##### Table of Contents









UNITED STATES

SECURITIES AND EXCHANGE COMMISSION


WASHINGTON, DC 20549




---

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 May 1,
    2004        
|                                                      
|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                                  |  | June 2, 2004            
|                                       |  |                         
|Common Stock, par value $.10 per share |  | 68,265,313              



---






---










MICHAELS STORES, INC.

FORM 10-Q


Part IFINANCIAL
INFORMATION

|                                                  |  |                                                                                                             |  |   
|------------------------------------------------- |  | ----------------------------------------------------------------------------------------------------------- |  | --
|Item 1.                                           |  | Financial
    Statements                                                                                    |  |   
|                                                  |  | Consolidated Balance Sheets
    at May 1, 2004, January 31, 2004, and May 3, 2003
    (unaudited)           |  | 3 
|                                                  |  | Consolidated Statements of
    Income for the quarter ended May 1, 2004 and May 3,
    2003 (unaudited)     |  | 4 
|                                                  |  | Consolidated Statements of
    Cash Flows for the quarter ended May 1, 2004 and
    May 3, 2003 (unaudited) |  | 5 
|                                                  |  | Notes to Consolidated
    Financial Statements (unaudited)                                                  |  | 6 
|Item 2.                                           |  | Managements
    Discussion and Analysis of Financial Condition and Results of
    Operations               |  | 10
|Item 3.                                           |  | Quantitative and
    Qualitative Disclosures About Market Risk                                              |  | 15
|Item 4.                                           |  | Controls and
    Procedures                                                                                 |  | 15
|Part IIOTHER
    INFORMATION                    
|Item 1.                                           |  | Legal
    Proceedings                                                                                       |  | 17
|Item 2.                                           |  | Changes in Securities,
    Use of Proceeds and Issuer Purchases of Equity
    Securities                    |  | 18
|Item 6.                                           |  | Exhibits and Reports on
    Form 8-K                                                                        |  | 19
|Signatures                                        |  | 20                                                                                                         
|2004 Bonus Plan for President and CEO            
|2004 Bonus Plan for President and Vice Presidents
|2004 Bonus Plan for Executive Vice President     
|Certifications Pursuant to Section 302           
|Certifications Pursuant to Section 302           
|Certification Pursuant to Section 906            



2



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##### Table of Contents






MICHAELS STORES, INC.

Part IFINANCIAL
INFORMATION







|        |                      
|------- | ---------------------
|Item 1. | Financial Statements.




MICHAELS STORES, INC.

CONSOLIDATED BALANCE SHEETS


(In thousands, except share data)


(Unaudited)


|                                           |                                                                                                                                                                                                     |                             |           |             |           |        |           |         |           |   |           |         |           | 
|------------------------------------------ | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------- | --------- | ----------- | --------- | ------ | --------- | ------- | --------- | - | --------- | ------- | --------- | 
|                                           |                                                                                                                                                                                                     | May 1,                      |           | January 31, |           | May 3,
|                                           |                                                                                                                                                                                                     | 2004                        |           | 2004        |           | 2003  
|                                           |                                                                                                                                                                                                     |                             |           |             |           |       
|                                           |                                                                                                                                                                                                     |                            
|                                           |                                                                                                                                                                                                     | (Note 1)                   
|ASSETS                                    
|Current assets:                            |                                                                                                                                                                                                     |                             |           |             |           |        |           |         |           |   |           |        
|                                           | Cash and equivalents                                                                                                                                                                                |                             | $         | 381,352     |           |        | $         | 341,825 |           |   | $         | 211,040 |          
|                                           | Merchandise inventories                                                                                                                                                                             |                             |           | 906,655     |           |        |           | 892,923 |           |   |           | 857,181 |          
|                                           | Prepaid expenses and other                                                                                                                                                                          |                             |           | 40,031      |           |        |           | 29,198  |           |   |           | 21,574  |          
|                                           | Deferred and prepaid income taxes                                                                                                                                                                   |                             |           | 20,990      |           |        |           | 19,426  |           |   |           | 20,348  |          
|                                           |                                                                                                                                                                                                     |                             |           |             |           |        |           |         |           |   |           |        
|                                           |                                                                                                                                                                                                     | Total current assets        |           |             | 1,349,028 |        |           |         | 1,283,372 |   |           |         | 1,110,143 | 
|                                           |                                                                                                                                                                                                     |                             |           |             |           |        |           |         |           |   |           |        
|Property and equipment, at cost            |                                                                                                                                                                                                     |                             | 825,928   |             |           |        | 808,230   |         |           |   | 731,548   |        
|Less accumulated depreciation              |                                                                                                                                                                                                     |                             | (434,257  | )           |           |        | (420,313  | )       |           |   | (368,995  | )      
|                                           |                                                                                                                                                                                                     |                             |           |             |           |        |           |         |           |   |           |        
|                                           |                                                                                                                                                                                                     |                             |           | 391,671     |           |        |           | 387,917 |           |   |           | 362,553 |          
|                                           |                                                                                                                                                                                                     |                             |           |             |           |        |           |         |           |   |           |        
|Goodwill                                   |                                                                                                                                                                                                     |                             | 115,839   |             |           |        | 115,839   |         |           |   | 115,839   |        
|Other assets                               |                                                                                                                                                                                                     |                             | 14,850    |             |           |        | 14,519    |         |           |   | 13,907    |        
|                                           |                                                                                                                                                                                                     |                             |           |             |           |        |           |         |           |   |           |        
|                                           |                                                                                                                                                                                                     |                             | 130,689   |             |           |        | 130,358   |         |           |   | 129,746   |        
|                                           |                                                                                                                                                                                                     |                             |           |             |           |        |           |         |           |   |           |        
|Total assets                               |                                                                                                                                                                                                     | $                           | 1,871,388 |             |           | $      | 1,801,647 |         |           | $ | 1,602,442 |        
|                                           |                                                                                                                                                                                                     |                             |           |             |           |        |           |         |           |   |           |        
|LIABILITIES AND STOCKHOLDERS
    EQUITY  
|Current liabilities:                       |                                                                                                                                                                                                     |                             |           |             |           |        |           |         |           |   |           |        
|                                           | Accounts payable                                                                                                                                                                                    |                             | $         | 214,454     |           |        | $         | 172,708 |           |   | $         | 166,944 |          
|                                           | Accrued liabilities and other                                                                                                                                                                       |                             |           | 190,040     |           |        |           | 194,395 |           |   |           | 160,162 |          
|                                           | Income taxes payable                                                                                                                                                                                |                             |           |            |           |        |           | 2,377   |           |   |           | 10,160  |          
|                                           |                                                                                                                                                                                                     |                             |           |             |           |        |           |         |           |   |           |        
|                                           |                                                                                                                                                                                                     | Total current liabilities   |           |             | 404,494   |        |           |         | 369,480   |   |           |         | 337,266   | 
|                                           |                                                                                                                                                                                                     |                             |           |             |           |        |           |         |           |   |           |        
|9 1/4% Senior Notes due
    2009           |                                                                                                                                                                                                     |                             | 200,000   |             |           |        | 200,000   |         |           |   | 200,000   |        
|Deferred income taxes                      |                                                                                                                                                                                                     |                             | 28,241    |             |           |        | 28,241    |         |           |   | 21,513    |        
|Other long-term liabilities                |                                                                                                                                                                                                     |                             | 38,184    |             |           |        | 36,628    |         |           |   | 31,498    |        
|                                           |                                                                                                                                                                                                     |                             |           |             |           |        |           |         |           |   |           |        
|                                           |                                                                                                                                                                                                     | Total long-term liabilities |           |             | 266,425   |        |           |         | 264,869   |   |           |         | 253,011   | 
|                                           |                                                                                                                                                                                                     |                             |           |             |           |        |           |         |           |   |           |        
|                                           |                                                                                                                                                                                                     |                             | 670,919   |             |           |        | 634,349   |         |           |   | 590,277   |        
|                                           |                                                                                                                                                                                                     |                             |           |             |           |        |           |         |           |   |           |        
|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 68,586,669 at May 1, 2004, 67,997,567 at
    January 31, 2004, and 66,566,841 at May 3, 2003 |                             |           | 6,859       |           |        |           | 6,800   |           |   |           | 6,657   |          
|                                           | Additional paid-in capital                                                                                                                                                                          |                             |           | 510,542     |           |        |           | 495,910 |           |   |           | 480,982 |          
|                                           | Retained earnings                                                                                                                                                                                   |                             |           | 681,477     |           |        |           | 660,365 |           |   |           | 523,479 |          
|                                           | Accumulated other comprehensive income                                                                                                                                                              |                             |           | 1,591       |           |        |           | 4,223   |           |   |           | 1,047   |          
|                                           |                                                                                                                                                                                                     |                             |           |             |           |        |           |         |           |   |           |        
|                                           |                                                                                                                                                                                                     | Total stockholders equity  |           |             | 1,200,469 |        |           |         | 1,167,298 |   |           |         | 1,012,165 | 
|                                           |                                                                                                                                                                                                     |                             |           |             |           |        |           |         |           |   |           |        
|Total liabilities and stockholders equity |                                                                                                                                                                                                     | $                           | 1,871,388 |             |           | $      | 1,801,647 |         |           | $ | 1,602,442 |        
|                                           |                                                                                                                                                                                                     |                             |           |             |           |        |           |         |           |   |           |        

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
|                                             |         |              
|                                             |         | May 1,        |         | May 3,
|                                             |         | 2004          |         | 2003  
|                                             |         |               |         |       
|Net sales                                    |         | $             | 725,852 |        |  | $ | 656,388 |     
|Cost of sales and occupancy expense          |         |               | 465,628 |        |  |   | 420,548 |     
|                                             |         |               |         |        |  |   |         |     
|Gross profit                                 |         |               | 260,224 |        |  |   | 235,840 |     
|Selling, general, and administrative expense |         |               | 205,701 |        |  |   | 194,594 |     
|Store pre-opening costs                      |         |               | 2,483   |        |  |   | 1,753   |     
|                                             |         |               |         |        |  |   |         |     
|Operating income                             |         |               | 52,040  |        |  |   | 39,493  |     
|Interest expense                             |         |               | 5,328   |        |  |   | 5,071   |     
|Other (income) and expense, net              |         |               | (789    | )      |  |   | (856    | )   
|                                             |         |               |         |        |  |   |         |     
|Income before income taxes                   |         |               | 47,501  |        |  |   | 35,278  |     
|Provision for income taxes                   |         |               | 18,169  |        |  |   | 14,464  |     
|                                             |         |               |         |        |  |   |         |     
|Net income                                   |         | $             | 29,332  |        |  | $ | 20,814  |     
|                                             |         |               |         |        |  |   |         |     
|Earnings per common share:                   |         |               |         |        |  |   |         |     
|                                             | Basic   |               | $       | 0.43   |  |   | $       | 0.31 | 
|                                             |         |               |         |        |  |   |         |     
|                                             | Diluted |               | $       | 0.42   |  |   | $       | 0.30 | 
|                                             |         |               |         |        |  |   |         |     
|Dividends per common share                   |         | $             | 0.12    |        |  | $ |        |     
|                                             |         |               |         |        |  |   |         |     

See accompanying notes to consolidated financial
statements.

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MICHAELS STORES, INC.

CONSOLIDATED STATEMENTS OF CASH
FLOWS


(In thousands)


(Unaudited)


|                                                    |                                                   |                                    |                                 |                                           |        |         |         |         |        |         |         |  
|--------------------------------------------------- | ------------------------------------------------- | ---------------------------------- | ------------------------------- | ----------------------------------------- | ------ | ------- | ------- | ------- | ------ | ------- | ------- | -
|                                                    |                                                   |                                   
|                                                    |                                                   | Quarter Ended                     
|                                                    |                                                   |                                   
|                                                    |                                                   | May 1,                             |                                 | May 3,                                   
|                                                    |                                                   | 2004                               |                                 | 2003                                     
|                                                    |                                                   |                                    |                                 |                                          
|Operating activities:                               |                                                   |                                    |                                 |                                           |        |         |         |        
|                                                    | Net income                                        |                                    | $                               | 29,332                                    |        |         | $       | 20,814  |       
|                                                    | Adjustments:                                      |                                    |                                 |                                           |        |         |         |         |       
|                                                    |                                                   | Depreciation                       |                                 |                                           | 21,678 |         |         |         | 19,854 |        
|                                                    |                                                   | Amortization                       |                                 |                                           | 98     |         |         |         | 100    |        
|                                                    |                                                   | Other                              |                                 |                                           | 291    |         |         |         | 283    |        
|                                                    |                                                   | Changes in assets and liabilities: |                                 |                                           |        |         |         |         |        |        
|                                                    |                                                   |                                    | Merchandise inventories         |                                           |        | (13,732 | )       |         |        | (47,763 | )      
|                                                    |                                                   |                                    | Prepaid expenses and other      |                                           |        | (10,833 | )       |         |        | (2,935  | )      
|                                                    |                                                   |                                    | Deferred income taxes and other |                                           |        | 919     |         |         |        | 297     |        
|                                                    |                                                   |                                    | Accounts payable                |                                           |        | 41,746  |         |         |        | 72,180  |        
|                                                    |                                                   |                                    | Income taxes payable            |                                           |        | 3,588   |         |         |        | (12,295 | )      
|                                                    |                                                   |                                    | Accrued liabilities and other   |                                           |        | (6,660  | )       |         |        | (19,517 | )      
|                                                    |                                                   |                                    |                                 |                                           |        |         |         |        
|                                                    |                                                   |                                    |                                 | Net change in assets and liabilities      |        |         | 15,028  |         |        |         | (10,033 | )
|                                                    |                                                   |                                    |                                 |                                           |        |         |         |        
|                                                    |                                                   |                                    |                                 | Net cash provided by operating activities |        |         | 66,427  |         |        |         | 31,018  |  
|                                                    |                                                   |                                    |                                 |                                           |        |         |         |        
|Investing activities:                               |                                                   |                                    |                                 |                                           |        |         |         |        
|                                                    | Additions to property and equipment               |                                    |                                 | (25,834                                   | )      |         |         | (13,746 | )     
|                                                    | Net proceeds from sales of property and equipment |                                    |                                 | 9                                         |        |         |         | 5       |       
|                                                    |                                                   |                                    |                                 |                                           |        |         |         |        
|                                                    |                                                   |                                    |                                 | Net cash used in investing activities     |        |         | (25,825 | )       |        |         | (13,741 | )
|                                                    |                                                   |                                    |                                 |                                           |        |         |         |        
|Financing activities:                               |                                                   |                                    |                                 |                                           |        |         |         |        
|                                                    | Proceeds from stock options exercised             |                                    |                                 | 14,236                                    |        |         |         | 1,257   |       
|                                                    | Repurchase of Common Stock                        |                                    |                                 | (7,798                                    | )      |         |         | (25,968 | )     
|                                                    | Cash dividends paid to stockholders               |                                    |                                 | (8,220                                    | )      |         |         |        |       
|                                                    | Proceeds from issuance of Common Stock and other  |                                    |                                 | 707                                       |        |         |         | 443     |       
|                                                    |                                                   |                                    |                                 |                                           |        |         |         |        
|                                                    |                                                   |                                    |                                 | Net cash used in financing activities     |        |         | (1,075  | )       |        |         | (24,268 | )
|                                                    |                                                   |                                    |                                 |                                           |        |         |         |        
|Net increase (decrease) in cash and
    equivalents |                                                   |                                    | 39,527                          |                                           |        |         | (6,991  | )      
|Cash and equivalents at beginning of
    period     |                                                   |                                    | 341,825                         |                                           |        |         | 218,031 |        
|                                                    |                                                   |                                    |                                 |                                           |        |         |         |        
|Cash and equivalents at end of
    period           |                                                   | $                                  | 381,352                         |                                           |        | $       | 211,040 |        
|                                                    |                                                   |                                    |                                 |                                           |        |         |         |        

See accompanying notes to consolidated financial
statements.

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##### Table of Contents



MICHAELS STORES, INC.




NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS


For the Quarter Ended May 1,
2004

(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 accounting
principles generally accepted in the United States 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 ended
May 1, 2004 are not indicative of the results to be
expected for the entire year.

The balance sheet at January 31, 2004 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
January 31, 2004.

All references herein to fiscal 2004
relate to the 52 weeks ending January 29, 2005 and all
references to fiscal 2003 relate to the
52 weeks ended January 31, 2004. In addition, all
references herein to the first quarter of fiscal
2004 relate to the 13 weeks ended May 1, 2004
and all references to the first quarter of fiscal
2003 relate to the 13 weeks ended May 3, 2003.



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

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

|                           |                                                                                                                |                        |   |        |       |  |   |        |       | 
|-------------------------- | -------------------------------------------------------------------------------------------------------------- | ---------------------- | - | ------ | ----- |  | - | ------ | ----- | 
|                           |                                                                                                                |                       
|                           |                                                                                                                | Quarter Ended         
|                           |                                                                                                                |                       
|                           |                                                                                                                | May 1,                 |   | May 3,
|                           |                                                                                                                | 2004                   |   | 2003  
|                           |                                                                                                                |                        |   |       
|                           |                                                                                                                |                       
|                           |                                                                                                                | (In thousands,        
|                           |                                                                                                                | except per share data)
|Numerator:                 |                                                                                                                |                        |   |        |       |  |   |       
|                           | Net income                                                                                                     |                        | $ | 29,332 |       |  | $ | 20,814 |      
|                           |                                                                                                                |                        |   |        |       |  |   |       
|Denominator:               |                                                                                                                |                        |   |        |       |  |   |       
|                           | Denominator for basic earnings per common
    share-weighted average shares                                    |                        |   | 68,281 |       |  |   | 67,082 |      
|                           | Effect of dilutive securities:                                                                                 |                        |   |        |       |  |   |        |      
|                           |                                                                                                                | Employee stock options |   |        | 1,565 |  |   |        | 2,071 | 
|                           |                                                                                                                |                        |   |        |       |  |   |       
|                           | Denominator for diluted earnings per common
    share-weighted average shares adjusted for dilutive securities |                        |   | 69,846 |       |  |   | 69,153 |      
|                           |                                                                                                                |                        |   |        |       |  |   |       
|Earnings per common share: |                                                                                                                |                        |   |        |       |  |   |       
|                           | Basic                                                                                                          |                        | $ | 0.43   |       |  | $ | 0.31   |      
|                           |                                                                                                                |                        |   |        |       |  |   |       
|                           | Diluted                                                                                                        |                        | $ | 0.42   |       |  | $ | 0.30   |      
|                           |                                                                                                                |                        |   |        |       |  |   |       

6



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##### Table of Contents



MICHAELS STORES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)


For the Quarter Ended May 1,
2004

(Unaudited)




|        |                               
|------- | ------------------------------
|Note 2. | Earnings per Share (Continued)

Our purchase and subsequent retirement of
156,400 shares of our Common Stock in the first quarter of
fiscal 2004 reduced the number of weighted average shares
outstanding by 2,578 shares for the first quarter of fiscal
2004. In addition, our purchase and subsequent retirement of
1.0 million shares of our Common Stock in the first quarter
of fiscal 2003 reduced the number of weighted average shares
outstanding by 408,332 shares for the first quarter of
fiscal 2003.



|        |                         
|------- | ------------------------
|Note 3. | 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         
|                                                   |                                                                 |                       
|                                                   |                                                                 | May 1,                 |        | May 3,
|                                                   |                                                                 | 2004                   |        | 2003  
|                                                   |                                                                 |                        |        |       
|                                                   |                                                                 |                       
|                                                   |                                                                 | (In thousands,        
|                                                   |                                                                 | except per share data)
|Net income, as reported                            |                                                                 | $                      | 29,332 |        |  | $ | 20,814 |       
|Stock-based employee compensation cost:            |                                                                 |                        |        |        |  |   |        |       
|                                                   | As if the fair value method were applied, net of
    income tax |                        |        | 3,389  |  |   |        | 3,244  | 
|                                                   |                                                                 |                        |        |        |  |   |        |       
|Pro forma net income                               |                                                                 | $                      | 25,943 |        |  | $ | 17,570 |       
|                                                   |                                                                 |                        |        |        |  |   |        |       
|Earnings per common share, as
    reported:        |                                                                 |                        |        |        |  |   |        |       
|                                                   | Basic                                                           |                        | $      | 0.43   |  |   | $      | 0.31   | 
|                                                   |                                                                 |                        |        |        |  |   |        |       
|                                                   | Diluted                                                         |                        | $      | 0.42   |  |   | $      | 0.30   | 
|                                                   |                                                                 |                        |        |        |  |   |        |       
|Pro forma earnings per common share:               |                                                                 |                        |        |        |  |   |        |       
|                                                   | Basic                                                           |                        | $      | 0.38   |  |   | $      | 0.26   | 
|                                                   |                                                                 |                        |        |        |  |   |        |       
|                                                   | Diluted                                                         |                        | $      | 0.37   |  |   | $      | 0.26   | 
|                                                   |                                                                 |                        |        |        |  |   |        |       
|Pro forma weighted average shares
    outstanding: |                                                                 |                        |        |        |  |   |        |       
|                                                   | Basic                                                           |                        |        | 68,281 |  |   |        | 67,082 | 
|                                                   | Diluted                                                         |                        |        | 69,316 |  |   |        | 67,290 | 



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



| |                                 
| | --------------------------------
| | 9 1/4% Senior Notes due
    2009

In 2001, we issued $200 million in principal
amount of 9 1/4% Senior Notes due July 1, 2009,
which are unsecured and interest thereon is payable
semi-annually on each January 1 and July 1. The Senior
Notes due 2009 are first callable, in part or in full, in July
2005. The terms and conditions of the Senior

7



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##### Table of Contents



MICHAELS STORES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)


For the Quarter Ended May 1,
2004

(Unaudited)




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

Notes due 2009 require us to comply with certain
covenants, which primarily limit certain activities, including,
among other things, levels of indebtedness, liens, investments,
payments of dividends, Common Stock repurchases, mergers and
acquisitions, and sales of assets. We are in compliance with all
terms and conditions of the Senior Notes due 2009.

Credit Agreement

Effective May 1, 2001, we signed a
$200 million unsecured revolving bank credit facility with
Fleet National Bank and other lending institutions, which
expires on April 30, 2005. The Credit Agreement requires us
to maintain certain financial covenants and limits certain
activities, including, among other things, levels of
indebtedness, liens, investments, payments of dividends, Common
Stock repurchases, mergers and acquisitions, and sales of
assets. We are in compliance with all terms and conditions of
the Credit Agreement. We had no borrowings under our Credit
Agreement during either the first quarter of fiscal 2004 or the
first quarter of fiscal 2003 and no borrowings were outstanding
under the Credit Agreement at the end of either quarter.
Borrowings available under the Credit Agreement are reduced by
the aggregate amount of letters of credit outstanding under the
Credit Agreement ($26.1 million as of May 1, 2004).



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

Comprehensive income for the quarter ended
May 1, 2004 and May 3, 2003 is as follows:

|                                   |                                         |                |        |        |   |   |        |       | 
|---------------------------------- | --------------------------------------- | -------------- | ------ | ------ | - | - | ------ | ----- | 
|                                   |                                         |               
|                                   |                                         | Quarter Ended 
|                                   |                                         |               
|                                   |                                         | May 1,         |        | May 3,
|                                   |                                         | 2004           |        | 2003  
|                                   |                                         |                |        |       
|                                   |                                         |               
|                                   |                                         | (In thousands)
|Net income                         |                                         | $              | 29,332 |        |   | $ | 20,814 |      
|Other comprehensive income (loss): |                                         |                |        |        |   |   |        |      
|                                   | Foreign currency translation adjustment |                |        | (2,632 | ) |   |        | 3,224 | 
|                                   |                                         |                |        |        |   |   |        |      
|Comprehensive income               |                                         | $              | 26,700 |        |   | $ | 24,038 |      
|                                   |                                         |                |        |        |   |   |        |      



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

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
consolidated complaint charges 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.

8



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##### Table of Contents



MICHAELS STORES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)


For the Quarter Ended May 1,
2004

(Unaudited)




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

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 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.

9



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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
January 31, 2004. 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 January 31, 2004,
particularly in Critical Accounting Policies and
Estimates and 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 2004
relate to the 52 weeks ending January 29, 2005 and all
references to fiscal 2003 relate to the
52 weeks ended January 31, 2004. In addition, all
references herein to the first quarter of fiscal
2004 relate to the 13 weeks ended May 1, 2004
and all references to the first quarter of fiscal
2003 relate to the 13 weeks ended May 3, 2003.

10



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##### Table of Contents



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

|                                   |                                                          |               |     |        |   |  |     |       |  
|---------------------------------- | -------------------------------------------------------- | ------------- | --- | ------ | - |  | --- | ----- | -
|                                   |                                                          |              
|                                   |                                                          | Quarter Ended
|                                   |                                                          |              
|                                   |                                                          | May 1,        |     | May 3,
|                                   |                                                          | 2004          |     | 2003  
|                                   |                                                          |               |     |       
|Michaels stores(1):                |                                                          |               |     |        |   |  |     |      
|                                   | Retail stores open at beginning of period                |               |     | 804    |   |  |     | 754   |  
|                                   | Retail stores opened during the period                   |               |     | 14     |   |  |     | 18    |  
|                                   | Retail stores opened (relocations) during the
    period |               |     | 12     |   |  |     | 5     |  
|                                   | Retail stores closed during the period                   |               |     |       |   |  |     | (1    | )
|                                   | Retail stores closed (relocations) during the
    period |               |     | (12    | ) |  |     | (5    | )
|                                   |                                                          |               |     |        |   |  |     |      
|                                   | Retail stores open at end of period                      |               |     | 818    |   |  |     | 771   |  
|Aaron Brothers stores:             |                                                          |               |     |        |   |  |     |      
|                                   | Retail stores open at beginning of period                |               |     | 158    |   |  |     | 148   |  
|                                   | Retail stores opened during the period                   |               |     |       |   |  |     | 5     |  
|                                   |                                                          |               |     |        |   |  |     |      
|                                   | Retail stores open at end of period                      |               |     | 158    |   |  |     | 153   |  
|ReCollections stores:              |                                                          |               |     |        |   |  |     |      
|                                   | Retail stores open at beginning of period                |               |     | 2      |   |  |     |      |  
|                                   | Retail stores opened during the period                   |               |     |       |   |  |     |      |  
|                                   |                                                          |               |     |        |   |  |     |      
|                                   | Retail stores open at end of period                      |               |     | 2      |   |  |     |      |  
|Star Wholesale stores(1):          |                                                          |               |     |        |   |  |     |      
|                                   | Wholesale stores open at beginning of period             |               |     | 3      |   |  |     | 2     |  
|                                   | Wholesale stores opened during the period                |               |     |       |   |  |     |      |  
|                                   |                                                          |               |     |        |   |  |     |      
|                                   | Wholesale stores open at end of period                   |               |     | 3      |   |  |     | 2     |  
|                                   |                                                          |               |     |        |   |  |     |      
|Total store count at end of period |                                                          |               | 981 |        |   |  | 926 |      
|                                   |                                                          |               |     |        |   |  |     |      
|Other operating data:              |                                                          |               |     |        |   |  |     |      
|                                   | Average inventory per Michaels store(2)                  |               | $   | 1,026  |   |  | $   | 1,059 |  
|                                   | Comparable store sales increase(3)                       |               |     | 6      | % |  |     | 2     | %



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                        
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Opening store counts reflect a reclassification
    of our Los Angeles combination wholesale-retail store from a
    Michaels store to a Star Wholesale store. Beginning in fiscal
    2004, our Los Angeles wholesale-retail store will be managed as
    part of our Star Wholesale concept.                                                                                                                         
|   
|(2) | Average inventory per Michaels store calculation
    excludes Aaron Brothers, ReCollections, and Star Wholesale
    stores.                                                                                                                                                                                                                                                                                            
|   
|(3) | 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.

11



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##### Table of Contents



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
|                                             |  |              
|                                             |  | May 1,        |       | May 3,
|                                             |  | 2004          |       | 2003  
|                                             |  |               |       |       
|Net sales                                    |  |               | 100.0 | %      |  |  | 100.0 | %
|Cost of sales and occupancy expense          |  |               | 64.2  |        |  |  | 64.1  |  
|                                             |  |               |       |        |  |  |       |  
|Gross profit                                 |  |               | 35.8  |        |  |  | 35.9  |  
|Selling, general, and administrative expense |  |               | 28.3  |        |  |  | 29.6  |  
|Store pre-opening costs                      |  |               | 0.3   |        |  |  | 0.3   |  
|                                             |  |               |       |        |  |  |       |  
|Operating income                             |  |               | 7.2   |        |  |  | 6.0   |  
|Interest expense                             |  |               | 0.8   |        |  |  | 0.7   |  
|Other (income) and expense, net              |  |               | (0.1  | )      |  |  | (0.1  | )
|                                             |  |               |       |        |  |  |       |  
|Income before income taxes                   |  |               | 6.5   |        |  |  | 5.4   |  
|Provision for income taxes                   |  |               | 2.5   |        |  |  | 2.2   |  
|                                             |  |               |       |        |  |  |       |  
|Net income                                   |  |               | 4.0   | %      |  |  | 3.2   | %
|                                             |  |               |       |        |  |  |       |  

Quarter Ended May 1, 2004 Compared to the
Quarter Ended May 3, 2003

Net sales for the first quarter of fiscal 2004
increased $69.5 million, or 11%, over the first quarter of
fiscal 2003. At the end of the first quarter of fiscal 2004, we
operated 818 Michaels, 158 Aaron Brothers, two ReCollections,
and three Star Wholesale stores. The results for the first
quarter of fiscal 2004 included sales from 51 Michaels, five
Aaron Brothers, two ReCollections, and one Star Wholesale store
that were opened during the 12-month period ended May 1,
2004, more than offsetting lost sales from the closure of four
Michaels stores. Sales at the new stores (net of closures)
during the first quarter of fiscal 2004 accounted for
$31.1 million of the increase in net sales. Comparable
store sales increased 6% in the first quarter of fiscal 2004
compared to the first quarter of fiscal 2003, which contributed
$38.4 million to the net sales increase. Customer traffic
increased approximately 4% in the first quarter of fiscal 2004
compared to the first quarter of fiscal 2003. Average ticket
increased approximately 3%, driven primarily by favorable
pricing trends and a strengthening of the Canadian dollar
(contributing 50 basis points). Comparable store sales
growth was strongest in our scrapbooking, yarn, general crafts,
and kids crafts categories. Our ability to continue to
generate comparable store sales increases is dependent, in part,
on our ability to continue to maintain store in-stock positions
on the top-selling items, to properly allocate 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, was relatively flat in the first
quarter of fiscal 2004 compared to the first quarter of fiscal
2003. The increase in cost of sales and occupancy expense was
due, in part, to the continuation of our accelerated clearance
markdown program in the first quarter of fiscal 2004. In
addition, new store additions since the first quarter of fiscal
2003 and our comparable store sales increase of 6% contributed
to the overall increase in cost of sales and occupancy expense.

Selling, general, and administrative expense was
$205.7 million, or 28.3% of net sales, in the first quarter
of fiscal 2004 compared with $194.6 million, or 29.6% of
net sales, in the first quarter of fiscal 2003. Advertising
expense, as a percentage of net sales, decreased approximately
70 basis points as a result of adjustments we made to our
advertising program in the first quarter of fiscal 2004 and a
leveraging of

12



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##### Table of Contents



expenses on higher net sales. In addition, other
operating expenses, as a percentage of net sales, decreased
approximately 60 basis points, primarily as a result of payroll
expense control, expense leverage on higher net sales, and a
decrease in physical inventory count fees, partially offset by
higher insurance costs.


The effective tax rate was 38.25% for the first
quarter of fiscal 2004 and 41% for the first quarter of fiscal
2003. The effective tax rate was reduced from 41% to 37.6% by
the end of fiscal 2003 due to the resolution of certain tax
issues that were pending with the Internal Revenue Service.

As a result of the above, net income for the
first quarter of fiscal 2004 increased 41% to
$29.3 million, or $0.42 per diluted share, from
$20.8 million, or $0.30 per diluted share, for the
first quarter of fiscal 2003.

Liquidity and Capital Resources

Our cash and equivalents increased
$39.5 million, or 12%, from $341.8 million at the end
of fiscal 2003. We require cash principally for day-to-day
operations and to finance capital investments, inventory for new
stores, and seasonal working capital needs. In recent years, we
have financed our operations, new store openings, Common Stock
repurchases, dividend payments, and other capital investments
primarily with cash from operations and proceeds from stock
option exercises. In addition, borrowings under our Credit
Agreement may be an additional source of cash for us to finance
future growth and other capital investments.

Cash Flow from Operating Activities

Cash flow provided by operating activities during
the first quarter of fiscal 2004 was $66.4 million compared
to $31.0 million during the first quarter of fiscal 2003.
The increase in cash provided by operating activities of
$35.4 million was primarily attributable to an
$8.5 million increase in net income and the timing of
payments for income taxes and other obligations totaling
$28.7 million.

Inventories per Michaels store decreased 3.1%
from May 3, 2003 to May 1, 2004. As a result of our
implementation of perpetual inventory and automated merchandise
replenishment systems and the corresponding improvement in
inventory management, we now anticipate average inventory per
Michaels store at the end of fiscal 2004 to decrease
approximately 3 to 5% from the average inventory per Michaels
store of $1.045 million we reported at the end of fiscal
2003.

Cash Flow from Investing Activities

Cash flow used in investing activities was
primarily the result of the following capital expenditure
activities:

|                                                   |  |                |        |         |  |   |        | 
|-------------------------------------------------- |  | -------------- | ------ | ------- |  | - | ------ | 
|                                                   |  |               
|                                                   |  | Quarter Ended 
|                                                   |  |               
|                                                   |  | May 1,         |        | May 3, 
|                                                   |  | 2004(1)        |        | 2003(2)
|                                                   |  |                |        |        
|                                                   |  |               
|                                                   |  | (In thousands)
|New and relocated stores and stores not yet opened |  | $              | 12,758 |         |  | $ | 4,134  | 
|Existing stores                                    |  |                | 1,864  |         |  |   | 3,542  | 
|Distribution system expansion                      |  |                | 5,558  |         |  |   | 931    | 
|Information systems                                |  |                | 4,859  |         |  |   | 3,552  | 
|Corporate and other                                |  |                | 795    |         |  |   | 1,587  | 
|                                                   |  |                |        |         |  |   |        | 
|                                                   |  | $              | 25,834 |         |  | $ | 13,746 | 
|                                                   |  |                |        |         |  |   |        | 



---



|    |                                                                                                                                                                                                                           
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | In the first quarter of fiscal 2004, we incurred
    capital expenditures related to the opening of 14 and the
    relocation of 12 Michaels stores and the completion of our New
    Lenox, Illinois distribution center.
|   
|(2) | In the first quarter of fiscal 2003, we incurred
    capital expenditures related to the opening of 18 Michaels and
    five Aaron Brothers stores and the relocation of five Michaels
    stores.                        

13



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##### Table of Contents



We anticipate capital expenditures for fiscal
2004 to total approximately $110.0 million. In fiscal 2004,
we plan to open approximately 45 Michaels, seven Aaron
Brothers, and seven ReCollections stores and relocate
31 Michaels and one Aaron Brothers store.

Cash Flow from Financing Activities

Proceeds from the exercise of outstanding stock
options have served as a source of cash for us, and we expect to
receive proceeds from the exercise of outstanding stock options
and options to be granted under our stock option plans in the
future. Proceeds from the exercise of stock options were
$14.2 million in the first quarter of fiscal 2004 and
$1.3 million in the first quarter of fiscal 2003.

Cash used for repurchases of our Common Stock
decreased $18.2 million from $26.0 million in the
first quarter of fiscal 2003 to $7.8 million in the first
quarter of fiscal 2004. The following table sets forth
information regarding our Common Stock repurchase plans as of
May 1, 2004:

|                                                        |  |                |           |             |  |               |            |   |  |  |           |    
|------------------------------------------------------- |  | -------------- | --------- | ----------- |  | ------------- | ---------- | - |  |  | --------- | ---
|                                                        |  | Shares         |           |             |  | Shares       
|                                                        |  | Authorized for |           | Shares      |  | Available for
|                                                        |  | Repurchase     |           | Repurchased |  | Repurchase   
|                                                        |  |                |           |             |  |              
|December 5, 2000 repurchase plan (fixed
    portion)    |  |                | 2,000,000 |             |  |               | (2,000,000 | ) |  |  |          | (1)
|December 5, 2000 repurchase plan (variable
    portion) |  |                | 14,691    |             |  |               |           |   |  |  | 14,691    | (2)
|September 11, 2002 repurchase plan                      |  |                | 1,000,000 |             |  |               | (1,000,000 | ) |  |  |          | (3)
|June 18, 2003 repurchase plan                           |  |                | 1,000,000 |             |  |               | (748,300   | ) |  |  | 251,700   | (4)
|February 2, 2004 repurchase plan                        |  |                | 2,500,000 |             |  |               |           |   |  |  | 2,500,000 |    
|                                                        |  |                |           |             |  |               |            |   |  |  |           |    
|                                                        |  |                | 6,514,691 |             |  |               | (3,748,300 | ) |  |  | 2,766,391 |    
|                                                        |  |                |           |             |  |               |            |   |  |  |           |    



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(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 from the exercise of stock
    options under our 2001 General Stock Option Plan may be used to
    repurchase additional 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 stock option
    exercises. As of April 2003, we had repurchased and subsequently
    retired a total of 2.0 million shares under the 2000
    repurchase plan at an average price 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.
|   
|(2) | No repurchases have been made using proceeds from
    exercises of stock options granted under the 2001 General Stock
    Option Plan. The number of shares authorized for repurchase from
    those proceeds fluctuates with the market price of our Common
    Stock. The estimated 14,691 shares available for repurchase
    was calculated based on the $50.03 closing price of our Common
    Stock on April 30, 2004.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|   
|(3) | As of January 2004, we repurchased and
    subsequently retired the 1.0 million shares of our Common
    Stock authorized under the 2002 repurchase plan at an average
    price of $35.45 per share.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|   
|(4) | In the fourth quarter of fiscal 2003, we
    repurchased and subsequently retired 591,900 shares of our
    Common Stock authorized under the 2003 repurchase plan at an
    average price of $43.10 per share. In the first quarter of
    fiscal 2004, we repurchased and subsequently retired
    156,400 shares of our Common Stock authorized under the
    2003 repurchase plan at an average price of $49.85 per
    share and, as a result, we have 251,700 shares available
    for repurchase under the plan as of May 1, 2004.                                                                                                                                                                                                                                                                                                                                                                       

In May 2004, we have repurchased and subsequently
retired 344,400 shares of our Common Stock at an average
price of $47.51 per share. As of June 2, 2004, we have
a total of 2,421,991 shares available for repurchase. We
anticipate that we will continue to repurchase shares of our
Common Stock during the remainder of fiscal 2004. 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.

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On March 16, 2004, our Board of Directors
approved a cash dividend of $0.12 per share, that was paid
to stockholders of record at the close of business on
April 15, 2004. This dividend reflects our strengthening
financial position and our Board of Directors commitment
to encouraging long-term investment by a diverse stockholder
base. We did not pay any dividends in the first quarter of
fiscal 2003.

Debt

In 2001, we issued $200 million in principal
amount of 9 1/4% Senior Notes due July 1, 2009,
which are unsecured and interest thereon is payable
semi-annually on each January 1 and July 1. The Senior Notes due
2009 are first callable, in part or in full, in July 2005. Based
on our current cash projections, we anticipate calling the
Senior Notes due 2009 in July 2005. The terms and conditions of
the Senior Notes due 2009 require us to comply with certain
covenants, which primarily limit certain activities, including,
among other things, levels of indebtedness, liens, investments,
payments of dividends, Common Stock repurchases, mergers and
acquisitions, and sales of assets. We are in compliance with all
terms and conditions of the Senior Notes due 2009.

Effective May 1, 2001, we signed a
$200 million unsecured revolving bank credit facility with
Fleet National Bank and other lending institutions, which
expires on April 30, 2005. The Credit Agreement requires us
to maintain certain financial covenants and limits certain
activities, including, among other things, levels of
indebtedness, liens, investments, payments of dividends, Common
Stock repurchases, mergers and acquisitions, and sales of
assets. We are in compliance with all terms and conditions of
the Credit Agreement. We had no borrowings under our Credit
Agreement during either the first quarter of fiscal 2004 or the
first quarter of fiscal 2003 and no borrowings were outstanding
under the Credit Agreement at the end of either quarter.
Borrowings available under the Credit Agreement are reduced by
the aggregate amount of letters of credit outstanding under the
Credit Agreement ($26.1 million as of May 1, 2004).

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.






|        |                                                                
|------- | ---------------------------------------------------------------
|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 May 1,
2004. 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 January 31, 2004.






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

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##### Table of Contents



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.


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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##### Table of Contents



MICHAELS STORES, INC.




Part IIOTHER INFORMATION







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

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
consolidated complaint charges 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 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.

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General

We are a defendant from time to time in lawsuits
incidental to our business. Based on currently available
information, we believe that resolution of all known
contingencies 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 2. | Changes in Securities, Use of Proceeds and
    Issuer Purchases of Equity Securities.

On December 5, 2000, our Board of Directors
authorized the repurchase 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.

On September 11, 2002, our Board of
Directors authorized the repurchase of up to 1.0 million
shares of our outstanding Common Stock. On June 18, 2003,
our Board of Directors authorized the repurchase of up to
1.0 million shares of our outstanding Common Stock. On
February 2, 2004, our Board of Directors authorized the
repurchase of up to 2.5 million shares of our outstanding
Common Stock.

The following table sets forth our repurchases of
Common Stock for each fiscal month in the first quarter of
fiscal 2004.

Issuer Purchases of Equity
Securities

|                                               |  |              |         |            |  |                  |       |                    |  |  |         |  |  |  |           | 
|---------------------------------------------- |  | ------------ | ------- | ---------- |  | ---------------- | ----- | ------------------ |  |  | ------- |  |  |  | --------- | 
|                                               |  |              |         |            |  | Total Number     |       | Maximum Number    
|                                               |  |              |         |            |  | of Shares        |       | (or Approximate   
|                                               |  |              |         |            |  | Purchased as     |       | Dollar Value) of  
|                                               |  |              |         |            |  | Part of Publicly |       | Shares That May   
|                                               |  | Total Number |         | Average    |  | Announced        |       | Yet Be Purchased  
|                                               |  | of Shares    |         | Price Paid |  | Plans or         |       | Under the Plans or
|                                               |  | Purchased(1) |         | per Share  |  | Programs(1)      |       | Programs(2)       
|                                               |  |              |         |            |  |                  |       |                   
|February 1, 2004 through February 28,
    2004 |  |              |        |            |  | $                |      |                    |  |  |        |  |  |  | 2,908,100 | 
|February 29, 2004 through April 3, 2004        |  |              |        |            |  |                  |      |                    |  |  |        |  |  |  | 2,922,791 | 
|April 4, 2004 through May 1, 2004              |  |              | 156,400 |            |  |                  | 49.85 |                    |  |  | 156,400 |  |  |  | 2,766,391 | 
|                                               |  |              |         |            |  |                  |       |                    |  |  |         |  |  |  |           | 
|Total                                          |  |              | 156,400 |            |  | $                | 49.85 |                    |  |  | 156,400 |  |  |  | 2,766,391 | 
|                                               |  |              |         |            |  |                  |       |                    |  |  |         |  |  |  |           | 



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Repurchased and subsequently retired under the
    2003 repurchase plan.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|   
|(2) | Under our 2000 repurchase plan, the Board of
    Directors authorized us to repurchase up to 2.0 million
    shares of our outstanding Common Stock, with the ability to
    increase the maximum number of shares authorized to be
    repurchased under the plan to the extent necessary to use the
    proceeds from stock options exercised under our 2001 General
    Stock Option Plan to make repurchases. We have used the entire
    2.0 million share fixed portion of the authority originally
    provided in the 2000 repurchase plan. No repurchases have been
    made using proceeds from exercises of stock options granted
    under the 2001 General Stock Option Plan. The number of shares
    authorized for repurchase from those proceeds fluctuates with
    the market price of our Common Stock. The estimated
    14,691 shares available for repurchase under the variable
    portion of our 2000 repurchase plan was calculated based on the
    $50.03 closing price of our Common Stock on April 30, 2004.
    As of May 1, 2004, we had an estimated 14,691 shares
    available for repurchase under the variable portion of our 2000
    repurchase plan, 251,700 shares available for repurchase
    under the 2003 repurchase plan, and 2.5 million shares
    available for repurchase under the 2004 repurchase plan.

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

(a) Exhibits:

|     |  |                                                                                                                                        
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------
|10.1 |  | Form of Fiscal Year 2004 Bonus Plan for President
    and Chief Executive Officer (filed herewith).                                    
|10.2 |  | Form of Fiscal Year 2004 Bonus Plan for
    President Michaels Stores Group/ Corporate Executive Vice
    Presidents (filed herewith).
|10.3 |  | Form of Fiscal Year 2004 Bonus Plan for Executive
    Vice President Store Operations (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. The following reports
    were filed or furnished by the Registrant during the quarter
    ended May 1, 2004:

|   |  |                                                                                                                                                          
|-- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------
|1. |  | Report on Form 8-K, dated and furnished to
    the Securities and Exchange Commission on February 5, 2004,
    reporting information pursuant to Item 12.
|2. |  | Report on Form 8-K, dated and furnished to
    the Securities and Exchange Commission on March 3, 2004,
    reporting information pursuant to Item 12.   

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##### Table of Contents






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: June 9, 2004

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INDEX TO EXHIBITS

|        |      |                        |  |                                                                                                                                       
|------- | ---- | ---------------------- |  | --------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |      |                       
|Number  |      | Description of Exhibit
|        |      |                       
|        | 10.1 |                        |  | Form of Fiscal Year 2004 Bonus Plan for President
    and Chief Executive Officer (filed herewith).                                   
|        | 10.2 |                        |  | Form of Fiscal Year 2004 Bonus Plan for
    PresidentMichaels Stores Group/ Corporate Executive Vice
    Presidents (filed herewith).
|        | 10.3 |                        |  | Form of Fiscal Year 2004 Bonus Plan for Executive
    Vice PresidentStore Operations (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).