##### 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 1934 
|                                                      
|For the quarterly period ended July 30, 2005          
|                                                      
|OR                                                    
|                                                      
|o                                                      |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934
|                                                      
|For 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


þ o




|                                       |  |                         
|-------------------------------------- |  | ------------------------
|                                       |  | Shares Outstanding as of
|Title                                  |  | August 30, 2005         
|                                       |  |                         
|Common Stock, par value $.10 per share |  | 135,437,312             









---










MICHAELS STORES, INC.


FORM 10-Q


|                                                             |  |                                                                                                                            |  |   
|------------------------------------------------------------ |  | -------------------------------------------------------------------------------------------------------------------------- |  | --
|Part IFINANCIAL
    INFORMATION                            
|                                                            
|Item 1.                                                      |  | Financial Statements                                                                                                       |  |   
|                                                             |  | Consolidated Balance Sheets at
    July 30, 2005, January 29, 2005, and July 31,
    2004 (unaudited)                      |  | 3 
|                                                             |  | Consolidated Statements of Income for the
    quarter and six months ended July 30, 2005 and
    July 31, 2004 (unaudited) |  | 4 
|                                                             |  | Consolidated Statements of Cash Flows for
    the six months ended July 30, 2005 and July 31, 2004
    (unaudited)         |  | 5 
|                                                             |  | Notes to Consolidated Financial Statements
    (unaudited)                                                                 |  | 6 
|Item 2.                                                      |  | Managements Discussion and
    Analysis of Financial Condition and Results of Operations                                  |  | 14
|Item 3.                                                      |  | Quantitative and Qualitative Disclosures
    About Market Risk                                                             |  | 22
|Item 4.                                                      |  | Controls and Procedures                                                                                                    |  | 22
|Part IIOTHER
    INFORMATION                               
|Item 1.                                                      |  | Legal Proceedings                                                                                                          |  | 23
|Item 2.                                                      |  | Changes in Securities, Use of Proceeds
    and Issuer Purchases of Equity Securities                                       |  | 24
|Item 4.                                                      |  | Submission of Matters to a Vote of
    Security Holders                                                                    |  | 25
|Item 6.                                                      |  | Exhibits                                                                                                                   |  | 26
|Signatures                                                   |  | 27                                                                                                                        
|Certifications of R. Michael Rouleau Pursuant to Section 302
|Certifications of Jeffrey N. Boyer Pursuant to Section 302  
|Certification 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 30,                    |           |           | January 29, |   |           | July 31, |          
|                                           |                                                                                                                                                                                                            | 2005                        |           |           | 2005        |   |           | 2004     |          
|                                           |                                                                                                                                                                                                            |                             |           |           |             |   |           |          |          
|ASSETS                                     |                                                                                                                                                                                                            |                             |           |           |             |   |           |          |           |   |           |        
|Current assets:                            |                                                                                                                                                                                                            |                             |           |           |             |   |           |          |           |   |           |        
|                                           | Cash and equivalents                                                                                                                                                                                       |                             | $         | 182,909   |             |   | $         | 535,852  |           |   | $         | 257,443 |          
|                                           | Short-term investments                                                                                                                                                                                     |                             |           |          |             |   |           | 50,379   |           |   |           | 50,000  |          
|                                           | Merchandise inventories                                                                                                                                                                                    |                             |           | 1,090,239 |             |   |           | 936,395  |           |   |           | 954,736 |          
|                                           | Prepaid expenses and other                                                                                                                                                                                 |                             |           | 39,010    |             |   |           | 26,613   |           |   |           | 39,655  |          
|                                           | Deferred and prepaid income taxes                                                                                                                                                                          |                             |           | 58,580    |             |   |           | 22,032   |           |   |           | 26,865  |          
|                                           |                                                                                                                                                                                                            |                             |           |           |             |   |           |          |          
|                                           |                                                                                                                                                                                                            | Total current assets        |           |           | 1,370,738   |   |           |          | 1,571,271 |   |           |         | 1,328,699 | 
|                                           |                                                                                                                                                                                                            |                             |           |           |             |   |           |          |          
|Property and equipment, at cost            |                                                                                                                                                                                                            |                             | 963,201   |           |             |   | 913,174   |          |           |   | 845,738   |        
|Less accumulated depreciation              |                                                                                                                                                                                                            |                             | (544,714  | )         |             |   | (506,193  | )        |           |   | (450,010  | )      
|                                           |                                                                                                                                                                                                            |                             |           |           |             |   |           |          |          
|                                           |                                                                                                                                                                                                            |                             | 418,487   |           |             |   | 406,981   |          |           |   | 395,728   |        
|                                           |                                                                                                                                                                                                            |                             |           |           |             |   |           |          |          
|Goodwill                                   |                                                                                                                                                                                                            |                             | 115,839   |           |             |   | 115,839   |          |           |   | 115,839   |        
|Other assets                               |                                                                                                                                                                                                            |                             | 18,765    |           |             |   | 17,569    |          |           |   | 14,923    |        
|                                           |                                                                                                                                                                                                            |                             |           |           |             |   |           |          |          
|                                           |                                                                                                                                                                                                            |                             | 134,604   |           |             |   | 133,408   |          |           |   | 130,762   |        
|                                           |                                                                                                                                                                                                            |                             |           |           |             |   |           |          |          
|Total assets                               |                                                                                                                                                                                                            | $                           | 1,923,829 |           |             | $ | 2,111,660 |          |           | $ | 1,855,189 |        
|                                           |                                                                                                                                                                                                            |                             |           |           |             |   |           |          |          
|                                          
|LIABILITIES AND STOCKHOLDERS EQUITY       |                                                                                                                                                                                                            |                             |           |           |             |   |           |          |           |   |           |        
|Current liabilities:                       |                                                                                                                                                                                                            |                             |           |           |             |   |           |          |           |   |           |        
|                                           | Accounts payable                                                                                                                                                                                           |                             | $         | 248,645   |             |   | $         | 256,266  |           |   | $         | 211,408 |          
|                                           | Accrued liabilities and other                                                                                                                                                                              |                             |           | 232,385   |             |   |           | 242,682  |           |   |           | 194,798 |          
|                                           | Income taxes payable                                                                                                                                                                                       |                             |           |          |             |   |           | 12,992   |           |   |           |        |          
|                                           |                                                                                                                                                                                                            |                             |           |           |             |   |           |          |          
|                                           |                                                                                                                                                                                                            | Total current liabilities   |           |           | 481,030     |   |           |          | 511,940   |   |           |         | 406,206   | 
|                                           |                                                                                                                                                                                                            |                             |           |           |             |   |           |          |          
|91/4% Senior
    Notes due 2009            |                                                                                                                                                                                                            |                             |          |           |             |   | 200,000   |          |           |   | 200,000   |        
|Deferred income taxes                      |                                                                                                                                                                                                            |                             | 26,848    |           |             |   | 30,355    |          |           |   | 28,241    |        
|Other long-term liabilities                |                                                                                                                                                                                                            |                             | 86,898    |           |             |   | 72,200    |          |           |   | 39,170    |        
|                                           |                                                                                                                                                                                                            |                             |           |           |             |   |           |          |          
|                                           |                                                                                                                                                                                                            | Total long-term liabilities |           |           | 113,746     |   |           |          | 302,555   |   |           |         | 267,411   | 
|                                           |                                                                                                                                                                                                            |                             |           |           |             |   |           |          |          
|                                           |                                                                                                                                                                                                            |                             | 594,776   |           |             |   | 814,495   |          |           |   | 673,617   |        
|                                           |                                                                                                                                                                                                            |                             |           |           |             |   |           |          |          
|Commitments and contingencies              |                                                                                                                                                                                                            |                             |           |           |             |   |           |          |           |   |           |        
|Stockholders 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; shares issued and outstanding of 135,827,039 at
    July 30, 2005, 135,726,717 at January 29, 2005, and
    135,774,156 at July 31, 2004 |                             |           | 13,583    |             |   |           | 13,573   |           |   |           | 13,577  |          
|                                           | Additional paid-in capital                                                                                                                                                                                 |                             |           | 425,002   |             |   |           | 451,449  |           |   |           | 463,523 |          
|                                           | Retained earnings                                                                                                                                                                                          |                             |           | 880,990   |             |   |           | 826,821  |           |   |           | 700,079 |          
|                                           | Accumulated other comprehensive income                                                                                                                                                                     |                             |           | 9,478     |             |   |           | 5,322    |           |   |           | 4,393   |          
|                                           |                                                                                                                                                                                                            |                             |           |           |             |   |           |          |          
|                                           |                                                                                                                                                                                                            | Total stockholders equity  |           |           | 1,329,053   |   |           |          | 1,297,165 |   |           |         | 1,181,572 | 
|                                           |                                                                                                                                                                                                            |                             |           |           |             |   |           |          |          
|Total liabilities and stockholders equity |                                                                                                                                                                                                            | $                           | 1,923,829 |           |             | $ | 2,111,660 |          |           | $ | 1,855,189 |        
|                                           |                                                                                                                                                                                                            |                             |           |           |             |   |           |          |          



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MICHAELS STORES, INC.





CONSOLIDATED STATEMENTS OF INCOME


(In thousands, except per share data)


(Unaudited)


|                                             |         |               |         |      |                  |   |         |          |  |   |           |      |  |   |           |      | 
|-------------------------------------------- | ------- | ------------- | ------- | ---- | ---------------- | - | ------- | -------- |  | - | --------- | ---- |  | - | --------- | ---- | 
|                                             |         | Quarter Ended |         |      | Six Months Ended |  
|                                             |         |               |         |      |                  |  
|                                             |         | July 30,      |         |      | July 31,         |   |         | July 30, |  |   | July 31,  |     
|                                             |         | 2005          |         |      | 2004             |   |         | 2005     |  |   | 2004      |     
|                                             |         |               |         |      |                  |   |         |          |  |   |           |     
|Net sales                                    |         | $             | 745,493 |      |                  | $ | 682,934 |          |  | $ | 1,566,509 |      |  | $ | 1,408,786 |     
|Cost of sales and occupancy expense          |         |               | 463,203 |      |                  |   | 425,628 |          |  |   | 979,539   |      |  |   | 891,256   |     
|                                             |         |               |         |      |                  |   |         |          |  |   |           |     
|Gross profit                                 |         |               | 282,290 |      |                  |   | 257,306 |          |  |   | 586,970   |      |  |   | 517,530   |     
|Selling, general, and administrative expense |         |               | 218,012 |      |                  |   | 207,158 |          |  |   | 442,482   |      |  |   | 412,859   |     
|Store pre-opening costs                      |         |               | 1,454   |      |                  |   | 2,643   |          |  |   | 4,193     |      |  |   | 5,126     |     
|                                             |         |               |         |      |                  |   |         |          |  |   |           |     
|Operating income                             |         |               | 62,824  |      |                  |   | 47,505  |          |  |   | 140,295   |      |  |   | 99,545    |     
|Interest expense                             |         |               | 15,500  |      |                  |   | 5,069   |          |  |   | 20,590    |      |  |   | 10,397    |     
|Other (income) and expense, net              |         |               | (2,369  | )    |                  |   | (877    | )        |  |   | (5,049    | )    |  |   | (1,666    | )   
|                                             |         |               |         |      |                  |   |         |          |  |   |           |     
|Income before income taxes                   |         |               | 49,693  |      |                  |   | 43,313  |          |  |   | 124,754   |      |  |   | 90,814    |     
|Provision for income taxes                   |         |               | 18,878  |      |                  |   | 16,567  |          |  |   | 47,406    |      |  |   | 34,736    |     
|                                             |         |               |         |      |                  |   |         |          |  |   |           |     
|Net income                                   |         | $             | 30,815  |      |                  | $ | 26,746  |          |  | $ | 77,348    |      |  | $ | 56,078    |     
|                                             |         |               |         |      |                  |   |         |          |  |   |           |     
|Earnings per common share:                   |         |               |         |      |                  |   |         |          |  |   |           |      |  |   |           |     
|                                             | Basic   |               | $       | 0.23 |                  |   | $       | 0.20     |  |   | $         | 0.57 |  |   | $         | 0.41 | 
|                                             |         |               |         |      |                  |   |         |          |  |   |           |     
|                                             | Diluted |               | $       | 0.22 |                  |   | $       | 0.19     |  |   | $         | 0.56 |  |   | $         | 0.40 | 
|                                             |         |               |         |      |                  |   |         |          |  |   |           |     
|Dividends per common share                   |         | $             | 0.10    |      |                  | $ | 0.06    |          |  | $ | 0.17      |      |  | $ | 0.12      |     
|                                             |         |               |         |      |                  |   |         |          |  |   |           |     



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MICHAELS STORES, INC.





CONSOLIDATED STATEMENTS OF CASH FLOWS


(In thousands)


(Unaudited)


|                                            |                                                   |                                        |                                 |                                                     |          |          |          |         |        |         |          |  
|------------------------------------------- | ------------------------------------------------- | -------------------------------------- | ------------------------------- | --------------------------------------------------- | -------- | -------- | -------- | ------- | ------ | ------- | -------- | -
|                                            |                                                   | Six Months Ended                       |                                
|                                            |                                                   |                                        |                                
|                                            |                                                   | July 30,                               |                                 |                                                     | July 31, |         
|                                            |                                                   | 2005                                   |                                 |                                                     | 2004     |         
|                                            |                                                   |                                        |                                 |                                                     |          |         
|Operating activities:                       |                                                   |                                        |                                 |                                                     |          |          |          |        
|                                            | Net income                                        |                                        | $                               | 77,348                                              |          |          | $        | 56,078  |       
|                                            | Adjustments:                                      |                                        |                                 |                                                     |          |          |          |         |       
|                                            |                                                   | Depreciation                           |                                 |                                                     | 48,085   |          |          |         | 43,576 |        
|                                            |                                                   | Amortization                           |                                 |                                                     | 194      |          |          |         | 197    |        
|                                            |                                                   | Loss from early extinguishment of debt |                                 |                                                     | 12,133   |          |          |         |       |        
|                                            |                                                   | Other                                  |                                 |                                                     | 325      |          |          |         | 521    |        
|                                            |                                                   | Changes in assets and liabilities:     |                                 |                                                     |          |          |          |         |        |        
|                                            |                                                   |                                        | Merchandise inventories         |                                                     |          | (153,844 | )        |         |        | (61,813 | )       
|                                            |                                                   |                                        | Prepaid expenses and other      |                                                     |          | (12,397  | )        |         |        | (10,457 | )       
|                                            |                                                   |                                        | Deferred income taxes and other |                                                     |          | (4,853   | )        |         |        | 1,712   |         
|                                            |                                                   |                                        | Accounts payable                |                                                     |          | (7,621   | )        |         |        | 38,700  |         
|                                            |                                                   |                                        | Income taxes payable            |                                                     |          | (32,737  | )        |         |        | (2,377  | )       
|                                            |                                                   |                                        | Accrued liabilities and other   |                                                     |          | (5,363   | )        |         |        | 869     |         
|                                            |                                                   |                                        | Other long-term liabilities     |                                                     |          | 11,584   |          |         |        | 2,190   |         
|                                            |                                                   |                                        |                                 |                                                     |          |         
|                                            |                                                   |                                        |                                 | Net cash (used in) provided by operating activities |          |          | (67,146  | )       |        |         | 69,196   |  
|                                            |                                                   |                                        |                                 |                                                     |          |         
|Investing activities:                       |                                                   |                                        |                                 |                                                     |          |          |          |        
|                                            | Additions to property and equipment               |                                        |                                 | (60,510                                             | )        |          |          | (51,861 | )     
|                                            | Purchases of short-term investments               |                                        |                                 | (226                                                | )        |          |          | (50,000 | )     
|                                            | Sales of short-term investments                   |                                        |                                 | 50,605                                              |          |          |          |        |       
|                                            | Net proceeds from sales of property and equipment |                                        |                                 |                                                    |          |          |          | 45      |       
|                                            |                                                   |                                        |                                 |                                                     |          |         
|                                            |                                                   |                                        |                                 | Net cash used in investing activities               |          |          | (10,131  | )       |        |         | (101,816 | )
|                                            |                                                   |                                        |                                 |                                                     |          |         
|Financing activities:                       |                                                   |                                        |                                 |                                                     |          |          |          |        
|                                            | Repayment of Senior Notes                         |                                        |                                 | (209,250                                            | )        |          |          |        |       
|                                            | Proceeds from stock options exercised             |                                        |                                 | 25,787                                              |          |          |          | 18,387  |       
|                                            | Repurchase of Common Stock                        |                                        |                                 | (71,197                                             | )        |          |          | (55,114 | )     
|                                            | Cash dividends paid to stockholders               |                                        |                                 | (23,184                                             | )        |          |          | (16,364 | )     
|                                            | Proceeds from issuance of Common Stock and other  |                                        |                                 | 2,178                                               |          |          |          | 1,329   |       
|                                            |                                                   |                                        |                                 |                                                     |          |         
|                                            |                                                   |                                        |                                 | Net cash used in financing activities               |          |          | (275,666 | )       |        |         | (51,762  | )
|                                            |                                                   |                                        |                                 |                                                     |          |         
|Net decrease in cash and equivalents        |                                                   |                                        | (352,943                        | )                                                   |          |          | (84,382  | )      
|Cash and equivalents at beginning of period |                                                   |                                        | 535,852                         |                                                     |          |          | 341,825  |        
|                                            |                                                   |                                        |                                 |                                                     |          |         
|Cash and equivalents at end of period       |                                                   | $                                      | 182,909                         |                                                     |          | $        | 257,443  |        
|                                            |                                                   |                                        |                                 |                                                     |          |         



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MICHAELS STORES, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


For the Six Months Ended July 30, 2005


(Unaudited)




|        |                      
|------- | ---------------------
|Note 1. | Basis of Presentation













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MICHAELS STORES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)


For the Six Months Ended July 30, 2005


(Unaudited)




|        |                   
|------- | ------------------
|Note 2. | Earnings per Share



|                           |                                                                                                                |                                       |   |         |                  |  |   |          |       |  |          |         |       |  |   |         |       | 
|-------------------------- | -------------------------------------------------------------------------------------------------------------- | ------------------------------------- | - | ------- | ---------------- |  | - | -------- | ----- |  | -------- | ------- | ----- |  | - | ------- | ----- | 
|                           |                                                                                                                | Quarter Ended                         |   |         | Six Months Ended | 
|                           |                                                                                                                |                                       |   |         |                  | 
|                           |                                                                                                                | July 30,                              |   |         | July 31,         |  |   | July 30, |       |  | July 31, |        
|                           |                                                                                                                | 2005                                  |   |         | 2004             |  |   | 2005     |       |  | 2004     |        
|                           |                                                                                                                |                                       |   |         |                  |  |   |          |       |  |          |        
|                           |                                                                                                                | (In thousands, except per share data) |  
|Numerator:                 |                                                                                                                |                                       |   |         |                  |  |   |          |       |  |          |         |       |  |   |        
|                           | Net income                                                                                                     |                                       | $ | 30,815  |                  |  | $ | 26,746   |       |  | $        | 77,348  |       |  | $ | 56,078  |      
|                           |                                                                                                                |                                       |   |         |                  |  |   |          |       |  |          |        
|Denominator:               |                                                                                                                |                                       |   |         |                  |  |   |          |       |  |          |         |       |  |   |        
|                           | Denominator for basic earnings per common share-weighted average
    shares                                    |                                       |   | 135,774 |                  |  |   | 136,304  |       |  |          | 135,896 |       |  |   | 136,432 |      
|                           | Effect of dilutive securities:                                                                                 |                                       |   |         |                  |  |   |          |       |  |          |         |       |  |   |         |      
|                           |                                                                                                                | Employee stock options                |   |         | 3,360            |  |   |          | 2,976 |  |          |         | 3,307 |  |   |         | 3,054 | 
|                           |                                                                                                                |                                       |   |         |                  |  |   |          |       |  |          |        
|                           | Denominator for diluted earnings per common share-weighted
    average shares adjusted for dilutive securities |                                       |   | 139,134 |                  |  |   | 139,280  |       |  |          | 139,203 |       |  |   | 139,486 |      
|                           |                                                                                                                |                                       |   |         |                  |  |   |          |       |  |          |        
|Earnings per common share: |                                                                                                                |                                       |   |         |                  |  |   |          |       |  |          |         |       |  |   |        
|                           | Basic                                                                                                          |                                       | $ | 0.23    |                  |  | $ | 0.20     |       |  | $        | 0.57    |       |  | $ | 0.41    |      
|                           |                                                                                                                |                                       |   |         |                  |  |   |          |       |  |          |        
|                           | Diluted                                                                                                        |                                       | $ | 0.22    |                  |  | $ | 0.19     |       |  | $        | 0.56    |       |  | $ | 0.40    |      
|                           |                                                                                                                |                                       |   |         |                  |  |   |          |       |  |          |        





|        |                         
|------- | ------------------------
|Note 3. | Stock-Based Compensation

Accounting for Stock Issued to Employees


Accounting for
Stock-Based Compensation Accounting for Stock-Based CompensationTransition and
Disclosure


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MICHAELS STORES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)


For the Six Months Ended July 30, 2005


(Unaudited)




|        |                                     
|------- | ------------------------------------
|Note 3. | Stock-Based Compensation (Continued)



|                                               |                                                             |                                       |        |         |                  |   |        |          |  |   |          |         |  |   |        |         | 
|---------------------------------------------- | ----------------------------------------------------------- | ------------------------------------- | ------ | ------- | ---------------- | - | ------ | -------- |  | - | -------- | ------- |  | - | ------ | ------- | 
|                                               |                                                             | Quarter Ended                         |        |         | Six Months Ended |  
|                                               |                                                             |                                       |        |         |                  |  
|                                               |                                                             | July 30,                              |        |         | July 31,         |   |        | July 30, |  |   | July 31, |        
|                                               |                                                             | 2005                                  |        |         | 2004(1)          |   |        | 2005     |  |   | 2004(1)  |        
|                                               |                                                             |                                       |        |         |                  |   |        |          |  |   |          |        
|                                               |                                                             | (In thousands, except per share data) |       
|Net income, as reported                        |                                                             | $                                     | 30,815 |         |                  | $ | 26,746 |          |  | $ | 77,348   |         |  | $ | 56,078 |        
|Stock-based employee compensation cost:        |                                                             |                                       |        |         |                  |   |        |          |  |   |          |         |  |   |        |        
|                                               | As if the fair value method were applied, net of income tax |                                       |        | 3,824   |                  |   |        | 3,435    |  |   |          | 6,600   |  |   |        | 6,033   | 
|                                               |                                                             |                                       |        |         |                  |   |        |          |  |   |          |        
|Pro forma net income                           |                                                             | $                                     | 26,991 |         |                  | $ | 23,311 |          |  | $ | 70,748   |         |  | $ | 50,045 |        
|                                               |                                                             |                                       |        |         |                  |   |        |          |  |   |          |        
|Earnings per common share, as reported:        |                                                             |                                       |        |         |                  |   |        |          |  |   |          |         |  |   |        |        
|                                               | Basic                                                       |                                       | $      | 0.23    |                  |   | $      | 0.20     |  |   | $        | 0.57    |  |   | $      | 0.41    | 
|                                               |                                                             |                                       |        |         |                  |   |        |          |  |   |          |        
|                                               | Diluted                                                     |                                       | $      | 0.22    |                  |   | $      | 0.19     |  |   | $        | 0.56    |  |   | $      | 0.40    | 
|                                               |                                                             |                                       |        |         |                  |   |        |          |  |   |          |        
|Pro forma earnings per common share:           |                                                             |                                       |        |         |                  |   |        |          |  |   |          |         |  |   |        |        
|                                               | Basic                                                       |                                       | $      | 0.20    |                  |   | $      | 0.17     |  |   | $        | 0.52    |  |   | $      | 0.37    | 
|                                               |                                                             |                                       |        |         |                  |   |        |          |  |   |          |        
|                                               | Diluted                                                     |                                       | $      | 0.20    |                  |   | $      | 0.17     |  |   | $        | 0.51    |  |   | $      | 0.36    | 
|                                               |                                                             |                                       |        |         |                  |   |        |          |  |   |          |        
|Pro forma weighted average shares outstanding: |                                                             |                                       |        |         |                  |   |        |          |  |   |          |         |  |   |        |        
|                                               | Basic                                                       |                                       |        | 135,774 |                  |   |        | 136,304  |  |   |          | 135,896 |  |   |        | 136,432 | 
|                                               | Diluted                                                     |                                       |        | 138,408 |                  |   |        | 138,661  |  |   |          | 138,459 |  |   |        | 138,660 | 






|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | The pro forma information for the quarter and six months ended
    July 31, 2004 was revised based on the results of
    managements review of prior years calculations. The
    impacts to the pro forma information resulting from the
    difference between previously reported stock-based employee
    compensation cost, net of tax, and the revised presentation are
    as follows: for the second quarter of fiscal 2004, a decrease in
    stock-based employee compensation cost, net of tax, a
    corresponding increase in pro-forma net income of $163,000 and
    an increase in pro-forma diluted weighted average shares
    outstanding of 325 thousand; for the six months ended
    July 31, 2004, a decrease in stock-based employee
    compensation cost, net of tax, a corresponding increase in
    pro-forma net income of $954,000, an increase in pro-forma
    diluted weighted average shares outstanding of 186 thousand, and
    an increase in pro-forma basic earnings per share of $0.01.



|        |     
|------- | ----
|Note 4. | Debt

91/4% Senior
Notes due 2009


1 4


8



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##### Table of Contents



MICHAELS STORES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)


For the Six Months Ended July 30, 2005


(Unaudited)




|        |                 
|------- | ----------------
|Note 4. | Debt (Continued)

Credit Agreement








|        |                     
|------- | --------------------
|Note 5. | Comprehensive Income



|                                   |                                                   |                |        |       |                  |   |        |          |  |   |          |       |  |   |        |     | 
|---------------------------------- | ------------------------------------------------- | -------------- | ------ | ----- | ---------------- | - | ------ | -------- |  | - | -------- | ----- |  | - | ------ | --- | 
|                                   |                                                   | Quarter Ended  |        |       | Six Months Ended |  
|                                   |                                                   |                |        |       |                  |  
|                                   |                                                   | July 30,       |        |       | July 31,         |   |        | July 30, |  |   | July 31, |      
|                                   |                                                   | 2005           |        |       | 2004             |   |        | 2005     |  |   | 2004     |      
|                                   |                                                   |                |        |       |                  |   |        |          |  |   |          |      
|                                   |                                                   | (In thousands) |       
|Net income                         |                                                   | $              | 30,815 |       |                  | $ | 26,746 |          |  | $ | 77,348   |       |  | $ | 56,078 |    
|Other comprehensive income (loss): |                                                   |                |        |       |                  |   |        |          |  |   |          |       |  |   |        |    
|                                   | Foreign currency translation adjustment and other |                |        | 1,302 |                  |   |        | 2,802    |  |   |          | 4,156 |  |   |        | 170 | 
|                                   |                                                   |                |        |       |                  |   |        |          |  |   |          |      
|Comprehensive income               |                                                   | $              | 32,117 |       |                  | $ | 29,548 |          |  | $ | 81,504   |       |  | $ | 56,248 |    
|                                   |                                                   |                |        |       |                  |   |        |          |  |   |          |      



|        |                  
|------- | -----------------
|Note 6. | Legal Proceedings

Stockholder Class Actions




9



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##### Table of Contents



MICHAELS STORES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)


For the Six Months Ended July 30, 2005


(Unaudited)




|        |                              
|------- | -----------------------------
|Note 6. | Legal Proceedings (Continued)



Derivative Claims






Cotton Claim




Clark Claim




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##### Table of Contents



MICHAELS STORES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)


For the Six Months Ended July 30, 2005


(Unaudited)




|        |                              
|------- | -----------------------------
|Note 6. | Legal Proceedings (Continued)



General






|        |         
|------- | --------
|Note 7. | Segments

Disclosures About Segments of an
Enterprise and Related Information.


11



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##### Table of Contents



MICHAELS STORES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)


For the Six Months Ended July 30, 2005


(Unaudited)


Note 7. Segments  (Continued)




|                                |  |                |           |  |                  |   |         |              |  |   |           | 
|------------------------------- |  | -------------- | --------- |  | ---------------- | - | ------- | ------------ |  | - | --------- | 
|                                |  | Net Sales      |           |  | Operating Income |   |         | Total Assets | 
|                                |  |                |           |  |                  |   |         |              | 
|                                |  | (In thousands) |          
|Quarter ended July 30, 2005:    |  |                |           |  |                  |   |         |              |  |   |           | 
|United States                   |  | $              | 703,288   |  |                  | $ | 55,534  |              |  | $ | 1,843,272 | 
|Canada                          |  |                | 42,205    |  |                  |   | 7,290   |              |  |   | 80,557    | 
|                                |  |                |           |  |                  |   |         |              | 
|Consolidated Total              |  | $              | 745,493   |  |                  | $ | 62,824  |              |  | $ | 1,923,829 | 
|                                |  |                |           |  |                  |   |         |              | 
|Quarter ended July 31, 2004:    |  |                |           |  |                  |   |         |              |  |   |           | 
|United States                   |  | $              | 650,961   |  |                  | $ | 43,113  |              |  | $ | 1,793,865 | 
|Canada                          |  |                | 31,973    |  |                  |   | 4,392   |              |  |   | 61,324    | 
|                                |  |                |           |  |                  |   |         |              | 
|Consolidated Total              |  | $              | 682,934   |  |                  | $ | 47,505  |              |  | $ | 1,855,189 | 
|                                |  |                |           |  |                  |   |         |              | 
|Six months ended July 30, 2005: |  |                |           |  |                  |   |         |              |  |   |           | 
|United States                   |  | $              | 1,480,188 |  |                  | $ | 127,459 |              |  | $ | 1,843,272 | 
|Canada                          |  |                | 86,321    |  |                  |   | 12,836  |              |  |   | 80,557    | 
|                                |  |                |           |  |                  |   |         |              | 
|Consolidated Total              |  | $              | 1,566,509 |  |                  | $ | 140,295 |              |  | $ | 1,923,829 | 
|                                |  |                |           |  |                  |   |         |              | 
|Six months ended July 31, 2004: |  |                |           |  |                  |   |         |              |  |   |           | 
|United States                   |  | $              | 1,340,386 |  |                  | $ | 90,767  |              |  | $ | 1,793,865 | 
|Canada                          |  |                | 68,400    |  |                  |   | 8,778   |              |  |   | 61,324    | 
|                                |  |                |           |  |                  |   |         |              | 
|Consolidated Total              |  | $              | 1,408,786 |  |                  | $ | 99,545  |              |  | $ | 1,855,189 | 
|                                |  |                |           |  |                  |   |         |              | 





|        |                                 
|------- | --------------------------------
|Note 8. | Recent Accounting Pronouncements

Stock-Based Compensation


Share-Based
Payment, Accounting for Stock-Based Compensation. Accounting for Stock Issued to Employees, Statement of Cash Flows.




12



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##### Table of Contents



MICHAELS STORES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)


For the Six Months Ended July 30, 2005


(Unaudited)


Note 8. Recent Accounting
Pronouncements  (Continued)




Inventory Costs


Inventory Costs,




|        |                                                         
|------- | --------------------------------------------------------
|Note 9. | Certain Issues Under the Securities Exchange Act of 1934





13



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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






| |   |                                                                                                                                                                                                                                                                                           
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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;                                                                                                                                                                  
| |  | 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 our suppliers
    due to 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, steel, and paper, which may adversely
    affect our costs, including cost of merchandise;                                                                                                    
| |  | 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, and
    service 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 comply with the terms and restrictions of our
    Credit Agreement;                                                                                                                                                                                                        

14



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##### Table of Contents



| |   |                                                                                                                                                                                                                                                                       
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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 29, 2005,
    particularly in Critical Accounting Policies and
    Estimates and Risk Factors, and in our other
    Securities and Exchange Commission filings.



General






|                                   |                                                      |               |       |       |                  |  |     |          |   |  |          |       |   |  |     |       |  
|---------------------------------- | ---------------------------------------------------- | ------------- | ----- | ----- | ---------------- |  | --- | -------- | - |  | -------- | ----- | - |  | --- | ----- | -
|                                   |                                                      | Quarter Ended |       |       | Six Months Ended | 
|                                   |                                                      |               |       |       |                  | 
|                                   |                                                      | July 30,      |       |       | July 31,         |  |     | July 30, |   |  | July 31, |      
|                                   |                                                      | 2005          |       |       | 2004             |  |     | 2005     |   |  | 2004     |      
|                                   |                                                      |               |       |       |                  |  |     |          |   |  |          |      
|Michaels stores:                   |                                                      |               |       |       |                  |  |     |          |   |  |          |       |   |  |     |      
|                                   | Retail stores open at beginning of period            |               |       | 857   |                  |  |     | 818      |   |  |          | 844   |   |  |     | 804   |  
|                                   | Retail stores opened during the period               |               |       | 13    |                  |  |     | 9        |   |  |          | 27    |   |  |     | 23    |  
|                                   | Retail stores opened (relocations) during the period |               |       | 3     |                  |  |     | 10       |   |  |          | 11    |   |  |     | 22    |  
|                                   | Retail stores closed during the period               |               |       |      |                  |  |     |         |   |  |          | (1    | ) |  |     |      |  
|                                   | Retail stores closed (relocations) during the period |               |       | (3    | )                |  |     | (10      | ) |  |          | (11   | ) |  |     | (22   | )
|                                   |                                                      |               |       |       |                  |  |     |          |   |  |          |      
|                                   | Retail stores open at end of period                  |               |       | 870   |                  |  |     | 827      |   |  |          | 870   |   |  |     | 827   |  
|Aaron Brothers stores:             |                                                      |               |       |       |                  |  |     |          |   |  |          |       |   |  |     |      
|                                   | Retail stores open at beginning of period            |               |       | 165   |                  |  |     | 158      |   |  |          | 164   |   |  |     | 158   |  
|                                   | Retail stores opened during the period               |               |       |      |                  |  |     | 3        |   |  |          | 1     |   |  |     | 3     |  
|                                   | Retail stores closed during the period               |               |       |      |                  |  |     | (1       | ) |  |          |      |   |  |     | (1    | )
|                                   |                                                      |               |       |       |                  |  |     |          |   |  |          |      
|                                   | Retail stores open at end of period                  |               |       | 165   |                  |  |     | 160      |   |  |          | 165   |   |  |     | 160   |  
|Recollections stores:              |                                                      |               |       |       |                  |  |     |          |   |  |          |       |   |  |     |      
|                                   | Retail stores open at beginning of period            |               |       | 9     |                  |  |     | 2        |   |  |          | 8     |   |  |     | 2     |  
|                                   | Retail stores opened during the period               |               |       | 2     |                  |  |     | 3        |   |  |          | 3     |   |  |     | 3     |  
|                                   |                                                      |               |       |       |                  |  |     |          |   |  |          |      
|                                   | Retail stores open at end of period                  |               |       | 11    |                  |  |     | 5        |   |  |          | 11    |   |  |     | 5     |  
|Star Wholesale stores:             |                                                      |               |       |       |                  |  |     |          |   |  |          |       |   |  |     |      
|                                   | Wholesale stores open at beginning of period         |               |       | 4     |                  |  |     | 3        |   |  |          | 3     |   |  |     | 3     |  
|                                   | Wholesale stores opened during the period            |               |       |      |                  |  |     |         |   |  |          | 1     |   |  |     |      |  
|                                   |                                                      |               |       |       |                  |  |     |          |   |  |          |      
|                                   | Wholesale stores open at end of period               |               |       | 4     |                  |  |     | 3        |   |  |          | 4     |   |  |     | 3     |  
|                                   |                                                      |               |       |       |                  |  |     |          |   |  |          |      
|Total store count at end of period |                                                      |               | 1,050 |       |                  |  | 995 |          |   |  | 1,050    |       |   |  | 995 |      
|                                   |                                                      |               |       |       |                  |  |     |          |   |  |          |      
|Other operating data:              |                                                      |               |       |       |                  |  |     |          |   |  |          |       |   |  |     |      
|                                   | Average inventory per Michaels store(1)              |               | $     | 1,154 |                  |  | $   | 1,079    |   |  | $        | 1,154 |   |  | $   | 1,079 |  
|                                   | Comparable store sales increase(2)                   |               |       | 4.2   | %                |  |     | 5.5      | % |  |          | 6.1   | % |  |     | 5.7   | %






|    |                                                                                                                                                                                                                    
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Average inventory per Michaels store calculation excludes our
    Aaron Brothers, Recollections, and Star Wholesale stores.                                                                                        
|(2) | Comparable store sales increase represents the increase in net
    sales for stores open the same number of months in the indicated
    period and the comparable period of the previous year, including
    stores

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| |                                                                                                                                                                                           
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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.

Results of Operations




|                                             |  |               |       |   |                  |  |       |          |  |  |          |   |  |  |       |  
|-------------------------------------------- |  | ------------- | ----- | - | ---------------- |  | ----- | -------- |  |  | -------- | - |  |  | ----- | -
|                                             |  | Quarter Ended |       |   | Six Months Ended | 
|                                             |  |               |       |   |                  | 
|                                             |  | July 30,      |       |   | July 31,         |  |       | July 30, |  |  | July 31, |  
|                                             |  | 2005          |       |   | 2004             |  |       | 2005     |  |  | 2004     |  
|                                             |  |               |       |   |                  |  |       |          |  |  |          |  
|Net sales                                    |  |               | 100.0 | % |                  |  | 100.0 | %        |  |  | 100.0    | % |  |  | 100.0 | %
|Cost of sales and occupancy expense          |  |               | 62.1  |   |                  |  | 62.3  |          |  |  | 62.5     |   |  |  | 63.3  |  
|                                             |  |               |       |   |                  |  |       |          |  |  |          |  
|Gross profit                                 |  |               | 37.9  |   |                  |  | 37.7  |          |  |  | 37.5     |   |  |  | 36.7  |  
|Selling, general, and administrative expense |  |               | 29.3  |   |                  |  | 30.3  |          |  |  | 28.2     |   |  |  | 29.3  |  
|Store pre-opening costs                      |  |               | 0.2   |   |                  |  | 0.4   |          |  |  | 0.3      |   |  |  | 0.3   |  
|                                             |  |               |       |   |                  |  |       |          |  |  |          |  
|Operating income                             |  |               | 8.4   |   |                  |  | 7.0   |          |  |  | 9.0      |   |  |  | 7.1   |  
|Interest expense                             |  |               | 2.1   |   |                  |  | 0.8   |          |  |  | 1.3      |   |  |  | 0.8   |  
|Other (income) and expense, net              |  |               | (0.4  | ) |                  |  | (0.1  | )        |  |  | (0.3     | ) |  |  | (0.1  | )
|                                             |  |               |       |   |                  |  |       |          |  |  |          |  
|Income before income taxes                   |  |               | 6.7   |   |                  |  | 6.3   |          |  |  | 8.0      |   |  |  | 6.4   |  
|Provision for income taxes                   |  |               | 2.6   |   |                  |  | 2.4   |          |  |  | 3.1      |   |  |  | 2.4   |  
|                                             |  |               |       |   |                  |  |       |          |  |  |          |  
|Net income                                   |  |               | 4.1   | % |                  |  | 3.9   | %        |  |  | 4.9      | % |  |  | 4.0   | %
|                                             |  |               |       |   |                  |  |       |          |  |  |          |  



| |                                                                            
| | ---------------------------------------------------------------------------
| | Quarter Ended July 30, 2005 Compared to the Quarter
    Ended July 31, 2004

Net Sales




Cost of Sales and Occupancy Expense




16



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##### Table of Contents





Selling, General, and Administrative
Expense




Operating Income


Interest Expense 1 4


Provision for Income Taxes


Net Income




| |                                                                                  
| | ---------------------------------------------------------------------------------
| | Six Months Ended July 30, 2005 Compared to the Six
    Months Ended July 31, 2004

Net Sales




Cost of Sales and Occupancy Expense


17



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##### Table of Contents







Selling, General, and Administrative
Expense




Operating Income


Interest Expense 1 4


Provision for Income Taxes


Net Income


Liquidity and Capital Resources






18



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##### Table of Contents







| |                                    
| | -----------------------------------
| | Cash Flow from Operating Activities







| |                                    
| | -----------------------------------
| | Cash Flow from Investing Activities



|                                                   |  |                  |        |  |          |   |        | 
|-------------------------------------------------- |  | ---------------- | ------ |  | -------- | - | ------ | 
|                                                   |  | Six Months Ended |       
|                                                   |  |                  |       
|                                                   |  | July 30,         |        |  | July 31, |  
|                                                   |  | 2005(1)          |        |  | 2004(2)  |  
|                                                   |  |                  |        |  |          |  
|                                                   |  | (In thousands)   |       
|New and relocated stores and stores not yet opened |  | $                | 21,285 |  |          | $ | 27,067 | 
|Existing stores                                    |  |                  | 16,482 |  |          |   | 7,892  | 
|Distribution system expansion                      |  |                  | 4,112  |  |          |   | 5,841  | 
|Information systems                                |  |                  | 11,973 |  |          |   | 9,196  | 
|Corporate and other                                |  |                  | 6,658  |  |          |   | 1,865  | 
|                                                   |  |                  |        |  |          |  
|                                                   |  | $                | 60,510 |  |          | $ | 51,861 | 
|                                                   |  |                  |        |  |          |  






|    |                                                                                                                                                                                                                                                                                               
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | 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 Wholesale store, and
    the relocation of 11 Michaels stores.                                                  
|(2) | In the first six months of fiscal 2004, we incurred capital
    expenditures related to the opening of 23 Michaels, three Aaron
    Brothers, and three Recollections stores, the relocation of 22
    Michaels stores, and the completion of our New Lenox, Illinois
    distribution center.







| |                                    
| | -----------------------------------
| | Cash Flow from Financing Activities



19



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|                                                    |  |                |           |  |             |  |            |               |  |  |           |    
|--------------------------------------------------- |  | -------------- | --------- |  | ----------- |  | ---------- | ------------- |  |  | --------- | ---
|                                                    |  | Shares         |           |  |             |  | Shares     |              
|                                                    |  | Authorized for |           |  | Shares      |  |            | Available for | 
|                                                    |  | Repurchase     |           |  | Repurchased |  |            | Repurchase    | 
|                                                    |  |                |           |  |             |  |            |               | 
|December 5, 2000 repurchase plan (variable portion) |  |                | 72,510    |  |             |  | (72,509    | )             |  |  | 1         | (1)
|February 2, 2004 repurchase plan                    |  |                | 5,000,000 |  |             |  | (5,000,000 | )             |  |  |          | (2)
|March 15, 2005 repurchase plan                      |  |                | 3,000,000 |  |             |  | (13,888    | )             |  |  | 2,986,112 | (3)
|                                                    |  |                |           |  |             |  |            |               | 
|                                                    |  |                | 8,072,510 |  |             |  | (5,086,397 | )             |  |  | 2,986,113 |    
|                                                    |  |                |           |  |             |  |            |               | 






|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(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 2004,
    we repurchased and subsequently retired 54,551 shares of
    our Common Stock at an average price of $27.03 per share.
    During the first six months of fiscal 2005, we repurchased and
    subsequently retired 17,958 shares of our Common Stock at
    an average price of $40.93 per share. The share repurchases
    were made using proceeds from exercises of stock options granted
    under the 2001 General Stock Option Plan that were exercised
    during fiscal 2004 and fiscal 2005.
|(2) | In the first six months of fiscal 2005, we repurchased and
    subsequently retired approximately 1.9 million shares of
    our Common Stock authorized to be repurchased under the 2004
    repurchase plan at an average price of $36.78 per share. As
    a result of these repurchases, and those made in the prior
    fiscal year, we exhausted our availability for further share
    repurchases under the 2004 repurchase plan.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|(3) | On March 15, 2005, our Board of Directors authorized an
    additional repurchase plan for up to 3.0 million shares of
    our outstanding Common Stock. In the first six months of fiscal
    2005, we repurchased and subsequently retired 13,888 shares
    of our Common Stock authorized to be repurchased under the 2005
    repurchase plan at an average price of $41.22 per share. As
    a result of these repurchases, we have 2,986,112 shares
    available for repurchase as of July 30, 2005.                                                                                                                                                                                                                                                                                                                                                                                                                 





Debt


1 4


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##### Table of Contents









General




Contractual Obligations




Recent Accounting Pronouncements


Stock-Based Compensation


Share-Based
Payment, Accounting for Stock-Based Compensation. Accounting for Stock Issued to Employees, Statement of Cash Flows.






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##### Table of Contents





Inventory Costs


Inventory Costs,







|        |                                                                
|------- | ---------------------------------------------------------------
|Item 3. | Quantitative and Qualitative Disclosures About Market
    Risk.








|        |                         
|------- | ------------------------
|Item 4. | Controls and Procedures.

Evaluation of Disclosure Controls and Procedures




Change in Internal Control Over Financial Reporting




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##### Table of Contents



MICHAELS STORES, INC.





Part IIOTHER INFORMATION







|        |                   
|------- | ------------------
|Item 1. | Legal Proceedings.

Stockholder Class Actions




Derivative Claims






Cotton Claim




23



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##### Table of Contents





Clark Claim




General









|        |                                                                                      
|------- | -------------------------------------------------------------------------------------
|Item 2. | Changes in Securities, Use of Proceeds and Issuer Purchases
    of Equity Securities.





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##### Table of Contents





Issuer Purchases of Equity Securities


|                                   |  |              |         |  |            |                  |       |             |             |  |                 |  |  |  |           | 
|---------------------------------- |  | ------------ | ------- |  | ---------- | ---------------- | ----- | ----------- | ----------- |  | --------------- |  |  |  | --------- | 
|                                   |  |              |         |  |            | Total Number     |       |             | Maximum     | 
|                                   |  |              |         |  |            | of Shares        |       |             | Number of   | 
|                                   |  |              |         |  |            | Purchased as     |       |             | Shares That | 
|                                   |  |              |         |  |            | Part of Publicly |       |             | May Yet Be  | 
|                                   |  | Total Number |         |  | Average    |                  |       | Announced   |             |  | Purchased       | 
|                                   |  | of Shares    |         |  | Price Paid |                  |       | Plans or    |             |  | Under the Plans | 
|                                   |  | Purchased(1) |         |  | per Share  |                  |       | Programs(1) |             |  | or Programs(2)  | 
|                                   |  |              |         |  |            |                  |       |             |             |  |                 | 
|May 1, 2005 through May 28, 2005   |  |              |        |  |            | $                |      |             |             |  |                |  |  |  | 3,426,055 | 
|May 29, 2005 through July 2, 2005  |  |              |        |  |            |                  |      |             |             |  |                |  |  |  | 3,426,055 | 
|July 3, 2005 through July 30, 2005 |  |              | 457,900 |  |            |                  | 41.13 |             |             |  | 457,900         |  |  |  | 2,986,113 | 
|                                   |  |              |         |  |            |                  |       |             |             |  |                 | 
|Total                              |  |              | 457,900 |  |            | $                | 41.13 |             |             |  | 457,900         |  |  |  | 2,986,113 | 
|                                   |  |              |         |  |            |                  |       |             |             |  |                 | 






|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Repurchased and subsequently retired 17,958 shares under
    the variable portion of the 2000 repurchase plan,
    426,054 shares under the 2004 repurchase plan, and
    13,888 shares under the 2005 repurchase plan.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|(2) | Under our 2000 repurchase plan, the Board of Directors
    authorized us to repurchase up to 4.0 million shares of our
    outstanding Common Stock, with the ability to increase the
    maximum number of shares authorized to be repurchased under the
    plan to the extent necessary to use the proceeds from stock
    options exercised under our 2001 General Stock Option Plan to
    make repurchases. We have used the entire 4.0 million share
    fixed portion of the authority originally provided in the 2000
    repurchase plan. We have used the entire 5.0 million share
    authorization provided under the 2004 repurchase plan. As of
    July 30, 2005, we had 2,986,112 shares available for
    repurchase under the 2005 repurchase plan.






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



Election of Directors




|                     |  |                |             |            |          |  |           | 
|-------------------- |  | -------------- | ----------- | ---------- | -------- |  | --------- | 
|                     |  |                |             | Total Vote |         
|                     |  |                |             | Withheld   |         
|                     |  | Total Vote for |             |            | for Each | 
|                     |  | Each Director  |             |            | Director | 
|                     |  |                |             |            |          | 
|Charles J. Wyly, Jr. |  |                | 123,319,698 |            |          |  | 2,111,873 | 
|Sam Wyly             |  |                | 123,217,336 |            |          |  | 2,214,235 | 
|Richard E. Hanlon    |  |                | 119,642,560 |            |          |  | 5,789,011 | 
|Richard C. Marcus    |  |                | 117,597,314 |            |          |  | 7,834,257 | 
|Liz Minyard          |  |                | 120,893,586 |            |          |  | 4,537,985 | 
|Cece Smith           |  |                | 124,170,454 |            |          |  | 1,261,117 | 



Ratification of the Selection of Our Independent Auditors




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##### Table of Contents





|            |  |  |             | 
|----------- |  |  | ----------- | 
|For         |  |  | 124,951,982 | 
|Against     |  |  | 407,786     | 
|Abstentions |  |  | 71,803      | 
|            |  |  |            
|            |  |  | 125,431,571 | 
|            |  |  |            

Approval of the 2005 Incentive Compensation Plan




|            |  |  |             | 
|----------- |  |  | ----------- | 
|For         |  |  | 93,647,230  | 
|Against     |  |  | 20,595,098  | 
|Abstentions |  |  | 233,402     | 
|            |  |  |            
|            |  |  | 114,475,730 | 
|            |  |  |            






|        |          
|------- | ---------
|Item 6. | Exhibits.



|     |  |                                                                                                                                                                                               
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.1 |  | Michaels Stores, Inc. 2005 Incentive Compensation Plan
    (previously filed as Exhibit 10.1 to Form 8-K, filed
    by Registrant on June 17, 2005, SEC File
    No. 001-09338).              
|10.2 |  | Description of Compensation of Directors (previously filed as
    Exhibit 10.2 to Form 8-K, filed by Registrant on
    June 17, 2005, SEC File No. 001-09338).                                
|10.3 |  | Form of Stock Option Agreement relating to June
    2005 Director Grants (previously filed as Exhibit 10.3
    to Form 8-K, filed by Registrant on June 17, 2005, SEC
    File No. 001-09338).
|31.1 |  | Certifications of R. Michael Rouleau pursuant to §302 of
    the Sarbanes-Oxley Act of 2002 (filed herewith).                                                                                 
|31.2 |  | Certifications of Jeffrey N. Boyer pursuant to §302 of the
    Sarbanes-Oxley Act of 2002 (filed herewith).                                                                                   
|32.1 |  | Certification pursuant to 18 U.S.C. §1350, as adopted
    pursuant to §906 of the Sarbanes-Oxley Act of 2002 (filed
    herewith).                                                            

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##### Table of Contents



MICHAELS STORES, INC.





SIGNATURES






| |                      
| | ---------------------
| | MICHAELS STORES, INC.



| |     |                     
| | --- | --------------------
| | By: | /s/ Jeffrey N. Boyer

| |                                                  
| | -------------------------------------------------
| |                                                  
| | Jeffrey N. Boyer                                 
| | Executive Vice President Chief Financial Officer
| | (Principal Financial Officer)                    



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##### Table of Contents



INDEX TO EXHIBITS


|        |      |                        |  |                                                                                                                                                                                               
|------- | ---- | ---------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |      |                       
|Number  |      | Description of Exhibit
|        |      |                       
|        | 10.1 |                        |  | Michaels Stores, Inc. 2005 Incentive Compensation Plan
    (previously filed as Exhibit 10.1 to Form 8-K, filed
    by Registrant on June 17, 2005, SEC File
    No. 001-09338).              
|        | 10.2 |                        |  | Description of Compensation of Directors (previously filed as
    Exhibit 10.2 to Form 8-K, filed by Registrant on
    June 17, 2002, SEC File No. 001-09338).                                
|        | 10.3 |                        |  | Form of Stock Option Agreement relating to June
    2005 Director Grants (previously filed as Exhibit 10.3
    to Form 8-K, filed by Registrant on June 17, 2005, SEC
    File No. 001-09338).
|        | 31.1 |                        |  | Certifications of R. Michael Rouleau pursuant to §302 of
    the Sarbanes-Oxley Act of 2002 (filed herewith).                                                                                 
|        | 31.2 |                        |  | Certifications of Jeffrey N. Boyer pursuant to §302 of the
    Sarbanes-Oxley Act of 2002 (filed herewith).                                                                                   
|        | 32.1 |                        |  | Certification pursuant to 18 U.S.C. §1350, as adopted
    pursuant to §906 of the Sarbanes-Oxley Act of 2002 (filed
    herewith).