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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION


WASHINGTON, DC 20549




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FORM 10-Q

|                                                      |  |                                                                                             
|----------------------------------------------------- |  | --------------------------------------------------------------------------------------------
|(Mark One)                                            |  |                                                                                             
|x                                                     |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR
    15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 
|                                                     
|For the quarterly period ended
    November 1, 2003  
|                                                     
|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



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MICHAELS STORES, INC.

(Exact name of registrant as specified in its
charter)


|                                                                   |  |                                            
|------------------------------------------------------------------ |  | -------------------------------------------
|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


(Address of principal executive offices,
including zip code)


(972) 409-1300

(Registrants telephone number, including
area code)




---

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

Indicate by check mark whether the Registrant is
an accelerated filer (as defined in Rule 12b-2 of the
Exchange
Act).     Yes x          No o

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

|                                       |  |                         
|-------------------------------------- |  | ------------------------
|                                       |  | Shares Outstanding as of
|Title                                  |  | December 4, 2003        
|                                       |  |                         
|Common Stock, par value $.10 per share |  | 67,830,642              



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TABLE OF CONTENTS



|                                                                                               |                                            |  |  |  |  |  |  | 
|---------------------------------------------------------------------------------------------- | ------------------------------------------ |  |  |  |  |  |  | 
|Part I--FINANCIAL INFORMATION                                                                 
|Item 1. Financial Statements.                                                                 
|                                                                                               | CONSOLIDATED BALANCE SHEETS               
|                                                                                               | CONSOLIDATED STATEMENTS OF INCOME         
|                                                                                               | CONSOLIDATED STATEMENTS OF CASH FLOWS     
|                                                                                               | NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations.
|Item 3. Quantitative and Qualitative Disclosures About Market Risk.                           
|Item 4. Controls and Procedures.                                                              
|Part II--OTHER INFORMATION                                                                    
|Item 1. Legal Proceedings.                                                                    
|Item 6. Exhibits and Reports on Form 8-K.                                                     
|SIGNATURES                                                                                    
|EX-10.1 Third Amendment to Employees 401(k) Plan                                              
|EX-10.2 Form of Director Indemnification Agreement                                            
|EX-10.3 Form of Officer Indemnification Agreement                                             
|EX-31.1 Certifications of R. Michael Rouleau                                                  
|EX-31.2 Certifications of Jeffrey N. Boyer                                                    
|EX-32.1 Certification Pursuant to Section 906                                                 



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##### Table of Contents



MICHAELS STORES, INC.

FORM 10-Q


Part IFINANCIAL
INFORMATION

|                          |  |                                                                                                                                   |  |   
|------------------------- |  | --------------------------------------------------------------------------------------------------------------------------------- |  | --
|Item 1.                   |  | Financial Statements                                                                                                              |  |   
|                          |  | Consolidated Balance Sheets at November 1,
    2003 and February 1, 2003 (unaudited)                                              |  | 3 
|                          |  | Consolidated Statements of Income for the quarter
    and nine months ended November 1, 2003 and November 2,
    2002 (unaudited) |  | 4 
|                          |  | Consolidated Statements of Cash Flows for the
    nine months ended November 1, 2003 and November 2,
    2002 (unaudited)         |  | 5 
|                          |  | Notes to Consolidated Financial Statements
    (unaudited)                                                                        |  | 6 
|Item 2.                   |  | Managements Discussion and Analysis of
    Financial Condition and Results of Operations                                         |  | 12
|Item 3.                   |  | Quantitative and Qualitative Disclosures About
    Market Risk                                                                    |  | 19
|Item 4.                   |  | Controls and Procedures                                                                                                           |  | 19
|Part IIOTHER INFORMATION
|Item 1.                   |  | Legal Proceedings                                                                                                                 |  | 21
|Item 6.                   |  | Exhibits and Reports on
    Form 8-K                                                                                              |  | 22
|Signatures                |  | 23                                                                                                                               

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)


|                                           |                                                                                                                                                                          |                             |           |             |           |   |           |         |           | 
|------------------------------------------ | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | --------------------------- | --------- | ----------- | --------- | - | --------- | ------- | --------- | 
|                                           |                                                                                                                                                                          | November 1,                 |           | February 1,
|                                           |                                                                                                                                                                          | 2003                        |           | 2003       
|                                           |                                                                                                                                                                          |                             |           |            
|                                           |                                                                                                                                                                          |                             |           | (Note 1)   
|ASSETS                                    
|Current assets:                            |                                                                                                                                                                          |                             |           |             |           |   |           |        
|                                           | Cash and equivalents                                                                                                                                                     |                             | $         | 105,477     |           |   | $         | 218,031 |          
|                                           | Merchandise inventories                                                                                                                                                  |                             |           | 1,103,527   |           |   |           | 809,418 |          
|                                           | Prepaid expenses and other                                                                                                                                               |                             |           | 28,979      |           |   |           | 18,639  |          
|                                           | Deferred and prepaid income taxes                                                                                                                                        |                             |           | 20,380      |           |   |           | 20,352  |          
|                                           |                                                                                                                                                                          |                             |           |             |           |   |           |        
|                                           |                                                                                                                                                                          | Total current assets        |           |             | 1,258,363 |   |           |         | 1,066,440 | 
|                                           |                                                                                                                                                                          |                             |           |             |           |   |           |        
|Property and equipment, at cost            |                                                                                                                                                                          |                             | 779,440   |             |           |   | 716,299   |        
|Less accumulated depreciation              |                                                                                                                                                                          |                             | (402,628  | )           |           |   | (348,602  | )      
|                                           |                                                                                                                                                                          |                             |           |             |           |   |           |        
|                                           |                                                                                                                                                                          |                             |           | 376,812     |           |   |           | 367,697 |          
|                                           |                                                                                                                                                                          |                             |           |             |           |   |           |        
|Goodwill                                   |                                                                                                                                                                          |                             | 115,839   |             |           |   | 115,839   |        
|Other assets                               |                                                                                                                                                                          |                             | 13,603    |             |           |   | 10,997    |        
|                                           |                                                                                                                                                                          |                             |           |             |           |   |           |        
|                                           |                                                                                                                                                                          |                             | 129,442   |             |           |   | 126,836   |        
|                                           |                                                                                                                                                                          |                             |           |             |           |   |           |        
|Total assets                               |                                                                                                                                                                          | $                           | 1,764,617 |             |           | $ | 1,560,973 |        
|                                           |                                                                                                                                                                          |                             |           |             |           |   |           |        
|LIABILITIES AND STOCKHOLDERS
    EQUITY  
|Current liabilities:                       |                                                                                                                                                                          |                             |           |             |           |   |           |        
|                                           | Accounts payable                                                                                                                                                         |                             | $         | 220,349     |           |   | $         | 94,764  |          
|                                           | Accrued liabilities and other                                                                                                                                            |                             |           | 189,976     |           |   |           | 181,867 |          
|                                           | Income taxes payable                                                                                                                                                     |                             |           | 3,916       |           |   |           | 22,823  |          
|                                           |                                                                                                                                                                          |                             |           |             |           |   |           |        
|                                           |                                                                                                                                                                          | Total current liabilities   |           |             | 414,241   |   |           |         | 299,454   | 
|                                           |                                                                                                                                                                          |                             |           |             |           |   |           |        
|9 1/4% Senior Notes due 2009               |                                                                                                                                                                          |                             | 200,000   |             |           |   | 200,000   |        
|Deferred income taxes                      |                                                                                                                                                                          |                             | 21,515    |             |           |   | 21,511    |        
|Other long-term liabilities                |                                                                                                                                                                          |                             | 34,004    |             |           |   | 27,981    |        
|                                           |                                                                                                                                                                          |                             |           |             |           |   |           |        
|                                           |                                                                                                                                                                          | Total long-term liabilities |           |             | 255,519   |   |           |         | 249,492   | 
|                                           |                                                                                                                                                                          |                             |           |             |           |   |           |        
|                                           |                                                                                                                                                                          |                             | 669,760   |             |           |   | 548,946   |        
|                                           |                                                                                                                                                                          |                             |           |             |           |   |           |        
|Commitments and contingencies              |                                                                                                                                                                          |                             |           |             |           |   |           |        
|Stockholders equity:                      |                                                                                                                                                                          |                             |           |             |           |   |           |        
|                                           | Preferred Stock, $0.10 par value, 2,000,000
    shares authorized; none issued                                                                                           |                             |           |            |           |   |           |        |          
|                                           | Common Stock, $0.10 par value, 150,000,000 shares
    authorized; shares issued and outstanding of 67,777,804 at
    November 1, 2003 and 67,466,612 at February 1, 2003 |                             |           | 6,778       |           |   |           | 6,747   |          
|                                           | Additional paid-in capital                                                                                                                                               |                             |           | 510,188     |           |   |           | 504,792 |          
|                                           | Retained earnings                                                                                                                                                        |                             |           | 577,891     |           |   |           | 500,488 |          
|                                           |                                                                                                                                                                          |                             |           |             |           |   |           |        
|                                           |                                                                                                                                                                          | Total stockholders equity  |           |             | 1,094,857 |   |           |         | 1,012,027 | 
|                                           |                                                                                                                                                                          |                             |           |             |           |   |           |        
|Total liabilities and stockholders equity |                                                                                                                                                                          | $                           | 1,764,617 |             |           | $ | 1,560,973 |        
|                                           |                                                                                                                                                                          |                             |           |             |           |   |           |        

See accompanying notes to consolidated financial
statements.

3



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MICHAELS STORES, INC.




CONSOLIDATED STATEMENTS OF INCOME


(In thousands, except per share
data)


(Unaudited)


|                                                                                                               |                                                               |               |         |                   |  |             |         |             |  |   |           |      |  |   |           |      | 
|-------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------- | ------------- | ------- | ----------------- |  | ----------- | ------- | ----------- |  | - | --------- | ---- |  | - | --------- | ---- | 
|                                                                                                               |                                                               |               |         |                  
|                                                                                                               |                                                               | Quarter Ended |         | Nine Months Ended
|                                                                                                               |                                                               |               |         |                  
|                                                                                                               |                                                               | November 1,   |         | November 2,       |  | November 1, |         | November 2,
|                                                                                                               |                                                               | 2003          |         | 2002              |  | 2003        |         | 2002       
|                                                                                                               |                                                               |               |         |                   |  |             |         |            
|Net sales                                                                                                      |                                                               | $             | 755,246 |                   |  | $           | 704,613 |             |  | $ | 2,028,150 |      |  | $ | 1,884,413 |     
|Cost of sales and occupancy expense                                                                            |                                                               |               | 479,471 |                   |  |             | 435,973 |             |  |   | 1,282,807 |      |  |   | 1,187,735 |     
|                                                                                                               |                                                               |               |         |                   |  |             |         |             |  |   |           |      |  |   |           |     
|Gross profit                                                                                                   |                                                               |               | 275,775 |                   |  |             | 268,640 |             |  |   | 745,343   |      |  |   | 696,678   |     
|Selling, general, and administrative expense                                                                   |                                                               |               | 208,474 |                   |  |             | 204,527 |             |  |   | 589,741   |      |  |   | 552,029   |     
|Store pre-opening costs                                                                                        |                                                               |               | 3,702   |                   |  |             | 3,546   |             |  |   | 7,045     |      |  |   | 7,353     |     
|                                                                                                               |                                                               |               |         |                   |  |             |         |             |  |   |           |      |  |   |           |     
|Operating income                                                                                               |                                                               |               | 63,599  |                   |  |             | 60,567  |             |  |   | 148,557   |      |  |   | 137,296   |     
|Interest expense                                                                                               |                                                               |               | 5,049   |                   |  |             | 5,668   |             |  |   | 15,185    |      |  |   | 15,897    |     
|Other (income) and expense, net                                                                                |                                                               |               | 77      |                   |  |             | 73      |             |  |   | (1,501    | )    |  |   | (1,210    | )   
|                                                                                                               |                                                               |               |         |                   |  |             |         |             |  |   |           |      |  |   |           |     
|Income before income taxes and cumulative
    effect of accounting change                                      |                                                               |               | 58,473  |                   |  |             | 54,826  |             |  |   | 134,873   |      |  |   | 122,609   |     
|Provision for income taxes                                                                                     |                                                               |               | 20,265  |                   |  |             | 22,478  |             |  |   | 51,589    |      |  |   | 50,269    |     
|                                                                                                               |                                                               |               |         |                   |  |             |         |             |  |   |           |      |  |   |           |     
|Income before cumulative effect of accounting
    change                                                       |                                                               |               | 38,208  |                   |  |             | 32,348  |             |  |   | 83,284    |      |  |   | 72,340    |     
|Cumulative effect of accounting change for
    cooperative advertising allowances, net of income tax of $5,165 |                                                               |               |        |                   |  |             |        |             |  |   |          |      |  |   | 7,433     |     
|                                                                                                               |                                                               |               |         |                   |  |             |         |             |  |   |           |      |  |   |           |     
|Net income                                                                                                     |                                                               | $             | 38,208  |                   |  | $           | 32,348  |             |  | $ | 83,284    |      |  | $ | 64,907    |     
|                                                                                                               |                                                               |               |         |                   |  |             |         |             |  |   |           |      |  |   |           |     
|Basic earnings per common share:                                                                               |                                                               |               |         |                   |  |             |         |             |  |   |           |      |  |   |           |     
|                                                                                                               | Income before cumulative effect of accounting
    change      |               | $       | 0.57              |  |             | $       | 0.48        |  |   | $         | 1.24 |  |   | $         | 1.09 | 
|                                                                                                               | Cumulative effect of accounting change, net of
    income tax |               |         |                  |  |             |         |            |  |   |           |     |  |   |           | 0.11 | 
|                                                                                                               |                                                               |               |         |                   |  |             |         |             |  |   |           |      |  |   |           |     
|                                                                                                               | Net income                                                    |               | $       | 0.57              |  |             | $       | 0.48        |  |   | $         | 1.24 |  |   | $         | 0.98 | 
|                                                                                                               |                                                               |               |         |                   |  |             |         |             |  |   |           |      |  |   |           |     
|Diluted earnings per common share:                                                                             |                                                               |               |         |                   |  |             |         |             |  |   |           |      |  |   |           |     
|                                                                                                               | Income before cumulative effect of accounting
    change      |               | $       | 0.54              |  |             | $       | 0.46        |  |   | $         | 1.19 |  |   | $         | 1.02 | 
|                                                                                                               | Cumulative effect of accounting change, net of
    income tax |               |         |                  |  |             |         |            |  |   |           |     |  |   |           | 0.10 | 
|                                                                                                               |                                                               |               |         |                   |  |             |         |             |  |   |           |      |  |   |           |     
|                                                                                                               | Net income                                                    |               | $       | 0.54              |  |             | $       | 0.46        |  |   | $         | 1.19 |  |   | $         | 0.92 | 
|                                                                                                               |                                                               |               |         |                   |  |             |         |             |  |   |           |      |  |   |           |     
|Cash dividends per share                                                                                       |                                                               | $             | 0.10    |                   |  | $           |        |             |  | $ | 0.20      |      |  | $ |          |     
|                                                                                                               |                                                               |               |         |                   |  |             |         |             |  |   |           |      |  |   |           |     

See accompanying notes to consolidated financial
statements.

4



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MICHAELS STORES, INC.




CONSOLIDATED STATEMENTS OF CASH
FLOWS


(In thousands)


(Unaudited)


|                                                |                                                   |                                                                                                           |                                 |                                                         |        |          |          |         |        |          |          |  
|----------------------------------------------- | ------------------------------------------------- | --------------------------------------------------------------------------------------------------------- | ------------------------------- | ------------------------------------------------------- | ------ | -------- | -------- | ------- | ------ | -------- | -------- | -
|                                                |                                                   |                                                                                                          
|                                                |                                                   | Nine Months Ended                                                                                        
|                                                |                                                   |                                                                                                          
|                                                |                                                   | November 1,                                                                                               |                                 | November 2,                                            
|                                                |                                                   | 2003                                                                                                      |                                 | 2002                                                   
|                                                |                                                   |                                                                                                           |                                 |                                                        
|Operating activities:                           |                                                   |                                                                                                           |                                 |                                                         |        |          |          |        
|                                                | Net income                                        |                                                                                                           | $                               | 83,284                                                  |        |          | $        | 64,907  |       
|                                                | Adjustments:                                      |                                                                                                           |                                 |                                                         |        |          |          |         |       
|                                                |                                                   | Depreciation                                                                                              |                                 |                                                         | 61,632 |          |          |         | 59,047 |         
|                                                |                                                   | Amortization                                                                                              |                                 |                                                         | 299    |          |          |         | 301    |         
|                                                |                                                   | Non-cash charge for the cumulative effect of
    accounting change for cooperative advertising allowances |                                 |                                                         |       |          |          |         | 12,598 |         
|                                                |                                                   | Other                                                                                                     |                                 |                                                         | 844    |          |          |         | 821    |         
|                                                |                                                   | Changes in assets and liabilities:                                                                        |                                 |                                                         |        |          |          |         |        |         
|                                                |                                                   |                                                                                                           | Merchandise inventories         |                                                         |        | (294,109 | )        |         |        | (364,026 | )       
|                                                |                                                   |                                                                                                           | Prepaid expenses and other      |                                                         |        | (10,340  | )        |         |        | (521     | )       
|                                                |                                                   |                                                                                                           | Deferred income taxes and other |                                                         |        | 2,435    |          |         |        | 4,535    |         
|                                                |                                                   |                                                                                                           | Accounts payable                |                                                         |        | 125,585  |          |         |        | 65,148   |         
|                                                |                                                   |                                                                                                           | Income taxes payable            |                                                         |        | (6,432   | )        |         |        | (36,715  | )       
|                                                |                                                   |                                                                                                           | Accrued liabilities and other   |                                                         |        | 14,036   |          |         |        | 21,707   |         
|                                                |                                                   |                                                                                                           |                                 |                                                         |        |          |          |        
|                                                |                                                   |                                                                                                           |                                 | Net change in assets and liabilities                    |        |          | (168,825 | )       |        |          | (309,872 | )
|                                                |                                                   |                                                                                                           |                                 |                                                         |        |          |          |        
|                                                |                                                   |                                                                                                           |                                 | Net cash used in operating activities                   |        |          | (22,766  | )       |        |          | (172,198 | )
|                                                |                                                   |                                                                                                           |                                 |                                                         |        |          |          |        
|Investing activities:                           |                                                   |                                                                                                           |                                 |                                                         |        |          |          |        
|                                                | Additions to property and equipment               |                                                                                                           |                                 | (69,333                                                 | )      |          |          | (88,826 | )     
|                                                | Net proceeds from sales of property and equipment |                                                                                                           |                                 | 31                                                      |        |          |          | 14      |       
|                                                |                                                   |                                                                                                           |                                 |                                                         |        |          |          |        
|                                                |                                                   |                                                                                                           |                                 | Net cash used in investing activities                   |        |          | (69,302  | )       |        |          | (88,812  | )
|                                                |                                                   |                                                                                                           |                                 |                                                         |        |          |          |        
|Financing activities:                           |                                                   |                                                                                                           |                                 |                                                         |        |          |          |        
|                                                | Proceeds from stock options exercised             |                                                                                                           |                                 | 28,556                                                  |        |          |          | 34,407  |       
|                                                | Proceeds from issuance of Common Stock and other  |                                                                                                           |                                 | 1,766                                                   |        |          |          | 1,473   |       
|                                                | Net borrowings under the Credit Agreement         |                                                                                                           |                                 |                                                        |        |          |          | 90,000  |       
|                                                | Repurchase of Common Stock                        |                                                                                                           |                                 | (37,369                                                 | )      |          |          | (12,821 | )     
|                                                | Cash dividends paid to stockholders               |                                                                                                           |                                 | (13,439                                                 | )      |          |          |        |       
|                                                | Payment of other long-term liabilities            |                                                                                                           |                                 |                                                        |        |          |          | (200    | )     
|                                                |                                                   |                                                                                                           |                                 |                                                         |        |          |          |        
|                                                |                                                   |                                                                                                           |                                 | Net cash (used in) provided by financing
    activities |        |          | (20,486  | )       |        |          | 112,859  |  
|                                                |                                                   |                                                                                                           |                                 |                                                         |        |          |          |        
|Net decrease in cash and equivalents            |                                                   |                                                                                                           | (112,554                        | )                                                       |        |          | (148,151 | )      
|Cash and equivalents at beginning of
    period |                                                   |                                                                                                           | 218,031                         |                                                         |        |          | 193,025  |        
|                                                |                                                   |                                                                                                           |                                 |                                                         |        |          |          |        
|Cash and equivalents at end of
    period       |                                                   | $                                                                                                         | 105,477                         |                                                         |        | $        | 44,874   |        
|                                                |                                                   |                                                                                                           |                                 |                                                         |        |          |          |        

See accompanying notes to consolidated financial
statements.

5



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##### Table of Contents



MICHAELS STORES, INC.




NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS


For the Nine Months Ended November 1,
2003

(Unaudited)




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

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

The accompanying unaudited consolidated financial
statements have been prepared in accordance with generally
accepted accounting principles for interim financial information
and with the instructions to Form 10-Q and Article 10
of Regulation S-X. Accordingly, they do not include all of
the information and notes required by generally accepted
accounting principles for complete financial statements. In the
opinion of management, all adjustments (consisting of normal
recurring accruals and other items, as disclosed) considered
necessary for a fair presentation have been included. Because of
the seasonal nature of our business, the results of operations
for the quarter and nine months ended November 1, 2003 are
not indicative of the results to be expected for the entire year.

The balance sheet at February 1, 2003 has
been derived from the audited financial statements at that date
but does not include all of the information and notes required
by generally accepted accounting principles for complete
financial statements. For further information, refer to the
consolidated financial statements and notes thereto included in
our Annual Report on Form 10-K for the fiscal year ended
February 1, 2003.

All references herein to fiscal 2003
relate to the 52 weeks ending January 31, 2004 and all
references to fiscal 2002 relate to the
52 weeks ended February 1, 2003. In addition, all
references herein to the third quarter of fiscal
2003 and the first nine months of fiscal 2003
relate to the 13 and 39 weeks ended November 1, 2003,
respectively, and all references to the third quarter of
fiscal 2002 and the first nine months of fiscal
2002 relate to the 13 and 39 weeks ended
November 2, 2002, respectively.



|        |                                    
|------- | -----------------------------------
|Note 2. | Change in Effective Income Tax Rate

During the third quarter of fiscal 2003, we
resolved certain tax issues pending with the Internal Revenue
Service. As a result, our effective tax rate for fiscal 2003 is
expected to be 38.25%. In the first two quarters of fiscal 2003,
we recorded our tax liability at an effective tax rate of 41%.
In the third quarter of fiscal 2003, we recorded our tax
liability at an effective tax rate of 34.7%, which adjusted the
effective tax rate for the first nine months of fiscal 2003 to
38.25%. Our effective tax rate for the third quarter and first
nine months of fiscal 2002 was 41%.



|        |                               
|------- | ------------------------------
|Note 3. | Change in Accounting Principle

In November 2002, the EITF reached consensus on
Issue 02-16, Accounting by a Customer (Including a
Reseller) for Cash Consideration Received from a Vendor.
Issue 02-16 addresses the accounting for cash consideration
received by a customer from a vendor (e.g., slotting fees,
cooperative advertising payments, buydowns) and rebates or
refunds from a vendor that are payable only if the customer
completes a specified cumulative level of purchases or remains a
customer for a specified time period. Issue 02-16 became
effective for new arrangements or modifications to existing
arrangements entered into after December 31, 2002, although
early adoption was permitted. We elected to adopt early,
effective February 3, 2002, the provisions of
Issue 02-16 in the preparation of our Annual Report on

6



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##### Table of Contents



MICHAELS STORES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)


For the Nine Months Ended November 1,
2003

(Unaudited)


Form 10-K for the fiscal year ended
February 1, 2003. Accordingly, in fiscal 2002, we recorded
a cumulative effect of accounting change of $12.6 million,
$7.4 million net of income tax, for the impact of this
adoption on prior fiscal years. The adoption of the provisions
of Issue 02-16 resulted in the ongoing deferral of our
cooperative advertising allowances into inventory, with the
allowances being recognized as the associated inventory is sold.
This adoption also resulted in the reclassification of our
cooperative advertising payments earned in fiscal 2002 from
selling, general, and administrative expense to cost of sales
and occupancy expense retroactively as of the beginning of
fiscal 2002. Results for the third quarter and first nine months
of fiscal 2002 have been restated to reflect our new accounting
policy for cooperative advertising allowances and, as a result,
income before cumulative effect of accounting change for the
third quarter and first nine months of fiscal 2002 was reduced
by $645,000 and $2.8 million, respectively.



|        |                   
|------- | ------------------
|Note 4. | Earnings per Share

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

|                                   |                                                                                                                |                                       |   |                   |       |             |   |             |       |  |   |        |       |  |   |        |       | 
|---------------------------------- | -------------------------------------------------------------------------------------------------------------- | ------------------------------------- | - | ----------------- | ----- | ----------- | - | ----------- | ----- |  | - | ------ | ----- |  | - | ------ | ----- | 
|                                   |                                                                                                                |                                       |   |                  
|                                   |                                                                                                                | Quarter Ended                         |   | Nine Months Ended
|                                   |                                                                                                                |                                       |   |                  
|                                   |                                                                                                                | November 1,                           |   | November 2,       |       | November 1, |   | November 2,
|                                   |                                                                                                                | 2003                                  |   | 2002              |       | 2003        |   | 2002       
|                                   |                                                                                                                |                                       |   |                   |       |             |   |            
|                                   |                                                                                                                |                                      
|                                   |                                                                                                                | (In thousands, except per share data)
|Numerator:                         |                                                                                                                |                                       |   |                   |       |             |   |             |       |  |   |        |       |  |   |       
|                                   | Income before cumulative effect of accounting
    change                                                       |                                       | $ | 38,208            |       |             | $ | 32,348      |       |  | $ | 83,284 |       |  | $ | 72,340 |      
|                                   | Cumulative effect of accounting change, net of
    income tax                                                  |                                       |   |                  |       |             |   |            |       |  |   |       |       |  |   | 7,433  |      
|                                   |                                                                                                                |                                       |   |                   |       |             |   |             |       |  |   |        |       |  |   |       
|                                   | Net income                                                                                                     |                                       | $ | 38,208            |       |             | $ | 32,348      |       |  | $ | 83,284 |       |  | $ | 64,907 |      
|                                   |                                                                                                                |                                       |   |                   |       |             |   |             |       |  |   |        |       |  |   |       
|Denominator:                       |                                                                                                                |                                       |   |                   |       |             |   |             |       |  |   |        |       |  |   |       
|                                   | Denominator for basic earnings per common share-
    weighted average shares                                   |                                       |   | 67,311            |       |             |   | 66,830      |       |  |   | 67,022 |       |  |   | 66,381 |      
|                                   | Effect of dilutive securities:                                                                                 |                                       |   |                   |       |             |   |             |       |  |   |        |       |  |   |        |      
|                                   |                                                                                                                | Employee stock options                |   |                   | 3,538 |             |   |             | 4,240 |  |   |        | 2,940 |  |   |        | 4,231 | 
|                                   |                                                                                                                |                                       |   |                   |       |             |   |             |       |  |   |        |       |  |   |       
|                                   | Denominator for diluted earnings per common
    share-weighted average shares adjusted for dilutive securities |                                       |   | 70,849            |       |             |   | 71,070      |       |  |   | 69,962 |       |  |   | 70,612 |      
|                                   |                                                                                                                |                                       |   |                   |       |             |   |             |       |  |   |        |       |  |   |       
|Basic earnings per common share:   |                                                                                                                |                                       |   |                   |       |             |   |             |       |  |   |        |       |  |   |       
|                                   | Income before cumulative effect of accounting
    change                                                       |                                       | $ | 0.57              |       |             | $ | 0.48        |       |  | $ | 1.24   |       |  | $ | 1.09   |      
|                                   | Cumulative effect of accounting change, net of
    income tax                                                  |                                       |   |                  |       |             |   |            |       |  |   |       |       |  |   | 0.11   |      
|                                   |                                                                                                                |                                       |   |                   |       |             |   |             |       |  |   |        |       |  |   |       
|                                   | Net income                                                                                                     |                                       | $ | 0.57              |       |             | $ | 0.48        |       |  | $ | 1.24   |       |  | $ | 0.98   |      
|                                   |                                                                                                                |                                       |   |                   |       |             |   |             |       |  |   |        |       |  |   |       
|Diluted earnings per common share: |                                                                                                                |                                       |   |                   |       |             |   |             |       |  |   |        |       |  |   |       
|                                   | Income before cumulative effect of accounting
    change                                                       |                                       | $ | 0.54              |       |             | $ | 0.46        |       |  | $ | 1.19   |       |  | $ | 1.02   |      
|                                   | Cumulative effect of accounting change, net of
    income tax                                                  |                                       |   |                  |       |             |   |            |       |  |   |       |       |  |   | 0.10   |      
|                                   |                                                                                                                |                                       |   |                   |       |             |   |             |       |  |   |        |       |  |   |       
|                                   | Net income                                                                                                     |                                       | $ | 0.54              |       |             | $ | 0.46        |       |  | $ | 1.19   |       |  | $ | 0.92   |      
|                                   |                                                                                                                |                                       |   |                   |       |             |   |             |       |  |   |        |       |  |   |       

7



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##### Table of Contents



MICHAELS STORES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)


For the Nine Months Ended November 1,
2003

(Unaudited)




|        |                               
|------- | ------------------------------
|Note 4. | Earnings per Share (Continued)

Our purchase and subsequent retirement of
1.0 million and 264,900 shares of our Common Stock in the
first and third quarters of fiscal 2003, respectively, reduced
the number of weighted average shares outstanding by
1.1 million and 829,000 shares for the third quarter and
first nine months of fiscal 2003, respectively.



|        |                         
|------- | ------------------------
|Note 5. | Stock-Based Compensation

We have elected to follow Accounting Principles
Board Opinion No. 25, Accounting for Stock Issued to
Employees, and related guidance in accounting for our
employee stock options. The exercise price of our employee stock
options equals the market price of the underlying stock on the
date of grant and, as a result, we do not recognize compensation
expense for stock option grants.

Pro forma information regarding net income and
earnings per common share, as required by the provisions of
Statement of Financial Accounting Standards No. 123,
Accounting for Stock-Based Compensation, and SFAS
No. 148, Accounting for Stock-Based
Compensation-Transition and Disclosure, has been determined
as if we had accounted for our employee stock options under the
fair value method.

For purposes of pro forma disclosures, the
estimated fair value of the options is amortized over the
options vesting periods. Our pro forma information is as
follows:

|                                                   |                                                                 |                                       |        |                   |  |             |        |             |  |   |        |        |  |   |        |        | 
|-------------------------------------------------- | --------------------------------------------------------------- | ------------------------------------- | ------ | ----------------- |  | ----------- | ------ | ----------- |  | - | ------ | ------ |  | - | ------ | ------ | 
|                                                   |                                                                 |                                       |        |                  
|                                                   |                                                                 | Quarter Ended                         |        | Nine Months Ended
|                                                   |                                                                 |                                       |        |                  
|                                                   |                                                                 | November 1,                           |        | November 2,       |  | November 1, |        | November 2,
|                                                   |                                                                 | 2003                                  |        | 2002              |  | 2003        |        | 2002(1)    
|                                                   |                                                                 |                                       |        |                   |  |             |        |            
|                                                   |                                                                 |                                      
|                                                   |                                                                 | (In thousands, except per share data)
|Net income, as reported                            |                                                                 | $                                     | 38,208 |                   |  | $           | 32,348 |             |  | $ | 83,284 |        |  | $ | 64,907 |       
|Stock-based employee compensation cost:            |                                                                 |                                       |        |                   |  |             |        |             |  |   |        |        |  |   |        |       
|                                                   | As if the fair value method were applied, net of
    income tax |                                       |        | 5,081             |  |             |        | 4,078       |  |   |        | 11,722 |  |   |        | 10,123 | 
|                                                   |                                                                 |                                       |        |                   |  |             |        |             |  |   |        |        |  |   |        |       
|Pro forma net income                               |                                                                 | $                                     | 33,127 |                   |  | $           | 28,270 |             |  | $ | 71,562 |        |  | $ | 54,784 |       
|                                                   |                                                                 |                                       |        |                   |  |             |        |             |  |   |        |        |  |   |        |       
|Earnings per common share, as
    reported:        |                                                                 |                                       |        |                   |  |             |        |             |  |   |        |        |  |   |        |       
|                                                   | Basic                                                           |                                       | $      | 0.57              |  |             | $      | 0.48        |  |   | $      | 1.24   |  |   | $      | 0.98   | 
|                                                   |                                                                 |                                       |        |                   |  |             |        |             |  |   |        |        |  |   |        |       
|                                                   | Diluted                                                         |                                       | $      | 0.54              |  |             | $      | 0.46        |  |   | $      | 1.19   |  |   | $      | 0.92   | 
|                                                   |                                                                 |                                       |        |                   |  |             |        |             |  |   |        |        |  |   |        |       
|Pro forma earnings per common share:               |                                                                 |                                       |        |                   |  |             |        |             |  |   |        |        |  |   |        |       
|                                                   | Basic                                                           |                                       | $      | 0.49              |  |             | $      | 0.42        |  |   | $      | 1.07   |  |   | $      | 0.83   | 
|                                                   |                                                                 |                                       |        |                   |  |             |        |             |  |   |        |        |  |   |        |       
|                                                   | Diluted                                                         |                                       | $      | 0.48              |  |             | $      | 0.41        |  |   | $      | 1.05   |  |   | $      | 0.80   | 
|                                                   |                                                                 |                                       |        |                   |  |             |        |             |  |   |        |        |  |   |        |       
|Pro forma weighted average shares
    outstanding: |                                                                 |                                       |        |                   |  |             |        |             |  |   |        |        |  |   |        |       
|                                                   | Basic                                                           |                                       |        | 67,311            |  |             |        | 66,830      |  |   |        | 67,022 |  |   |        | 66,381 | 
|                                                   | Diluted                                                         |                                       |        | 68,998            |  |             |        | 69,071      |  |   |        | 68,184 |  |   |        | 68,563 | 



---



|    |                                                                                                                                                                                                                               
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | The net income amount for the first nine months
    of fiscal 2002 includes the cumulative effect of the change in
    accounting principle, net of income tax, related to cooperative
    advertising allowances. See Note 2.

8



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##### Table of Contents



MICHAELS STORES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)


For the Nine Months Ended November 1,
2003

(Unaudited)




|        |                 
|------- | ----------------
|Note 6. | Credit Agreement

Effective May 1, 2001, we signed a
$200 million unsecured revolving bank credit facility with
Fleet National Bank and other lending institutions. The Credit
Agreement had an original term of three years (with a maturity
extension for one additional year available under certain
conditions) and contains a $25 million competitive bid
feature and a $70 million letter of credit sub-facility.
Effective May 21, 2002, pursuant to the terms of the Credit
Agreement, our lenders agreed to extend the term of the Credit
Agreement from April 30, 2004 to April 30, 2005.

We are in compliance with all terms and
conditions of the Credit Agreement. No borrowings were
outstanding under the Credit Agreement as of November 1,
2003 or at any time during the first nine months of fiscal 2003.
Borrowings outstanding under the Credit Agreement were
$90.0 million as of November 2, 2002. Borrowings
available under the Credit Agreement are reduced by the
aggregate amount of letters of credit outstanding under the
Credit Agreement ($26.2 million as of November 1,
2003).



|        |                  
|------- | -----------------
|Note 7. | Legal Proceedings



| |            
| | -----------
| | Brown Claim

On April 17, 2003, Donald Brown, Thomas
Lamour, and Sau Yeung, acting on behalf of themselves and the
general public, filed a putative class action in the Superior
Court of California for the County of Los Angeles against a
number of employers, including Aaron Brothers, Inc., a
wholly-owned subsidiary of Michaels Stores, Inc. The lawsuit
alleges that the defendants violated California Labor Code
provisions that prohibit employers from requesting job
applicants to disclose prior criminal convictions for specified
marijuana-related infractions or participation in certain
criminal diversionary programs. We believe these claims are
without merit and will vigorously contest them.



| |                          
| | -------------------------
| | Stockholder Class Actions

On various dates between February 4, 2003
and March 25, 2003, 10 purported class action lawsuits were
filed in the United States District Court for the Northern
District of Texas, Dallas Division, against Michaels Stores,
Inc. and certain of the current and former directors and
officers of Michaels. All of these lawsuits have been
consolidated. The suits assert various claims under
Sections 10(b) and 20(a) of the Securities Exchange Act of
1934 related to actions prior to Michaels announcement on
November 7, 2002, that, among other things, it had revised
its outlook for the fourth fiscal quarter of 2002, adjusting
downward its guidance for annual earnings per diluted share. The
complaints charge that, prior to that announcement, Michaels and
certain of the other defendants made misrepresentations and
failed to disclose negative information about the financial
condition of Michaels while the individual defendants were
selling shares of Michaels common stock. We believe these claims
are without merit and will vigorously contest them.



| |                  
| | -----------------
| | Derivative Claims

On March 21, 2003, Julie Fathergill filed a
purported stockholder derivative action, which is pending in the
192nd District Court for Dallas County, Texas. The lawsuit names
certain former and current officers and directors, including all
of Michaels current directors, as individual defendants and
Michaels as a nominal defendant. In this derivative action, the
plaintiff makes allegations of fact similar to those made in the
purported securities class actions described above. The
plaintiff asserts claims against the individual

9



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##### Table of Contents



MICHAELS STORES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)


For the Nine Months Ended November 1,
2003

(Unaudited)




|        |                              
|------- | -----------------------------
|Note 7. | Legal Proceedings (Continued)

defendants for breach of fiduciary duties, abuse
of control, gross mismanagement, waste of corporate assets, and
unjust enrichment. All of these claims are asserted derivatively
on behalf of Michaels. We believe this claim is also without
merit and will vigorously oppose it.

On April 8, 2003, the Chairman of the Board
of Michaels received a demand letter on behalf of Chris Frith, a
purported Michaels stockholder, requesting that the Board
commence an action against certain former and current officers
and directors. The demand letter threatens to file a derivative
lawsuit if an action is not commenced within a reasonable time.
The purported bases of the demand are similar to those made in
the purported stockholder class actions and stockholder
derivative lawsuit described above.

On September 11, 2003, Leo J. Dutil filed a
purported stockholder derivative action, which is pending in the
United States District Court for the Northern District of Texas,
Dallas Division. The lawsuit names certain former and current
officers and directors as individual defendants and Michaels as
a nominal defendant. In this derivative action, the plaintiff
makes allegations of fact similar to those made in the purported
stockholder class actions and the Fathergill derivative lawsuit
described above. The plaintiff asserts claims against the
individual defendants for breach of fiduciary duty,
misappropriation of confidential information, and contribution
and indemnification. All of these claims are asserted
derivatively on behalf of Michaels. We believe this claim is
also without merit and will vigorously oppose it.



| |             
| | ------------
| | Cotton Claim

On December 20, 2002, James Cotton, a former
store manager of Michaels of Canada, ULC, our wholly-owned
subsidiary, and Suzette Kennedy, a former assistant manager of
Michaels of Canada, commenced a proposed class proceeding
against Michaels of Canada and Michaels Stores, Inc. on behalf
of themselves and current and former employees employed in
Canada. The Cotton claim was filed in the Ontario Superior Court
of Justice and alleges that the defendants violated employment
standards legislation in Ontario and other provinces and
territories of Canada by failing to pay overtime compensation as
required by that legislation. The Cotton claim also alleges that
this conduct was in breach of the contracts of employment of
those individuals. The Cotton claim seeks a declaration that the
defendants have acted in breach of applicable legislation,
payment to current and former employees for overtime, damages
for breach of contract, punitive, aggravated and exemplary
damages, interest, and costs. We believe we have certain
meritorious defenses and intend to defend this lawsuit
vigorously.



| |        
| | -------
| | General

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



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

In May 2003, the Financial Accounting Standards
Board issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities, which amends
and clarifies the accounting for derivative instruments,
including certain derivative instruments embedded in other
contracts, and for hedging activities under SFAS No. 133.
SFAS No. 149 is effective for contracts entered into or

10



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##### Table of Contents



MICHAELS STORES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)


For the Nine Months Ended November 1,
2003

(Unaudited)




|        |                                                 
|------- | ------------------------------------------------
|Note 8. | Recent Accounting Pronouncements
    (Continued)

modified after June 30, 2003. The adoption
of the provisions of SFAS No. 149 had no material impact on
our operating results or financial position.

In December 2002, the FASB issued SFAS
No. 148, Accounting for Stock-Based Compensation
Transition and Disclosure, as an amendment to SFAS
No. 123 and to provide alternative methods of transition
for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. In addition,
SFAS No. 148 amends the disclosure requirements of SFAS
No. 123 to require prominent disclosures in both annual and
interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method
used on reported results. Our policy is to account for
stock-based employee compensation using the intrinsic value
method in accordance with APB Opinion No. 25. Prior to the
adoption of the disclosure provisions of SFAS No. 148, we
reported the pro forma effect of the fair value method of
accounting for stock-based employee compensation under the
provisions of SFAS No. 123. We adopted the disclosure
provisions of SFAS No. 148 in the preparation of our Annual
Report on Form 10-K for the fiscal year ended
February 1, 2003. While this adoption does not change our
policy of accounting for stock-based employee compensation using
the intrinsic value method, we have disclosed our stock-based
employee compensation in Note 4 and have revised our
presentation format of the pro forma effect of the fair value
method of accounting.

11



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##### Table of Contents








|        |                                                                                           
|------- | ------------------------------------------------------------------------------------------
|Item 2. | Managements Discussion and Analysis of
    Financial Condition and Results of Operations.

The following discussion should be read in
conjunction with our consolidated financial statements and
related notes included elsewhere in this Quarterly Report on
Form 10-Q. The following discussion, as well as other
portions of this Quarterly Report on Form 10-Q, contains
forward-looking statements that reflect our plans, estimates,
and beliefs. Any statements contained herein (including, but not
limited to, statements to the effect that Michaels or its
management anticipates, plans,
estimates, expects,
believes, and other similar expressions) that are
not statements of historical fact should be considered
forward-looking statements and should be read in conjunction
with our consolidated financial statements and related notes in
our Annual Report on Form 10-K for the fiscal year ended
February 1, 2003. Specific examples of forward-looking
statements include, but are not limited to, statements regarding
our future cash dividend policy, forecasts of capital
expenditures, working capital requirements, and stock
repurchases. Our actual results could materially differ from
those discussed in these forward-looking statements. Factors
that could cause or contribute to such differences include, but
are not limited to, those discussed in our Annual Report on
Form 10-K for the fiscal year ended February 1, 2003,
and particularly in Risk Factors, and in our other
Securities and Exchange Commission filings.

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

General

All references herein to fiscal 2003
relate to the 52 weeks ending January 31, 2004 and all
references to fiscal 2002 relate to the
52 weeks ended February 1, 2003. In addition, all
references herein to the third quarter of fiscal
2003 and the first nine months of fiscal 2003
relate to the 13 and 39 weeks ended November 1, 2003,
respectively, and all references to the third quarter of
fiscal 2002 and the first nine months of fiscal
2002 relate to the 13 and 39 weeks ended
November 2, 2002, respectively.

12



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##### Table of Contents



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

|                                   |                                           |               |   |                   |   |             |   |             |   |  |   |       |   |  |   |       |  
|---------------------------------- | ----------------------------------------- | ------------- | - | ----------------- | - | ----------- | - | ----------- | - |  | - | ----- | - |  | - | ----- | -
|                                   |                                           |               |   |                  
|                                   |                                           | Quarter Ended |   | Nine Months Ended
|                                   |                                           |               |   |                  
|                                   |                                           | November 1,   |   | November 2,       |   | November 1, |   | November 2,
|                                   |                                           | 2003          |   | 2002              |   | 2003        |   | 2002       
|                                   |                                           |               |   |                   |   |             |   |            
|Michaels stores:                   |                                           |               |   |                   |   |             |   |             |   |  |   |       |   |  |   |      
|                                   | Retail stores open at end of period       |               |   | 798               |   |             |   | 756         |   |  |   | 798   |   |  |   | 756   |  
|                                   | Retail stores opened during the period    |               |   | 25                |   |             |   | 28          |   |  |   | 47    |   |  |   | 64    |  
|                                   | Retail stores closed during the period    |               |   |                  |   |             |   |            |   |  |   | 1     |   |  |   | 3     |  
|                                   | Retail stores relocated during the period |               |   | 7                 |   |             |   | 9           |   |  |   | 16    |   |  |   | 18    |  
|Aaron Brothers stores:             |                                           |               |   |                   |   |             |   |             |   |  |   |       |   |  |   |      
|                                   | Retail stores open at end of period       |               |   | 158               |   |             |   | 148         |   |  |   | 158   |   |  |   | 148   |  
|                                   | Retail stores opened during the period    |               |   | 1                 |   |             |   | 2           |   |  |   | 10    |   |  |   | 12    |  
|                                   | Retail stores closed during the period    |               |   |                  |   |             |   | 1           |   |  |   |      |   |  |   | 3     |  
|                                   | Retail stores relocated during the period |               |   |                  |   |             |   |            |   |  |   |      |   |  |   | 1     |  
|Village Crafts by Michaels stores: |                                           |               |   |                   |   |             |   |             |   |  |   |       |   |  |   |      
|                                   | Retail stores open at end of period       |               |   | 11                |   |             |   | 3           |   |  |   | 11    |   |  |   | 3     |  
|                                   | Retail stores opened during the period    |               |   | 3                 |   |             |   | 2           |   |  |   | 8     |   |  |   | 3     |  
|ReCollections stores:              |                                           |               |   |                   |   |             |   |             |   |  |   |       |   |  |   |      
|                                   | Retail stores open at end of period       |               |   | 2                 |   |             |   |            |   |  |   | 2     |   |  |   |      |  
|                                   | Retail stores opened during the period    |               |   | 1                 |   |             |   |            |   |  |   | 2     |   |  |   |      |  
|Star Wholesale stores:             |                                           |               |   |                   |   |             |   |             |   |  |   |       |   |  |   |      
|                                   | Wholesale stores open at end of period    |               |   | 2                 |   |             |   | 1           |   |  |   | 2     |   |  |   | 1     |  
|                                   | Wholesale stores opened during the period |               |   | 1                 |   |             |   |            |   |  |   | 1     |   |  |   |      |  
|Other operating data:              |                                           |               |   |                   |   |             |   |             |   |  |   |       |   |  |   |      
|                                   | Average inventory per Michaels store(1)   |               | $ | 1,313             |   |             | $ | 1,351       |   |  | $ | 1,313 |   |  | $ | 1,351 |  
|                                   | Comparable store sales increase(2)        |               |   | 2                 | % |             |   | 6           | % |  |   | 2     | % |  |   | 7     | %



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Average inventory per Michaels store calculation
    includes Michaels and Village Crafts by Michaels stores, but
    excludes 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 that were relocated or expanded
    during either period. A store is deemed to become comparable in
    its 14th full month of operation in order to eliminate grand
    opening sales distortions. Beginning in fiscal 2003, we began
    including the effect of deferring the recognition of custom
    frame sales for orders that have not been picked up by the
    customer at the end of the period in our comparable store sales
    calculation. As a result, we have retroactively applied the
    custom frame sales deferral to our comparable store sales
    increase for the third quarter and first nine months of fiscal
    2002. There was no change in the comparable store sales increase
    percentage for the third quarter and first nine months of fiscal
    2002 from the amount previously reported as a result of this
    adjustment.

Change in Accounting Principle

In November 2002, the EITF reached consensus on
Issue 02-16, Accounting by a Customer (Including a
Reseller) for Cash Consideration Received from a Vendor.
Issue 02-16 addresses the accounting for cash consideration
received by a customer from a vendor (e.g., slotting fees,
cooperative advertising payments, buydowns) and rebates or
refunds from a vendor that are payable only if the customer
completes a specified cumulative level of purchases or remains a
customer for a specified time period. Issue 02-16 became
effective for new arrangements or modifications to existing
arrangements entered into after December 31, 2002, although
early adoption was permitted. We elected to adopt early,
effective February 3, 2002, the provisions of
Issue 02-16 in the preparation of our Annual Report on
Form 10-K for the fiscal year ended February 1, 2003.
Accordingly, in fiscal 2002, we recorded a

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cumulative effect of accounting change of
$12.6 million, $7.4 million net of income tax, for the
impact of this adoption on prior fiscal years. The adoption of
the provisions of Issue 02-16 resulted in the ongoing
deferral of our cooperative advertising allowances into
inventory, with the allowances being recognized as the
associated inventory is sold. This adoption also resulted in the
reclassification of our cooperative advertising payments earned
in fiscal 2002 from selling, general, and administrative expense
to cost of sales and occupancy expense retroactively as of the
beginning of fiscal 2002. Results for the third quarter and
first nine months of fiscal 2002 have been restated to reflect
our new accounting policy for cooperative advertising allowances
and, as a result, income before cumulative effect of accounting
change for the third quarter and first nine months of fiscal
2002 was reduced by $645,000 and $2.8 million, respectively.


Results of Operations

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

|                                                                                                         |  |               |       |                   |  |             |       |             |  |  |       |   |  |  |       |  
|-------------------------------------------------------------------------------------------------------- |  | ------------- | ----- | ----------------- |  | ----------- | ----- | ----------- |  |  | ----- | - |  |  | ----- | -
|                                                                                                         |  |               |       |                  
|                                                                                                         |  | Quarter Ended |       | Nine Months Ended
|                                                                                                         |  |               |       |                  
|                                                                                                         |  | November 1,   |       | November 2,       |  | November 1, |       | November 2,
|                                                                                                         |  | 2003          |       | 2002              |  | 2003        |       | 2002       
|                                                                                                         |  |               |       |                   |  |             |       |            
|Net sales                                                                                                |  |               | 100.0 | %                 |  |             | 100.0 | %           |  |  | 100.0 | % |  |  | 100.0 | %
|Cost of sales and occupancy expense                                                                      |  |               | 63.5  |                   |  |             | 61.9  |             |  |  | 63.3  |   |  |  | 63.0  |  
|                                                                                                         |  |               |       |                   |  |             |       |             |  |  |       |   |  |  |       |  
|Gross profit                                                                                             |  |               | 36.5  |                   |  |             | 38.1  |             |  |  | 36.7  |   |  |  | 37.0  |  
|Selling, general, and administrative expense                                                             |  |               | 27.6  |                   |  |             | 29.0  |             |  |  | 29.1  |   |  |  | 29.3  |  
|Store pre-opening costs                                                                                  |  |               | 0.5   |                   |  |             | 0.5   |             |  |  | 0.3   |   |  |  | 0.4   |  
|                                                                                                         |  |               |       |                   |  |             |       |             |  |  |       |   |  |  |       |  
|Operating income                                                                                         |  |               | 8.4   |                   |  |             | 8.6   |             |  |  | 7.3   |   |  |  | 7.3   |  
|Interest expense                                                                                         |  |               | 0.6   |                   |  |             | 0.8   |             |  |  | 0.7   |   |  |  | 0.9   |  
|Other (income) and expense, net                                                                          |  |               | 0.0   |                   |  |             | 0.0   |             |  |  | (0.1  | ) |  |  | (0.1  | )
|                                                                                                         |  |               |       |                   |  |             |       |             |  |  |       |   |  |  |       |  
|Income before income taxes and cumulative
    effect of accounting change                                |  |               | 7.8   |                   |  |             | 7.8   |             |  |  | 6.7   |   |  |  | 6.5   |  
|Provision for income taxes                                                                               |  |               | 2.7   |                   |  |             | 3.2   |             |  |  | 2.6   |   |  |  | 2.7   |  
|                                                                                                         |  |               |       |                   |  |             |       |             |  |  |       |   |  |  |       |  
|Income before cumulative effect of
    accounting change                                                 |  |               | 5.1   |                   |  |             | 4.6   |             |  |  | 4.1   |   |  |  | 3.8   |  
|Cumulative effect of accounting change for
    cooperative
    advertising allowances, net of income tax |  |               |      |                   |  |             |      |             |  |  |      |   |  |  | 0.4   |  
|                                                                                                         |  |               |       |                   |  |             |       |             |  |  |       |   |  |  |       |  
|Net income                                                                                               |  |               | 5.1   | %                 |  |             | 4.6   | %           |  |  | 4.1   | % |  |  | 3.4   | %
|                                                                                                         |  |               |       |                   |  |             |       |             |  |  |       |   |  |  |       |  

Quarter Ended November 1, 2003 Compared
to the Quarter Ended November 2, 2002

Net sales for the third quarter of fiscal 2003
increased $50.6 million, or 7%, over the third quarter of
fiscal 2002. At the end of the third quarter of fiscal 2003, we
operated 798 Michaels, 158 Aaron Brothers, 11 Village Crafts by
Michaels, two ReCollections, and two Star Wholesale stores. The
results for the third quarter of fiscal 2003 included sales from
47 Michaels, 11 Aaron Brothers, eight Village Crafts by
Michaels, two ReCollections, and one Star Wholesale store that
were opened during the 12-month period ended November 1,
2003, more than offsetting lost sales from the closure of five
Michaels and one Aaron Brothers store. Sales at the new stores
(net of closures) during the third quarter of fiscal 2003
accounted for $38.7 million of the increase in net sales.
Comparable store sales increased 2% in the third quarter of
fiscal 2003 compared to the third quarter of fiscal 2002, which
contributed $11.9 million to the net sales increase.
Comparable store sales growth was strongest in our apparel
crafts, seasonal, framing, kids crafts, and art
categories. Customer traffic was essentially flat in the third
quarter of fiscal 2003 compared to the third quarter of fiscal
2002. Average ticket increased approximately 2%, driven
primarily by favorable pricing /product mix trends and a
strengthening of the Canadian dollar (contributing 66 basis
points), partially offset by higher clearance sales levels. Our
ability to continue to generate comparable store sales increases
is dependent, in part, on our ability to continue to maintain
store in-stock positions on the top-

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selling items, to properly allocate merchandise
to our stores, to be successful in our sales promotion efforts,
to anticipate customer demand and trends in the arts and crafts
industry, and to respond to competitors activities.


Cost of sales and occupancy expense, as a
percentage of net sales, for the third quarter of fiscal 2003
was 63.5%, an increase of 1.6% compared to the third quarter of
fiscal 2002. This increase was primarily attributable to lower
merchandise margins as a result of accelerated markdowns in the
third quarter of fiscal 2003 on fall and Halloween seasonal
products as well as specific products in categories that will be
discontinued in connection with our fiscal 2004 planogram
resets. In addition, distribution costs recognized in the third
quarter of fiscal 2003 were higher, as a percentage of net
sales, than in the third quarter of fiscal 2002 as a result of
the timing of merchandise receipts and shipments within our
distribution network. These increases were partially offset by a
decrease in store occupancy costs as a percentage of net sales.

Selling, general, and administrative expense was
$208.5 million, or 27.6% of net sales, in the third quarter
of fiscal 2003 compared with $204.5 million, or 29.0% of
net sales, in the third quarter of fiscal 2002. This decrease,
as a percentage of net sales, was primarily the result of lower
store compensation costs and a leveraging of corporate general
and administrative costs.

We expense all store pre-opening costs as
incurred. Store pre-opening costs were $3.7 million, or
0.5% of net sales, in the third quarter of fiscal 2003 compared
to $3.5 million, or 0.5% of net sales, in the third quarter
of fiscal 2002. In the third quarter of fiscal 2003, we opened
or relocated 32 Michaels, one Aaron Brothers, three Village
Crafts by Michaels, one ReCollections, and one Star Wholesale
store compared to 37 Michaels, two Aaron Brothers, and two
Village Crafts by Michaels stores opened or relocated in the
third quarter of fiscal 2002.

Operating income increased 5% to
$63.6 million, or 8.4% of net sales, in the third quarter
of fiscal 2003 from $60.6 million, or 8.6% of net sales, in
the third quarter of fiscal 2002.

Interest expense was $5.0 million, or 0.6%
of net sales, in the third quarter of fiscal 2003 and
$5.7 million, or 0.8% of net sales in the third quarter of
fiscal 2002. This decrease was primarily due to decreased
interest expense on borrowings under the Credit Agreement. There
were no borrowings outstanding under the Credit Agreement at any
time during the third quarter of fiscal 2003 compared with
average borrowings of $93.5 million outstanding for the
entire third quarter of fiscal 2002.

The effective tax rate was 34.7% for the third
quarter of fiscal 2003 and 41% for the third quarter of fiscal
2002. The effective tax rate was reduced from 41% to 34.7% in
the third quarter of fiscal 2003 due to the resolution of
certain tax issues pending with the Internal Revenue Service.
The effective tax rate for fiscal 2003 is expected to be 38.25%.

Net income for the third quarter of fiscal 2003
was $38.2 million, or $0.54 per diluted share, compared to
$32.3 million, or $0.46 per diluted share, for the third
quarter of fiscal 2002.

First Nine Months Ended November 1, 2003
Compared to the First Nine Months Ended November 2,
2002

Net sales for the first nine months of fiscal
2003 increased $143.7 million, or 8%, over the first nine
months of fiscal 2002. Sales at the new stores (net of closures)
during the first nine months of fiscal 2003 accounted for
$111.9 million of the increase in net sales. Comparable
store sales increased 2% in the first nine months of fiscal 2003
compared to the first nine months of fiscal 2002, which
contributed $31.8 million to the net sales increase.
Comparable store sales growth was strongest in our seasonal,
general crafts, ribbon, kids crafts, and framing
categories. Customer traffic increased approximately 1% in the
first nine months of fiscal 2003 compared to the first nine
months of fiscal 2002. Average ticket increased approximately
1%, driven by favorable pricing/product mix trends and a
strengthening of the Canadian dollar (contributing 47 basis
points), partially offset by higher clearance sales levels.

Cost of sales and occupancy expense, as a
percentage of net sales, for the first nine months of fiscal
2003 was 63.3%, an increase of 0.3% compared to the first nine
months of fiscal 2002. This increase was

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primarily attributable to lower merchandise
margins as a result of the accelerated markdowns in the third
quarter of fiscal 2003 related to our fiscal 2004 planogram
resets.


Selling, general, and administrative expense was
$589.7 million, or 29.1% of net sales, in the first nine
months of fiscal 2003 compared with $552.0 million, or
29.3% of net sales, in the first nine months of fiscal 2002.
This decrease, as a percentage of net sales, was primarily the
result of lower store compensation costs and a leveraging of
corporate general and administrative costs. These decreases were
partially offset by increased store employee benefit costs. In
addition, inventory counting service fees increased from the
first nine months of fiscal 2002 to the first nine months of
fiscal 2003 in connection with the rollout of our perpetual
inventory and automated merchandise replenishment systems. These
fees will also be higher in the fourth quarter of fiscal 2003
compared to fiscal 2002 as we complete this chain-wide rollout.

Store pre-opening costs were $7.0 million,
or 0.3% of net sales, in the first nine months of fiscal 2003
compared to $7.4 million, or 0.4% of net sales, in the
first nine months of fiscal 2002. In the first nine months of
fiscal 2003, we opened or relocated 63 Michaels, 10 Aaron
Brothers, eight Village Crafts by Michaels, two ReCollections,
and one Star Wholesale store compared to 82 Michaels, 13 Aaron
Brothers, and three Village Crafts by Michaels stores opened or
relocated in the first nine months of fiscal 2002.

Operating income increased 8% to
$148.6 million, or 7.3% of net sales, in the first nine
months of fiscal 2003 from $137.3 million, or 7.3% of net
sales, in the first nine months of fiscal 2002.

Interest expense was $15.2 million, or 0.7%
of net sales, in the first nine months of fiscal 2003 and
$15.9 million, or 0.9% of net sales in the first nine
months of fiscal 2002. This decrease was primarily due to
decreased interest expense on borrowings under the Credit
Agreement. There were no borrowings outstanding under the Credit
Agreement at any time during the first nine months of fiscal
2003 compared with average borrowings of $89.5 million
outstanding for 96 days in the first nine months of fiscal
2002.

The effective tax rate was 38.25% for the first
nine months of fiscal 2003 and 41% for the first nine months of
fiscal 2002. The reduction in our fiscal 2003 effective tax rate
was primarily due to the resolution of certain tax issues
pending with the Internal Revenue Service. The effective tax
rate for fiscal 2003 is expected to be 38.25%.

In the fourth quarter of fiscal 2002, in
connection with the adoption of the provisions of EITF Issue
02-16, we changed our accounting policy with respect to
recording cooperative advertising allowances effective
retroactively as of the beginning of fiscal 2002. As a result,
we recorded a non-cash charge of $7.4 million, net of
income tax, in the first quarter of fiscal 2002 for the
cumulative effect of the change on fiscal years prior to fiscal
2002.

Net income for the first nine months of fiscal
2003 was $83.3 million, or $1.19 per diluted share,
compared to $64.9 million, or $0.92 per diluted share, for
the first nine months of fiscal 2002. Income before cumulative
effect of accounting change for the first nine months of fiscal
2002 was $72.3 million, or $1.02 per diluted share.

Liquidity and Capital Resources

Changes in Cash and Equivalents

Cash flow used in operating activities during the
first nine months of fiscal 2003 was $22.8 million compared
to $172.2 million during the first nine months of fiscal
2002. The decrease in cash used in operating activities of
$149.4 million in the first nine months of fiscal 2003
compared to the first nine months of fiscal 2002 was primarily
attributable to a decrease in the change in merchandise
inventories, net of accounts payable, totaling
$130.4 million, as a result of the timing of inventory
purchases and related payments, a decrease in the change in
income taxes payable of $30.3 million, and an increase in
net income of $18.4 million. Inventories per Michaels store
decreased 2.8% from November 2, 2002 to November 1,
2003. As a result of our continuing efforts to improve store
in-stock positions, we now

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anticipate average inventory per Michaels store
at the end of fiscal 2003 to increase approximately 2% from the
average inventory per Michaels store of $1.018 million we
reported at the end of fiscal 2002.


Cash flow used in investing activities in the
first nine months of fiscal 2003 was $69.3 million compared
to $88.8 million in the first nine months of fiscal 2002.
In the first nine months of fiscal 2003, we incurred capital
expenditures related to the construction of our new Illinois
distribution center, the opening of 47 Michaels,
10 Aaron Brothers, eight Village Crafts by Michaels, two
ReCollections, and one Star Wholesale store and the relocation
of 16 Michaels stores. In the first nine months of fiscal 2002,
we incurred capital expenditures related to the completion of
our Hazleton, Pennsylvania distribution center, the expansion of
our Lancaster, California distribution center, the opening of
64 Michaels, 12 Aaron Brothers, and three Village
Crafts by Michaels stores, and the relocation of
18 Michaels and one Aaron Brothers store.

The following table sets forth capital
expenditures for the first nine months of fiscal 2003 and the
first nine months of fiscal 2002 (unaudited):

|                                                   |  |                   |        |             |  |   |        | 
|-------------------------------------------------- |  | ----------------- | ------ | ----------- |  | - | ------ | 
|                                                   |  |                  
|                                                   |  | Nine Months Ended
|                                                   |  |                  
|                                                   |  | November 1,       |        | November 2,
|                                                   |  | 2003              |        | 2002       
|                                                   |  |                   |        |            
|                                                   |  |                  
|                                                   |  | (In thousands)   
|New and relocated stores and stores not yet opened |  | $                 | 29,052 |             |  | $ | 37,531 | 
|Existing stores                                    |  |                   | 15,527 |             |  |   | 17,934 | 
|Distribution system expansion                      |  |                   | 11,737 |             |  |   | 14,929 | 
|Information systems                                |  |                   | 9,360  |             |  |   | 14,042 | 
|Corporate and other                                |  |                   | 3,657  |             |  |   | 4,390  | 
|                                                   |  |                   |        |             |  |   |        | 
|                                                   |  | $                 | 69,333 |             |  | $ | 88,826 | 
|                                                   |  |                   |        |             |  |   |        | 

We anticipate capital expenditures for fiscal
2003 to total approximately $115.0 million. In fiscal 2004,
we plan to open approximately 45 Michaels, five Aaron Brothers,
10 ReCollections, and up to two Star Wholesale stores and
relocate 30 Michaels stores. In the first quarter of fiscal
2003, we entered into an agreement to purchase our Illinois
distribution center once construction is completed. The
estimated purchase price is $29.0 million. We plan to
execute a sale/leaseback transaction for the distribution center
in conjunction with the purchase of the property. We anticipate
our Illinois distribution center will be operational in fiscal
2004 and will replace our Lexington, Kentucky distribution
center.

Cash flow used in financing activities was
$20.5 million during the first nine months of fiscal 2003
compared to cash provided by financing activities of
$112.9 million during the first nine months of fiscal 2002.
This decrease in cash from financing activities was primarily
due to net borrowings under the Credit Agreement in the first
nine months of fiscal 2002 totaling $90.0 million, a
$24.5 million increase in the repurchase of our Common
Stock from the first nine months of fiscal 2002 to the first
nine months of fiscal 2003, and the payment of cash dividends to
stockholders totaling $13.4 million in the first nine
months of fiscal 2003. In addition, proceeds from the exercise
of stock options decreased to $28.6 million for
approximately 1.5 million shares of our Common Stock in the
first nine months of fiscal 2003 from $34.4 million for
approximately 2.1 million shares of our Common Stock in the
first nine months of fiscal 2002.

Bank Credit Facility

Effective May 1, 2001, we signed a
$200 million unsecured revolving bank credit facility with
Fleet National Bank and other lending institutions. The Credit
Agreement had an original term of three years (with a maturity
extension for one additional year available under certain
conditions) and contains a $25 million competitive bid
feature and a $70 million letter of credit sub-facility.
Effective May 21, 2002, pursuant to the terms of the Credit
Agreement, our lenders agreed to extend the term of the Credit
Agreement from April 30, 2004 to April 30, 2005.

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We are in compliance with all terms and
conditions of the Credit Agreement. No borrowings were
outstanding under the Credit Agreement as of November 1,
2003 or at any time during the first nine months of fiscal 2003.
Borrowings outstanding under the Credit Agreement were
$90.0 million as of November 2, 2002. Borrowings
available under the Credit Agreement are reduced by the
aggregate amount of letters of credit outstanding under the
Credit Agreement ($26.2 million as of November 1,
2003).

Equity

On June 18, 2003, our Board of Directors
authorized the repurchase of up to 1.0 million shares of
our outstanding Common Stock in addition to shares available for
repurchase under the 2000 and 2002 repurchase plans. The
following table sets forth information regarding our Common
Stock repurchase plans as of November 1, 2003:

|                                   |  |                |           |             |  |               |            |      |  |  |           |    
|---------------------------------- |  | -------------- | --------- | ----------- |  | ------------- | ---------- | ---- |  |  | --------- | ---
|                                   |  | Shares         |           |             |  | Shares       
|                                   |  | Authorized for |           | Shares      |  | Available for
|                                   |  | Repurchase     |           | Repurchased |  | Repurchase   
|                                   |  |                |           |             |  |              
|December 5, 2000 repurchase plan   |  |                | 2,000,000 | (1)         |  |               | (2,000,000 | )(2) |  |  |          | (1)
|September 11, 2002 repurchase plan |  |                | 1,000,000 |             |  |               | (707,000   | )(3) |  |  | 293,000   |    
|June 18, 2003 repurchase plan      |  |                | 1,000,000 |             |  |               |           |      |  |  | 1,000,000 |    
|                                   |  |                |           |             |  |               |            |      |  |  |           |    
|                                   |  |                | 4,000,000 |             |  |               | (2,707,000 | )    |  |  | 1,293,000 |    
|                                   |  |                |           |             |  |               |            |      |  |  |           |    



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | On December 5, 2000, our Board of Directors
    authorized the purchase of up to 2.0 million shares of our
    outstanding Common Stock. By later resolutions, 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.                                                                                                                                                                                                                                                                                                                                                                                
|   
|(2) | During fiscal 2002, we repurchased and
    subsequently retired 392,100 shares of our Common Stock under
    the 2000 repurchase plan at an average cost of $32.70 per share.
    In the first quarter of fiscal 2003, we repurchased and
    subsequently retired 557,900 shares of our Common Stock at an
    average cost of $26.05 per share under the 2000 repurchase plan.
    As of April 1, 2003, we had repurchased and retired a total
    of 2.0 million shares under the 2000 repurchase plan at an
    average cost of $22.25 per share and, as a result, we have used
    the entire fixed portion of the authority originally provided in
    the 2000 repurchase plan. As of November 1, 2003, no
    repurchases from proceeds of stock option exercises under the
    2001 General Stock Option Plan had been made since no options
    outstanding under the 2001 General Stock Option Plan had been
    exercised as of that date.
|   
|(3) | In the first quarter of fiscal 2003, we
    repurchased and subsequently retired 442,100 shares of our
    Common Stock under the 2002 repurchase plan at an average cost
    of $25.87 per share. In the third quarter of fiscal 2003, we
    repurchased and subsequently retired 264,900 shares of our
    Common Stock under the 2002 repurchase plan at an average cost
    of $43.04 per share.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

Under the agreements governing our outstanding
indebtedness, we can only repurchase shares of our Common Stock
if we maintain or comply with specified financial ratios and
other covenants. We may also be restricted by regulations of the
Securities and Exchange Commission from making future
repurchases during certain time periods.

General

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

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Recent Accounting Pronouncements

In May 2003, the Financial Accounting Standards
Board issued Statement of Financial Accounting Standards
No. 149, Amendment of Statement 133 on Derivative
Instruments and Hedging Activities, which amends and
clarifies the accounting for derivative instruments, including
certain derivative instruments embedded in other contracts, and
for hedging activities under SFAS No. 133. SFAS
No. 149 is effective for contracts entered into or modified
after June 30, 2003. The adoption of the provisions of SFAS
No. 149 had no material impact on our operating results or
financial position.

In December 2002, the FASB issued SFAS
No. 148, Accounting for Stock-Based Compensation
Transition and Disclosure, as an amendment to SFAS
No. 123 and to provide alternative methods of transition
for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. In addition,
SFAS No. 148 amends the disclosure requirements of SFAS
No. 123 to require prominent disclosures in both annual and
interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method
used on reported results. Our policy is to account for
stock-based employee compensation using the intrinsic value
method in accordance with APB Opinion No. 25. Prior to the
adoption of the disclosure provisions of SFAS No. 148, we
reported the pro forma effect of the fair value method of
accounting for stock-based employee compensation under the
provisions of SFAS No. 123. We adopted the disclosure
provisions of SFAS No. 148 in the preparation of our Annual
Report on Form 10-K for the fiscal year ended
February 1, 2003. While this adoption does not change our
policy of accounting for stock-based employee compensation using
the intrinsic value method, we have disclosed our stock-based
employee compensation in Note 4 of Notes to Consolidated
Financial Statements and have revised our presentation format of
the pro forma effect of the fair value method of accounting.






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

We have market risk exposure arising from changes
in interest rates. The interest rates on the Credit Agreement
are repriced frequently, at market prices, which would result in
carrying amounts that approximate fair value. We had no
borrowings outstanding under the Credit Agreement at
November 1, 2003. In July 2001, we issued $200 million
of the Senior Notes due 2009 with a fixed interest rate of
9 1/4%. Generally, the fair market value of our fixed
interest rate long-term debt will increase as interest rates
fall and decrease as interest rates rise. Our market risk is
described in more detail in our Annual Report on Form 10-K
for the fiscal year ended February 1, 2003.






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

Evaluation of Disclosure Controls and
Procedures

We maintain a set of disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e)
promulgated by the Securities and Exchange Commission under the
Securities Exchange Act of 1934). An evaluation was carried out
under the supervision and with the participation of our
management, including our Chief Executive Officer and our
Executive Vice President Chief Financial Officer, of the
effectiveness of our disclosure controls and procedures as of
the end of the period covered by this Quarterly Report on
Form 10-Q. Based on that evaluation, our Chief Executive
Officer and our Executive Vice President Chief Financial
Officer concluded that our disclosure controls and procedures
are effective to provide reasonable assurance that information
required to be disclosed in the reports that we file or submit
under the Securities Exchange Act of 1934 is recorded,
processed, summarized, and reported within the time periods
specified in Securities and Exchange Commission rules and forms.
We note that the design of any system of controls is based in
part upon certain assumptions about the likelihood of future
events, and there can be no assurance that any design will
succeed in achieving its stated goals under all potential future
conditions.

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Change in Internal Control Over Financial
Reporting

There has not been any change in our internal
control over financial reporting (as defined in
Rules 13a-15(f) and 15d-15(f) as promulgated by the
Securities and Exchange Commission under the Securities Act of
1934) during our most recently completed fiscal quarter that has
materially affected, or is reasonably likely to materially
affect, our internal control over financial reporting.

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MICHAELS STORES, INC.




Part II OTHER INFORMATION







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

Brown Claim

On April 17, 2003, Donald Brown, Thomas
Lamour, and Sau Yeung, acting on behalf of themselves and the
general public, filed a putative class action in the Superior
Court of California for the County of Los Angeles against a
number of employers, including Aaron Brothers, Inc., a
wholly-owned subsidiary of Michaels Stores, Inc. The lawsuit
alleges that the defendants violated California Labor Code
provisions that prohibit employers from requesting job
applicants to disclose prior criminal convictions for specified
marijuana-related infractions or participation in certain
criminal diversionary programs. We believe these claims are
without merit and will vigorously contest them.

Stockholder Class Actions

On various dates between February 4, 2003
and March 25, 2003, 10 purported class action lawsuits were
filed in the United States District Court for the Northern
District of Texas, Dallas Division, against Michaels Stores,
Inc. and certain of the current and former directors and
officers of Michaels. All of these lawsuits have been
consolidated. The suits assert various claims under
Sections 10(b) and 20(a) of the Securities Exchange Act of
1934 related to actions prior to Michaels announcement on
November 7, 2002, that, among other things, it had revised
its outlook for the fourth fiscal quarter of 2002, adjusting
downward its guidance for annual earnings per diluted share. The
complaints charge that, prior to that announcement, Michaels and
certain of the other defendants made misrepresentations and
failed to disclose negative information about the financial
condition of Michaels while the individual defendants were
selling shares of Michaels common stock. We believe these claims
are without merit and will vigorously contest them.

Derivative Claims

On March 21, 2003, Julie Fathergill filed a
purported stockholder derivative action, which is pending in the
192nd District Court for Dallas County, Texas. The lawsuit names
certain former and current officers and directors, including all
of Michaels current directors, as individual defendants and
Michaels as a nominal defendant. In this derivative action, the
plaintiff makes allegations of fact similar to those made in the
purported securities class actions described above. The
plaintiff asserts claims against the individual defendants for
breach of fiduciary duties, abuse of control, gross
mismanagement, waste of corporate assets, and unjust enrichment.
All of these claims are asserted derivatively on behalf of
Michaels. We believe this claim is also without merit and will
vigorously oppose it.

On April 8, 2003, the Chairman of the Board
of Michaels received a demand letter on behalf of Chris Frith, a
purported Michaels stockholder, requesting that the Board
commence an action against certain former and current officers
and directors. The demand letter threatens to file a derivative
lawsuit if an action is not commenced within a reasonable time.
The purported bases of the demand are similar to those made in
the purported stockholder class actions and stockholder
derivative lawsuit described above.

On September 11, 2003, Leo J. Dutil filed a
purported stockholder derivative action, which is pending in the
United States District Court for the Northern District of Texas,
Dallas Division. The lawsuit names certain former and current
officers and directors as individual defendants and Michaels as
a nominal defendant. In this derivative action, the plaintiff
makes allegations of fact similar to those made in the purported
stockholder class actions and the Fathergill derivative lawsuit
described above. The plaintiff asserts claims against the
individual defendants for breach of fiduciary duty,
misappropriation of confidential information, and contribution
and indemnification. All of these claims are asserted
derivatively on behalf of Michaels. We believe this claim is
also without merit and will vigorously oppose it.

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Cotton Claim

On December 20, 2002, James Cotton, a former
store manager of Michaels of Canada, ULC, our wholly-owned
subsidiary, and Suzette Kennedy, a former assistant manager of
Michaels of Canada, commenced a proposed class proceeding
against Michaels of Canada and Michaels Stores, Inc. on behalf
of themselves and current and former employees employed in
Canada. The Cotton claim was filed in the Ontario Superior Court
of Justice and alleges that the defendants violated employment
standards legislation in Ontario and other provinces and
territories of Canada by failing to pay overtime compensation as
required by that legislation. The Cotton claim also alleges that
this conduct was in breach of the contracts of employment of
those individuals. The Cotton claim seeks a declaration that the
defendants have acted in breach of applicable legislation,
payment to current and former employees for overtime, damages
for breach of contract, punitive, aggravated and exemplary
damages, interest, and costs. We believe we have certain
meritorious defenses and intend to defend this lawsuit
vigorously.

General

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






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

(a) Exhibits:

|     |  |                                                                                                                                                                           
|---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.1 |  | Third Amendment to the Michaels Stores, Inc.
    Employees 401(k) Plan, as amended and restated effective
    August 1, 1999, dated December 3, 2002 (filed
    herewith).
|10.2 |  | Form of Director Indemnification Agreement
    between Michaels Stores, Inc. and certain directors of the
    Registrant (filed herewith).                                
|10.3 |  | Form of Officer Indemnification Agreement between
    Michaels Stores, Inc. and certain officers of the Registrant
    (filed herewith).                                  
|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).                                        

(b) Reports on Form 8-K filed during
the quarter ended November 1, 2003:

|   |  |                                                                                                                                                                
|-- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------
|1. |  | Report on Form 8-K, dated and furnished to
    the Securities and Exchange Commission on August 8, 2003,
    reporting information pursuant to Items 7 and 12. 
|2. |  | Report on Form 8-K, dated and furnished to
    the Securities and Exchange Commission on August 27, 2003,
    reporting information pursuant to Items 7 and 12.

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MICHAELS STORES, INC.




SIGNATURES


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

| |  |                       |  |                                                                                        
| |  | --------------------- |  | ---------------------------------------------------------------------------------------
| |  | MICHAELS STORES, INC.
|
| |  | By:                   |  | /s/ Jeffrey N. Boyer                                                                   
| |  |                       |  |                                                                                        
| |  |                       |  | Jeffrey N. Boyer                                                                       
| |  |                       |  | Executive Vice President Chief Financial
    Officer
    (Principal Financial Officer)

Dated: December 16, 2003

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INDEX TO EXHIBITS

|        |      |                        |  |                                                                                                                                                                           
|------- | ---- | ---------------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |      |                       
|Number  |      | Description of Exhibit
|        |      |                       
|        | 10.1 |                        |  | Third Amendment to the Michaels Stores, Inc.
    Employees 401(k) Plan, as amended and restated effective
    August 1, 1999, dated December 3, 2002 (filed
    herewith).
|        | 10.2 |                        |  | Form of Director Indemnification Agreement
    between Michaels Stores, Inc. and certain directors of the
    Registrant (filed herewith).                                
|        | 10.3 |                        |  | Form of Officer Indemnification Agreement between
    Michaels Stores, Inc. and certain officers of the Registrant
    (filed herewith).                                  
|        | 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).