidated Financial Statements and related notes, included herein.

|                                                                           |  | Three Months Ended |   | Six Months Ended |  
|-------------------------------------------------------------------------- |  | ------------------ | - | ---------------- | -
|
|Net sales                                                                  |  | 100.0              | % | 100.0            | %
|Cost of sales and occupancy expense                                        |  | 67.2               |   | 67.3             |  
|                                                                           |  |                    |   |                  |  
|Gross profit                                                               |  | 32.8               |   | 32.7             |  
|Selling, general, and administrative expense                               |  | 29.6               |   | 29.5             |  
|Store pre-opening costs                                                    |  | 0.4                |   | 0.5              |  
|Litigation settlement                                                      |  |                   |   |                 |  
|                                                                           |  |                    |   |                  |  
|Operating income                                                           |  | 2.8                |   | 2.7              |  
|Interest expense                                                           |  | 1.2                |   | 1.1              |  
|Other (income) and expense, net                                            |  | (0.0               | ) | (0.1             | )
|                                                                           |  |                    |   |                  |  
|Income before income taxes and cumulative effect of accounting change      |  | 1.6                |   | 1.7              |  
|Provision for income taxes                                                 |  | 0.6                |   | 0.7              |  
|                                                                           |  |                    |   |                  |  
|Income before cumulative effect of accounting change                       |  | 1.0                |   | 1.0              |  
|Cumulative effect of accounting change for revenue recognition, net of tax |  |                   |   |                 |  
|                                                                           |  |                    |   |                  |  
|Net income                                                                 |  | 1.0                | % | 1.0              | %
|                                                                           |  |                    |   |                  |  

Quarter Ended August 4, 2001 Compared to the Quarter Ended July 29, 2000

Net sales for the second quarter of fiscal 2001 increased $52.0 million, or 12%, over the second quarter of fiscal 2000. At the end of the second
quarter of fiscal 2001, we operated 657 Michaels and 128 Aaron Brothers retail stores. The results for the second quarter of fiscal 2001 included sales from 62 Michaels and 25 Aaron Brothers retail
stores that were opened during the 12-month period ended August 4, 2001, more than offsetting lost sales from one Michaels and one Aaron Brothers store closures. Sales at the new
stores (net of closures) during the second quarter of fiscal 2001 accounted for $39.1 million of the increase in net sales. In addition, net sales were impacted by the net deferral of revenue
related to the sale of custom frames, which accounted for $6.8 million of the increase in net sales over the second quarter of fiscal 2000. This increase was due to the fluctuation in custom
frame sales volume during the last two weeks of each fiscal quarter as a result of, but not limited to, seasonal trends and the timing of custom framing promotional activities. Comparable store sales
increased 1% in

13

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the second quarter of fiscal 2001 compared to the second quarter of fiscal 2000, which contributed $6.1 million to the net sales increase. The improvement in comparable store sales was due to a
strong performance in our core categories of decorative accents, seasonal, stitchery, and ready-made frames. Going forward, we expect to achieve comparable store sales increases for the
remainder of fiscal 2001, taken as a whole. Our ability to continue to generate comparable store sales increases is dependent, in part, on our ability to continue to maintain store
in-stock positions on the top-selling items, to properly allocate seasonal merchandise to the stores based upon anticipated sales trends utilizing
point-of-sale rate of sale information, and the success of our sales promotion efforts.

Cost
of sales and occupancy expense, as a percentage of net sales, for the second quarter of fiscal 2001 was 67.2%, a decrease of 0.1% compared to the second quarter of fiscal 2000.
This decrease was primarily attributable to improved merchandise margins partially offset by higher occupancy costs associated with new and relocated stores and higher utilities costs compared to the
second quarter of fiscal 2000.

Selling,
general, and administrative expense, as a percentage of net sales, increased by 0.1% from the second quarter of fiscal 2000 to the second quarter of fiscal 2001. This
increase resulted principally from increased store payroll and related expenses, as a percentage of net sales, partially offset by lower advertising costs as a percentage of net sales, a $326,000
adjustment to reduce the one-time charge recorded in the first quarter of fiscal 2001 related to severance agreements with certain of our former senior executives, and the leveraging of
depreciation expense on increased sales.

Store
pre-opening costs, as a percentage of net sales, decreased by 0.1% in the second quarter of fiscal 2001 compared to the second quarter of fiscal 2000. In the second
quarter of fiscal 2001, we opened or relocated 16 Michaels and five Aaron Brothers stores compared to 18 Michaels and eight Aaron Brothers stores opened or relocated in the second quarter of fiscal
2000.

Operating
income increased by 0.1%, as a percentage of net sales, to $13.5 million in the second quarter of fiscal 2001 compared to $11.6 million for the second quarter
of fiscal 2000. Operating income for the second quarter of fiscal 2001 was positively impacted by a $326,000 adjustment to reduce the one-time charge recorded in the first quarter of
fiscal 2001 related to senior executive severance. Excluding the effects of the adjustment to the severance charge, operating income increased 14% from $11.6 million in the second quarter of
fiscal 2000 to $13.2 million in the second quarter of fiscal 2001, on a 12% increase in net sales during the same period.

Interest
expense (net of interest income), as a percentage of net sales, increased by 0.3% in the second quarter of fiscal 2001 compared to the second quarter of fiscal 2000. This
increase resulted principally from interest expense of $1.5 million on the 91/4% senior notes due July 1, 2009 (the "Senior Notes due 2009"), which were issued in
July 2001, and interest on borrowings against the Credit Agreement. These increases were partially offset by interest savings related to the conversion and redemption of our convertible
subordinated notes in June 2000, discussed under "Liquidity and Capital Resources" below.

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

First Six Months Ended August 4, 2001 Compared to the First Six Months Ended July 29, 2000

Net sales for the first six months of fiscal 2001 increased $102.6 million, or 11%, over the first six months of fiscal 2000. Sales at the new stores
(net of closures) during the first six months of fiscal 2001 accounted for $85.5 million of the increase in net sales. Comparable store sales increased 2% in the first six months of fiscal 2001
compared to the first six months of fiscal 2000, which contributed $17.8 million to the net sales increase. The improvement in comparable store sales was due to a strong performance in our core
categories of seasonal, decorative accents, ready-made frames, and ribbon.

14

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The above increases in net sales were partially offset by the net deferral of revenue related to the sale of custom frames, which accounted for a $687,000 decrease in net sales over the first six
months of fiscal 2000. This decrease was due to the fluctuation in custom frame sales volume during the last two weeks of each fiscal quarter as a result of, but not limited to, seasonal trends and
the timing of custom framing promotional activities.

Cost
of sales and occupancy expense of 66.7% for the first six months of fiscal 2001 remained relatively constant as a percentage of net sales compared with the first six months of
fiscal 2000. Improvements in merchandise margins for the first six months of fiscal 2001 compared with the first six months of fiscal 2000 were offset by higher occupancy costs associated with new and
relocated stores and higher utilities costs compared to the first six months of fiscal 2000.

Selling,
general, and administrative expense, as a percentage of net sales, increased by 0.5% from the first six months of fiscal 2000 to the first six months of fiscal 2001. This
increase resulted principally from increased store payroll and related expenses, as a percentage of net sales, and costs of approximately $600,000 recorded in the first six months of fiscal 2001
related to severance agreements with certain of our former senior executives.

Store
pre-opening costs, as a percentage of net sales, decreased by 0.1% in the first six months of fiscal 2001 compared to the first six months of fiscal 2000. In the
first six months of fiscal 2001, we opened or relocated 36 Michaels and nine Aaron Brothers stores compared to 48 Michaels and 10 Aaron Brothers stores opened or relocated in the first six months of
fiscal 2000.

On
June 6, 2001, we negotiated a tentative settlement of a purported class action with a former assistant manager of the Company, Taiyeb Raniwala. Pursuant to the terms of the
settlement, in exchange for a full release of claims, we are obligated to pay a maximum of $3.0 million, covering all claims and attorneys' fees, plus estimated payroll taxes of approximately
$153,000, which amounts were accrued in the first quarter of fiscal 2001. The specific terms of the settlement are currently being finalized between the parties and must then be approved by the court.
While we believe that it is likely that the settlement will be approved, we can provide no assurance to that effect.

Operating
income decreased by 0.7%, as a percentage of net sales, to $29.6 million in the first six months of fiscal 2001 compared to $32.9 million for the first six
months of fiscal 2000. Operating income for the first six months of fiscal 2001 was negatively impacted by one-time severance costs of approximately $600,000 and the litigation settlement
charge of $3.2 million. Excluding the effects of the one-time severance charge and the litigation settlement charge, operating income increased 1% from $32.9 million in the
first six months of fiscal 2000 to $33.4 million in the first six months of fiscal 2001, on an 11% increase in net sales during the same period.

Interest
expense (net of interest income) remained relatively constant as a percentage of net sales in the first six months of fiscal 2001 compared to the first six months of fiscal
2000. Interest expense decreased by $2.5 million as a result of interest savings related to the conversion and redemption of our convertible subordinated notes in June 2000, discussed
under "Liquidity and Capital Resources" below, partially offset by interest expense of $1.5 million on the Senior Notes due 2009, which were issued in July 2001, and lower investment
income on lower average cash balances during the first six months of fiscal 2001.

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

We
changed our accounting policy with respect to revenue recognition related to the sale of custom frames effective retroactively as of the beginning of fiscal 2000. As a result, we
recorded a non-cash charge of $1.9 million, net of tax, in the first quarter of fiscal 2000 for the cumulative effect of the change on fiscal years prior to fiscal 2000. Including
this one-time charge, net income for the

15

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first six months of fiscal 2000 was $12.8 million, or $0.38 per diluted share. Excluding this one-time charge, net income for the first six months of fiscal 2000 was
$14.6 million, or $0.43 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 2001 was $101.5 million, compared with $15.4 million during the
first six months of fiscal 2000. The increase in cash flow used in operating activities was principally the result of higher investments in merchandise inventories in the amount of
$137.7 million in the first six months of fiscal 2001 compared with $36.1 million in the first six months of fiscal 2000, primarily as a result of purchases made in the first six months
of fiscal 2001 to improve our in-stock position by receiving core merchandise for the holiday season earlier in the year than in the prior fiscal year. Inventories per Michaels store of
$1.164 million at August 4, 2001 increased 11% from $1.044 million at July 29, 2000. In connection with our continuing supply chain management initiatives, our plans are to
continue to increase the basic inventory levels carried in our distribution centers in an effort to reduce the number of direct vendor shipments to our stores, thereby reducing the safety stock
required at the store level.

Cash
flow used in investing activities in the first six months of fiscal 2001 was $20.7 million compared to $42.8 million in the first six months of fiscal 2000. Cash
flow from investing activities in the first six months of fiscal 2001 was due in part to capital expenditures related to the opening of 29 Michaels and nine Aaron Brothers stores and the relocation of
seven Michaels stores in the first six months of fiscal 2001. In addition, we received proceeds in the amount of $26.9 million from the July 2001 completion of a sale/leaseback
transaction for two distribution center properties which we purchased in December 2000. The gain from the sale/leaseback transaction was deferred and will be amortized over the life of the
sale/leaseback contract, which was accounted for as an operating lease.

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

Six Months EndedAugust 4,
2001

July 29,
2000(in thousands)New and relocated stores and stores not yet opened

$
25,935

$
25,760Existing stores


11,338


4,051Distribution system expansion


1,943


757Information systems


5,527


8,168Corporate and other


2,938


1,99947,681


40,735Proceeds from sale/leaseback transaction


(26,886
)

$
20,795

$
40,735


The
increase in capital expenditures for existing stores was primarily due to fixture costs for planogram resets at the stores during the second quarter of fiscal 2001. We anticipate
additional capital expenditures during the remainder of fiscal 2001 to total approximately $124.2 million, which amount is net of proceeds in the amount of $26.9 million from the
June 2001 sale/leaseback transaction.

Cash
flow provided by financing activities in the first six months of fiscal 2001 was $207.8 million compared to $68.9 million in the first six months of fiscal 2000.
The increase in cash provided by financing activities was primarily due to proceeds of $194.5 million from the issuance of the Senior Notes due 2009 partially offset by a decrease in the
proceeds from the exercise of stock options.

16

---

Proceeds from the exercise of stock options were $13.2 million for approximately 536,000 shares of our common stock ("Common Stock") in the first six months of fiscal 2001 and
$75.7 million for approximately 3.5 million shares of Common Stock in the first six months of fiscal 2000.

Bank Credit Facility

Effective May 1, 2001, we completed a new $200 million unsecured bank credit facility with Fleet National Bank and other lending institutions
(the "Credit Agreement"), which replaced the previous $100 million unsecured bank credit facility. The Credit Agreement has a term of three years (with a maturity extension for one additional
year available under certain conditions) and contains a $25 million competitive bid feature and a $70 million letter of credit sub-facility.

The
Credit Agreement contains certain financial covenants, including a balance sheet leverage ratio, a cash flow coverage ratio, a cash flow leverage ratio, and a capital expenditure
limitation. Interest on all borrowings varies based upon the type of borrowing, the fixed charge coverage ratio, and whether we elect to utilize the competitive bid feature available under the Credit
Agreement. If the competitive bid feature is not utilized, the interest rate on borrowings under the Credit Agreement is generally (a) the higher of (i) an annual rate of interest
announced from time to time by Fleet National Bank, as agent, as its "base rate" or (ii) one-half of one percent (1/2%) above the Federal Funds Effective Rate or
(b) the Eurodollar Rate, as defined by the Credit Agreement, plus an applicable margin based on our fixed charge coverage ratio. If the competitive bid feature is utilized, loans up to
$25 million may be made under the Credit Agreement at competitively bid interest rates offered by lending institutions participating in the facility, which may have the effect of decreasing the
amount of interest we would otherwise be obligated to pay on such borrowings. We are required to pay a facility fee from 0.2% to 0.35% per annum on the unused portion of the revolving line of credit
as well as letter of credit fees that vary depending on the fixed charge coverage ratio.

We
are in compliance with all terms and conditions of the Credit Agreement. No borrowings were outstanding under the Credit Agreement at August 4, 2001. Borrowings available
under the Credit Agreement are reduced by the aggregate amount of letters of credit outstanding under the Credit Agreement ($8.7 million at August 4, 2001). Borrowings under the Credit
Agreement and our previous $100 million bank credit facility in the first six months of fiscal 2001 were outstanding for 140 days, with average outstanding borrowings of
$37.0 million and a weighted average interest rate of 6.20%.

General

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

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

17

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On December 14, 2000, our Board of Directors authorized the repurchase of 1.0 million shares of outstanding Common Stock. In the fourth quarter of fiscal 2000, we
repurchased and retired 525,000 shares under this plan at an aggregate price of $17.2 million (average cost of $32.67 per share). No additional shares of Common Stock were repurchased in the
first six months of fiscal 2001. We may continue our stock repurchases provided that market prices of our Common Stock make it advantageous. Securities and Exchange Commission regulations restrict us
from making repurchases during specified time periods. Finally, under the agreements governing our outstanding indebtedness, we can only repurchase shares of our Common Stock if we maintain or comply
with specified financial ratios. As a result, we can give no assurance that we will repurchase any additional shares under the December 2000 stock repurchase plan.

On
June 9, 2000, we called for the redemption on June 29, 2000 of our convertible subordinated notes due January 15, 2003 (the "Subordinated Notes"). The
aggregate principal amount of the Subordinated Notes outstanding was $96,935,000. The holders had the option to convert their Subordinated Notes into shares of Common Stock by June 22, 2000 at
a price of $38.00 per share. Alternatively, holders could have their Subordinated Notes redeemed on June 29, 2000 at a total redemption price of $1,051.25 per $1,000 principal amount of
Subordinated Notes, which included a premium for early redemption and accrued interest. As a result, the majority of the Subordinated Notes was surrendered by the June 22, 2000 conversion date
and was converted into 2,445,565 shares of Common Stock. The remaining Subordinated Notes were redeemed at a total redemption price of $4.2 million on June 29, 2000. The loss from the
redemption was not material.

We
believe that our available cash, funds generated by operating activities, funds available under the Credit Agreement, the net proceeds from the Senior Notes due 2009, and proceeds
from the exercise of stock options will be sufficient to redeem the Senior Notes due 2006 and fund anticipated capital expenditures, working capital requirements, and any stock repurchases for the
foreseeable future.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

We have market risk exposure arising from changes in interest rates. In July 2001, we issued $200 million of the Senior Notes due 2009 with a
fixed interest rate of 91/4%. Using a portion of the proceeds from the Senior Notes due 2009, in August 2001, we redeemed the Senior Notes due 2006. Generally, the fair market
value of our fixed interest rate long-term debt will increase as interest rates fall and decrease as interest rates rise. Our market risk is described in more detail in our Annual Report
on Form 10-K for the fiscal year ended February 3, 2001.

18

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MICHAELS STORES, INC.    Part IIOTHER INFORMATION

Item 1. Legal Proceedings

Raniwala Proceeding

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

On
July 20, 2000, Raniwala filed an amended complaint to correct certain deficiencies in the original Raniwala Complaint (the "Amended Raniwala Complaint"). On
September 25, 2000, we filed our answer to the Amended Raniwala Complaint.

On
June 6, 2001, we negotiated a tentative settlement of the purported class action with Raniwala. Pursuant to the terms of the settlement, in exchange for a full release of
claims, we are obligated to pay a maximum of $3.0 million, covering all claims and attorneys' fees, plus estimated payroll taxes of approximately $153,000, which amounts were accrued in the
first quarter of fiscal 2001. The specific terms of the settlement are currently being finalized between the parties and must then be approved by the Alameda County Superior Court. While we believe
that it is likely that the settlement will be approved, we can provide no assurance to that effect.

Collins Proceeding

On April 14, 1999, Suzanne Collins ("Collins"), a former assistant manager of our subsidiary, Aaron Brothers, Inc. ("Aaron Brothers"), filed a
class action complaint (the "Collins Complaint") against Aaron Brothers on behalf of Aaron Brothers' former store managers, assistant store managers, and managers-in-training.
The Collins Complaint was filed in the Los Angeles County Superior Court, California and alleges that Aaron Brothers violated various California laws by erroneously treating its store managers,
assistant store managers, and managers-in-training as "exempt" employees who are not entitled to overtime compensation. Based on these allegations, the Collins Complaint
asserts that Aaron Brothers: (1) violated various California Labor Codes; (2) violated Section 17200 of the California Business and Professions Code; and (3) engaged in
conversion. The Collins Complaint seeks back wages, interest, penalties, punitive damages, and attorneys' fees.

On
June 25, 2001, Collins filed an amended complaint which expanded the purported class to include all current Aaron Brothers' salaried store managers, assistant store
managers, and managers-in-training based in California; added a new plaintiff as a class representative; and added two additional causes of action for injunctive and
declaratory relief.

The
court has set a hearing date during the fourth quarter of fiscal 2001 to determine whether the case should proceed as a class action lawsuit. A trial date has not yet been
scheduled.

The
case is currently in the discovery phase. There can be no assurance that Aaron Brothers will be successful in defending this litigation or that future operating results will not
be materially adversely affected by the final resolution of the lawsuit.

19

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General

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

Item 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:                  
|Dated: September 18, 2001 |  |                      

21

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INDEX TO EXHIBITS

|Exhibits |  |                                                                                                                                                                                                                                                                                                                                                                                                                                
|-------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1(ii)  |  | Amended and Restated Bylaws of Michaels Stores, Inc. (previously filed as Exhibit 3.1(ii) to Form S-4 (SEC File No. 333-66462), filed August 1, 2001, and incorporated herein by reference).                                                                                                                                                                                                                                   
|4.1      |  | Indenture, dated as of July 6, 2001, by and between Michaels Stores, Inc. and The Bank of New York, as Trustee (previously filed as Exhibit 4.3 to Form S-4 (SEC File No. 333-66462), filed August 1, 2001, and incorporated
herein by reference).                                                                                                                                                                             
|4.2      |  | Registration Rights Agreement, dated as of July 6, 2001, by and among Michaels Stores, Inc. and Merrill Lynch, Pierce, Fenner & Smith Incorporated, Credit Suisse First Boston Corporation, Deutsche Banc Alex. Brown Inc., Fleet Securities,
 Inc. and Wells Fargo Brokerage Services, LLC (previously filed as Exhibit 4.4 to Form S-4 (SEC File No. 333-66462), filed August 1, 2001, and incorporated herein by reference).
|10.1     |  | Michaels Stores, Inc. Employees 401(k) Plan, as amended and restated, effective August 1, 1999 (filed herewith).                                                                                                                                                                                                                                                                                                               

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