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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION


WASHINGTON, DC 20549




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FORM 10-Q

|                                                       |  |                                                                                             
|------------------------------------------------------ |  | --------------------------------------------------------------------------------------------
|(Mark One)                                             |  |                                                                                             
|x                                                      |  | QUARTERLY REPORT PURSUANT TO SECTION 13
    OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 
|                                                      
|For the quarterly period ended August 2,
    2003     
|                                                      
|OR                                                    
|                                                      
|o                                                      |  | TRANSITION REPORT PURSUANT TO SECTION 13
    OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|                                                      
|For the transition period
    from                  to

Commission file number 001-09338



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MICHAELS STORES, INC.

(Exact name of registrant as specified in its
charter)


|                                                                   |  |                                            
|------------------------------------------------------------------ |  | -------------------------------------------
|Delaware                                                           |  | 75-1943604                                 
|(State or other jurisdiction of
    incorporation or organization) |  | (I.R.S. employer
    identification number)

8000 Bent Branch Drive

Irving, Texas 75063


P.O. Box 619566


DFW, Texas 75261-9566


(Address of principal executive offices,
including zip code)


(972) 409-1300

(Registrants telephone number, including
area code)




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Indicate by check mark whether the Registrant:
(1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period
that the Registrant was required to file such reports), and
(2) has been subject to such filing requirements for the
past
90 days.     Yes x          No 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                                  |  | September 4, 2003       
|                                       |  |                         
|Common Stock, par value $.10 per share |  | 67,002,513              



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TABLE OF CONTENTS



|                                                                                               |                                            |  |  |  |  |  |  | 
|---------------------------------------------------------------------------------------------- | ------------------------------------------ |  |  |  |  |  |  | 
|Part I--FINANCIAL INFORMATION                                                                 
|Item 1. Financial Statements.                                                                 
|                                                                                               | CONSOLIDATED BALANCE SHEETS               
|                                                                                               | CONSOLIDATED STATEMENTS OF INCOME         
|                                                                                               | CONSOLIDATED STATEMENTS OF CASH FLOWS     
|                                                                                               | NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations.
|Item 3. Quantitative and Qualitative Disclosures About Market Risk.                           
|Item 4. Controls and Procedures.                                                              
|Part II--OTHER INFORMATION                                                                    
|Item 1. Legal Proceedings.                                                                    
|Item 4. Submission of Matters to a Vote of Security Holders.                                  
|Item 6. Exhibits and Reports on Form 8-K.                                                     
|SIGNATURES                                                                                    
|EX-31.1 Certifications of R. Michael Rouleau                                                  
|EX-31.1 Certifications of Jeffrey N. Boyer                                                    
|EX-32.1 Certification Pursuant to 18 U.S.C. 1350                                              



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##### Table of Contents



MICHAELS STORES, INC.

FORM 10-Q


Part IFINANCIAL
INFORMATION

|                          |  |                                                                                                                              |  |   
|------------------------- |  | ---------------------------------------------------------------------------------------------------------------------------- |  | --
|Item 1.                   |  | Financial Statements                                                                                                         |  |   
|                          |  | Consolidated Balance Sheets at August 2,
    2003 (unaudited) and February 1, 2003                                           |  | 3 
|                          |  | Consolidated Statements of Income for the quarter
    and six months ended August 2, 2003 and August 3, 2002
    (unaudited) |  | 4 
|                          |  | Consolidated Statements of Cash Flows for the six
    months ended August 2, 2003 and August 3, 2002
    (unaudited)         |  | 5 
|                          |  | Notes to Consolidated Financial Statements
    (unaudited)                                                                   |  | 6 
|Item 2.                   |  | Managements Discussion and Analysis of
    Financial Condition and Results of Operations                                    |  | 11
|Item 3.                   |  | Quantitative and Qualitative Disclosures About
    Market Risk                                                               |  | 18
|Item 4.                   |  | Controls and Procedures                                                                                                      |  | 18
|Part IIOTHER INFORMATION
|Item 1.                   |  | Legal Proceedings                                                                                                            |  | 19
|Item 4.                   |  | Submission of Matters to a Vote of Security
    Holders                                                                      |  | 20
|Item 6.                   |  | Exhibits and Reports on
    Form 8-K                                                                                         |  | 21
|Signatures                |  | 22                                                                                                                          

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)


|                                           |                                                                                                                                                                            |                             |           |             |           |   |           |         |           | 
|------------------------------------------ | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------- | --------- | ----------- | --------- | - | --------- | ------- | --------- | 
|                                           |                                                                                                                                                                            | August 2,                   |           | February 1,
|                                           |                                                                                                                                                                            | 2003                        |           | 2003       
|                                           |                                                                                                                                                                            |                             |           |            
|                                           |                                                                                                                                                                            | (Unaudited)                 |           |            
|ASSETS                                    
|Current assets:                            |                                                                                                                                                                            |                             |           |             |           |   |           |        
|                                           | Cash and equivalents                                                                                                                                                       |                             | $         | 137,201     |           |   | $         | 218,031 |          
|                                           | Merchandise inventories                                                                                                                                                    |                             |           | 988,276     |           |   |           | 809,418 |          
|                                           | Prepaid expenses and other                                                                                                                                                 |                             |           | 24,084      |           |   |           | 18,639  |          
|                                           | Deferred and prepaid income taxes                                                                                                                                          |                             |           | 20,946      |           |   |           | 20,352  |          
|                                           |                                                                                                                                                                            |                             |           |             |           |   |           |        
|                                           |                                                                                                                                                                            | Total current assets        |           |             | 1,170,507 |   |           |         | 1,066,440 | 
|                                           |                                                                                                                                                                            |                             |           |             |           |   |           |        
|Property and equipment, at cost            |                                                                                                                                                                            |                             | 754,699   |             |           |   | 716,299   |        
|Less accumulated depreciation              |                                                                                                                                                                            |                             | (385,712  | )           |           |   | (348,602  | )      
|                                           |                                                                                                                                                                            |                             |           |             |           |   |           |        
|                                           |                                                                                                                                                                            |                             | 368,987   |             |           |   | 367,697   |        
|                                           |                                                                                                                                                                            |                             |           |             |           |   |           |        
|Goodwill                                   |                                                                                                                                                                            |                             | 115,839   |             |           |   | 115,839   |        
|Other assets                               |                                                                                                                                                                            |                             | 13,172    |             |           |   | 10,997    |        
|                                           |                                                                                                                                                                            |                             |           |             |           |   |           |        
|                                           |                                                                                                                                                                            |                             | 129,011   |             |           |   | 126,836   |        
|                                           |                                                                                                                                                                            |                             |           |             |           |   |           |        
|Total assets                               |                                                                                                                                                                            | $                           | 1,668,505 |             |           | $ | 1,560,973 |        
|                                           |                                                                                                                                                                            |                             |           |             |           |   |           |        
|LIABILITIES AND STOCKHOLDERS
    EQUITY  
|Current liabilities:                       |                                                                                                                                                                            |                             |           |             |           |   |           |        
|                                           | Accounts payable                                                                                                                                                           |                             | $         | 209,911     |           |   | $         | 94,764  |          
|                                           | Accrued liabilities and other                                                                                                                                              |                             |           | 167,325     |           |   |           | 181,867 |          
|                                           | Income taxes payable                                                                                                                                                       |                             |           |            |           |   |           | 22,823  |          
|                                           |                                                                                                                                                                            |                             |           |             |           |   |           |        
|                                           |                                                                                                                                                                            | Total current liabilities   |           |             | 377,236   |   |           |         | 299,454   | 
|                                           |                                                                                                                                                                            |                             |           |             |           |   |           |        
|9 1/4% Senior Notes due
    2009           |                                                                                                                                                                            |                             | 200,000   |             |           |   | 200,000   |        
|Deferred income taxes                      |                                                                                                                                                                            |                             | 21,514    |             |           |   | 21,511    |        
|Other long-term liabilities                |                                                                                                                                                                            |                             | 32,625    |             |           |   | 27,981    |        
|                                           |                                                                                                                                                                            |                             |           |             |           |   |           |        
|                                           |                                                                                                                                                                            | Total long-term liabilities |           |             | 254,139   |   |           |         | 249,492   | 
|                                           |                                                                                                                                                                            |                             |           |             |           |   |           |        
|                                           |                                                                                                                                                                            |                             | 631,375   |             |           |   | 548,946   |        
|                                           |                                                                                                                                                                            |                             |           |             |           |   |           |        
|Commitments and contingencies              |                                                                                                                                                                            |                             |           |             |           |   |           |        
|Stockholders equity:                      |                                                                                                                                                                            |                             |           |             |           |   |           |        
|                                           | Common Stock, $0.10 par value,
    150,000,000 shares authorized; shares issued and
    outstanding of 66,821,014 at August 2, 2003 and 67,466,612
    at February 1, 2003 |                             |           | 6,682       |           |   |           | 6,747   |          
|                                           | Additional paid-in capital                                                                                                                                                 |                             |           | 487,406     |           |   |           | 504,792 |          
|                                           | Retained earnings                                                                                                                                                          |                             |           | 543,042     |           |   |           | 500,488 |          
|                                           |                                                                                                                                                                            |                             |           |             |           |   |           |        
|                                           |                                                                                                                                                                            | Total stockholders equity  |           |             | 1,037,130 |   |           |         | 1,012,027 | 
|                                           |                                                                                                                                                                            |                             |           |             |           |   |           |        
|Total liabilities and stockholders equity |                                                                                                                                                                            | $                           | 1,668,505 |             |           | $ | 1,560,973 |        
|                                           |                                                                                                                                                                            |                             |           |             |           |   |           |        

See accompanying notes to consolidated financial
statements.

3



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MICHAELS STORES, INC.




CONSOLIDATED STATEMENTS OF INCOME


(In thousands, except per share
data)


(Unaudited)


|                                                                                                               |                                                               |               |         |                  |  |           |         |           |  |   |           |      |  |   |           |      | 
|-------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------- | ------------- | ------- | ---------------- |  | --------- | ------- | --------- |  | - | --------- | ---- |  | - | --------- | ---- | 
|                                                                                                               |                                                               |               |         |                 
|                                                                                                               |                                                               | Quarter Ended |         | Six Months Ended
|                                                                                                               |                                                               |               |         |                 
|                                                                                                               |                                                               | August 2,     |         | August 3,        |  | August 2, |         | August 3,
|                                                                                                               |                                                               | 2003          |         | 2002             |  | 2003      |         | 2002     
|                                                                                                               |                                                               |               |         |                  |  |           |         |          
|Net sales                                                                                                      |                                                               | $             | 616,516 |                  |  | $         | 576,580 |           |  | $ | 1,272,904 |      |  | $ | 1,179,800 |     
|Cost of sales and occupancy expense                                                                            |                                                               |               | 382,788 |                  |  |           | 359,682 |           |  |   | 803,336   |      |  |   | 751,762   |     
|                                                                                                               |                                                               |               |         |                  |  |           |         |           |  |   |           |      |  |   |           |     
|Gross profit                                                                                                   |                                                               |               | 233,728 |                  |  |           | 216,898 |           |  |   | 469,568   |      |  |   | 428,038   |     
|Selling, general, and administrative expense                                                                   |                                                               |               | 186,673 |                  |  |           | 174,303 |           |  |   | 381,267   |      |  |   | 347,502   |     
|Store pre-opening costs                                                                                        |                                                               |               | 1,590   |                  |  |           | 2,123   |           |  |   | 3,343     |      |  |   | 3,807     |     
|                                                                                                               |                                                               |               |         |                  |  |           |         |           |  |   |           |      |  |   |           |     
|Operating income                                                                                               |                                                               |               | 45,465  |                  |  |           | 40,472  |           |  |   | 84,958    |      |  |   | 76,729    |     
|Interest expense                                                                                               |                                                               |               | 5,065   |                  |  |           | 5,145   |           |  |   | 10,136    |      |  |   | 10,229    |     
|Other (income) and expense, net                                                                                |                                                               |               | (722    | )                |  |           | (429    | )         |  |   | (1,578    | )    |  |   | (1,283    | )   
|                                                                                                               |                                                               |               |         |                  |  |           |         |           |  |   |           |      |  |   |           |     
|Income before income taxes and cumulative
    effect of accounting change                                      |                                                               |               | 41,122  |                  |  |           | 35,756  |           |  |   | 76,400    |      |  |   | 67,783    |     
|Provision for income taxes                                                                                     |                                                               |               | 16,860  |                  |  |           | 14,660  |           |  |   | 31,324    |      |  |   | 27,791    |     
|                                                                                                               |                                                               |               |         |                  |  |           |         |           |  |   |           |      |  |   |           |     
|Income before cumulative effect of accounting
    change                                                       |                                                               |               | 24,262  |                  |  |           | 21,096  |           |  |   | 45,076    |      |  |   | 39,992    |     
|Cumulative effect of accounting change for
    cooperative advertising allowances, net of income tax of $5,165 |                                                               |               |        |                  |  |           |        |           |  |   |          |      |  |   | 7,433     |     
|                                                                                                               |                                                               |               |         |                  |  |           |         |           |  |   |           |      |  |   |           |     
|Net income                                                                                                     |                                                               | $             | 24,262  |                  |  | $         | 21,096  |           |  | $ | 45,076    |      |  | $ | 32,559    |     
|                                                                                                               |                                                               |               |         |                  |  |           |         |           |  |   |           |      |  |   |           |     
|Basic earnings per common share:                                                                               |                                                               |               |         |                  |  |           |         |           |  |   |           |      |  |   |           |     
|                                                                                                               | Income before cumulative effect of accounting
    change      |               | $       | 0.36             |  |           | $       | 0.32      |  |   | $         | 0.67 |  |   | $         | 0.60 | 
|                                                                                                               | Cumulative effect of accounting change, net of
    income tax |               |         |                 |  |           |         |          |  |   |           |     |  |   |           | 0.11 | 
|                                                                                                               |                                                               |               |         |                  |  |           |         |           |  |   |           |      |  |   |           |     
|                                                                                                               | Net income                                                    |               | $       | 0.36             |  |           | $       | 0.32      |  |   | $         | 0.67 |  |   | $         | 0.49 | 
|                                                                                                               |                                                               |               |         |                  |  |           |         |           |  |   |           |      |  |   |           |     
|Diluted earnings per common share:                                                                             |                                                               |               |         |                  |  |           |         |           |  |   |           |      |  |   |           |     
|                                                                                                               | Income before cumulative effect of accounting
    change      |               | $       | 0.35             |  |           | $       | 0.30      |  |   | $         | 0.65 |  |   | $         | 0.57 | 
|                                                                                                               | Cumulative effect of accounting change, net of
    income tax |               |         |                 |  |           |         |          |  |   |           |     |  |   |           | 0.11 | 
|                                                                                                               |                                                               |               |         |                  |  |           |         |           |  |   |           |      |  |   |           |     
|                                                                                                               | Net income                                                    |               | $       | 0.35             |  |           | $       | 0.30      |  |   | $         | 0.65 |  |   | $         | 0.46 | 
|                                                                                                               |                                                               |               |         |                  |  |           |         |           |  |   |           |      |  |   |           |     
|Cash dividends per share                                                                                       |                                                               | $             | 0.10    |                  |  | $         |        |           |  | $ | 0.10      |      |  | $ |          |     

See accompanying notes to consolidated financial
statements.

4



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MICHAELS STORES, INC.




CONSOLIDATED STATEMENTS OF CASH
FLOWS


(In thousands)


(Unaudited)


|                                                |                                                   |                                                                                                           |                                 |                                                         |        |          |          |         |        |          |          |  
|----------------------------------------------- | ------------------------------------------------- | --------------------------------------------------------------------------------------------------------- | ------------------------------- | ------------------------------------------------------- | ------ | -------- | -------- | ------- | ------ | -------- | -------- | -
|                                                |                                                   |                                                                                                          
|                                                |                                                   | Six Months Ended                                                                                         
|                                                |                                                   |                                                                                                          
|                                                |                                                   | August 2,                                                                                                 |                                 | August 3,                                              
|                                                |                                                   | 2003                                                                                                      |                                 | 2002                                                   
|                                                |                                                   |                                                                                                           |                                 |                                                        
|Operating activities:                           |                                                   |                                                                                                           |                                 |                                                         |        |          |          |        
|                                                | Net income                                        |                                                                                                           | $                               | 45,076                                                  |        |          | $        | 32,559  |       
|                                                | Adjustments:                                      |                                                                                                           |                                 |                                                         |        |          |          |         |       
|                                                |                                                   | Depreciation                                                                                              |                                 |                                                         | 40,464 |          |          |         | 39,291 |         
|                                                |                                                   | Amortization                                                                                              |                                 |                                                         | 200    |          |          |         | 201    |         
|                                                |                                                   | Non-cash charge for the cumulative effect of
    accounting change for cooperative advertising allowances |                                 |                                                         |       |          |          |         | 12,598 |         
|                                                |                                                   | Other                                                                                                     |                                 |                                                         | 561    |          |          |         | 538    |         
|                                                |                                                   | Changes in assets and liabilities:                                                                        |                                 |                                                         |        |          |          |         |        |         
|                                                |                                                   |                                                                                                           | Merchandise inventories         |                                                         |        | (178,858 | )        |         |        | (241,761 | )       
|                                                |                                                   |                                                                                                           | Prepaid expenses and other      |                                                         |        | (5,445   | )        |         |        | 1,617    |         
|                                                |                                                   |                                                                                                           | Deferred income taxes and other |                                                         |        | 1,835    |          |         |        | 2,740    |         
|                                                |                                                   |                                                                                                           | Accounts payable                |                                                         |        | 115,147  |          |         |        | 82,558   |         
|                                                |                                                   |                                                                                                           | Income taxes payable            |                                                         |        | (21,438  | )        |         |        | (43,369  | )       
|                                                |                                                   |                                                                                                           | Accrued liabilities and other   |                                                         |        | (11,397  | )        |         |        | (11,853  | )       
|                                                |                                                   |                                                                                                           |                                 |                                                         |        |          |          |        
|                                                |                                                   |                                                                                                           |                                 | Net change in assets and liabilities                    |        |          | (100,156 | )       |        |          | (210,068 | )
|                                                |                                                   |                                                                                                           |                                 |                                                         |        |          |          |        
|                                                |                                                   |                                                                                                           |                                 | Net cash used in operating activities                   |        |          | (13,855  | )       |        |          | (124,881 | )
|                                                |                                                   |                                                                                                           |                                 |                                                         |        |          |          |        
|Investing activities:                           |                                                   |                                                                                                           |                                 |                                                         |        |          |          |        
|                                                | Additions to property and equipment               |                                                                                                           |                                 | (40,880                                                 | )      |          |          | (71,362 | )     
|                                                | Net proceeds from sales of property and equipment |                                                                                                           |                                 | 13                                                      |        |          |          | 14      |       
|                                                |                                                   |                                                                                                           |                                 |                                                         |        |          |          |        
|                                                |                                                   |                                                                                                           |                                 | Net cash used in investing activities                   |        |          | (40,867  | )       |        |          | (71,348  | )
|                                                |                                                   |                                                                                                           |                                 |                                                         |        |          |          |        
|Financing activities:                           |                                                   |                                                                                                           |                                 |                                                         |        |          |          |        
|                                                | Proceeds from stock options exercised             |                                                                                                           |                                 | 5,469                                                   |        |          |          | 11,581  |       
|                                                | Proceeds from issuance of Common Stock and other  |                                                                                                           |                                 | 1,069                                                   |        |          |          | 772     |       
|                                                | Net borrowings under the Credit Agreement         |                                                                                                           |                                 |                                                        |        |          |          | 20,400  |       
|                                                | Repurchase of Common Stock                        |                                                                                                           |                                 | (25,968                                                 | )      |          |          | (12,821 | )     
|                                                | Cash dividend paid to stockholders                |                                                                                                           |                                 | (6,678                                                  | )      |          |          |        |       
|                                                | Payment of other long-term liabilities            |                                                                                                           |                                 |                                                        |        |          |          | (200    | )     
|                                                |                                                   |                                                                                                           |                                 |                                                         |        |          |          |        
|                                                |                                                   |                                                                                                           |                                 | Net cash (used in) provided by financing
    activities |        |          | (26,108  | )       |        |          | 19,732   |  
|                                                |                                                   |                                                                                                           |                                 |                                                         |        |          |          |        
|Net decrease in cash and equivalents            |                                                   |                                                                                                           | (80,830                         | )                                                       |        |          | (176,497 | )      
|Cash and equivalents at beginning of
    period |                                                   |                                                                                                           | 218,031                         |                                                         |        |          | 193,025  |        
|                                                |                                                   |                                                                                                           |                                 |                                                         |        |          |          |        
|Cash and equivalents at end of
    period       |                                                   | $                                                                                                         | 137,201                         |                                                         |        | $        | 16,528   |        
|                                                |                                                   |                                                                                                           |                                 |                                                         |        |          |          |        

See accompanying notes to consolidated financial
statements.

5



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##### Table of Contents



MICHAELS STORES, INC.




NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS


For the Six Months Ended August 2,
2003

(Unaudited)




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

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

The accompanying unaudited consolidated financial
statements have been prepared in accordance with generally
accepted accounting principles for interim financial information
and with the instructions to Form 10-Q and Article 10
of Regulation S-X. Accordingly, they do not include all of
the information and notes required by generally accepted
accounting principles for complete financial statements. In the
opinion of management, all adjustments (consisting of normal
recurring accruals and other items, as disclosed) considered
necessary for a fair presentation have been included. Because of
the seasonal nature of our business, the results of operations
for the quarter and six months ended August 2, 2003 are not
indicative of the results to be expected for the entire year.

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

All references herein to fiscal 2003
relate to the 52 weeks ending January 31, 2004 and all
references to fiscal 2002 relate to the
52 weeks ended February 1, 2003. In addition, all
references herein to the second quarter of fiscal
2003 and the first six months of fiscal 2003
relate to the 13 and 26 weeks ended August 2, 2003,
respectively, and all references to the second quarter of
fiscal 2002 and the first six months of fiscal
2002 relate to the 13 and 26 weeks ended
August 3, 2002, respectively.



|        |                               
|------- | ------------------------------
|Note 2. | Change in Accounting Principle

In November 2002, the EITF reached consensus on
Issue 02-16, Accounting by a Customer (Including a
Reseller) for Cash Consideration Received from a Vendor.
Issue 02-16 addresses the accounting for cash consideration
received by a customer from a vendor (e.g., slotting fees,
cooperative advertising payments, buydowns) and rebates or
refunds from a vendor that are payable only if the customer
completes a specified cumulative level of purchases or remains a
customer for a specified time period. Issue 02-16 became
effective for new arrangements or modifications to existing
arrangements entered into after December 31, 2002, although
early adoption was permitted. We elected to adopt early,
effective February 3, 2002, the provisions of
Issue 02-16 in the preparation of our Annual Report on
Form 10-K for the fiscal year ended February 1, 2003.
Accordingly, in fiscal 2002, we recorded a cumulative effect of
accounting change of $12.6 million, $7.4 million net
of income tax, for the impact of this adoption on prior fiscal
years. The adoption of the provisions of Issue 02-16
resulted in the ongoing deferral of our cooperative advertising
allowances into inventory, with the allowances being recognized
as the associated inventory is sold. This adoption also resulted
in the reclassification of our cooperative advertising payments
earned in fiscal 2002 from selling, general, and administrative
expense to cost of sales and occupancy expense retroactively as
of the beginning of fiscal 2002. Results for the second quarter
and first six months of fiscal 2002 have been restated to
reflect our new accounting policy for cooperative advertising
allowances and, as a result, income before cumulative effect of
accounting change for the second quarter and first
six months of fiscal 2002 was reduced by $358,000 and
$2.1 million, respectively.

6



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##### Table of Contents



MICHAELS STORES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (Continued)


For the Six Months Ended August 2,
2003

(Unaudited)




|        |                   
|------- | ------------------
|Note 3. | Earnings per Share

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

|                                   |                                                                                                                |                                       |   |                  |       |           |   |           |       |  |   |        |       |  |   |        |       | 
|---------------------------------- | -------------------------------------------------------------------------------------------------------------- | ------------------------------------- | - | ---------------- | ----- | --------- | - | --------- | ----- |  | - | ------ | ----- |  | - | ------ | ----- | 
|                                   |                                                                                                                |                                       |   |                 
|                                   |                                                                                                                | Quarter Ended                         |   | Six Months Ended
|                                   |                                                                                                                |                                       |   |                 
|                                   |                                                                                                                | August 2,                             |   | August 3,        |       | August 2, |   | August 3,
|                                   |                                                                                                                | 2003                                  |   | 2002             |       | 2003      |   | 2002(1)  
|                                   |                                                                                                                |                                       |   |                  |       |           |   |          
|                                   |                                                                                                                |                                      
|                                   |                                                                                                                | (In thousands, except per share data)
|Numerator:                         |                                                                                                                |                                       |   |                  |       |           |   |           |       |  |   |        |       |  |   |       
|                                   | Income before cumulative effect of accounting
    change                                                       |                                       | $ | 24,262           |       |           | $ | 21,096    |       |  | $ | 45,076 |       |  | $ | 39,992 |      
|                                   | Cumulative effect of accounting change, net of
    income tax                                                  |                                       |   |                 |       |           |   |          |       |  |   |       |       |  |   | 7,433  |      
|                                   |                                                                                                                |                                       |   |                  |       |           |   |           |       |  |   |        |       |  |   |       
|                                   | Net income                                                                                                     |                                       | $ | 24,262           |       |           | $ | 21,096    |       |  | $ | 45,076 |       |  | $ | 32,559 |      
|                                   |                                                                                                                |                                       |   |                  |       |           |   |           |       |  |   |        |       |  |   |       
|Denominator:                       |                                                                                                                |                                       |   |                  |       |           |   |           |       |  |   |        |       |  |   |       
|                                   | Denominator for basic earnings per common
    share-weighted average shares                                    |                                       |   | 66,673           |       |           |   | 66,355    |       |  |   | 66,878 |       |  |   | 66,157 |      
|                                   | Effect of dilutive securities:                                                                                 |                                       |   |                  |       |           |   |           |       |  |   |        |       |  |   |        |      
|                                   |                                                                                                                | Employee stock options                |   |                  | 3,210 |           |   |           | 4,236 |  |   |        | 2,640 |  |   |        | 4,226 | 
|                                   |                                                                                                                |                                       |   |                  |       |           |   |           |       |  |   |        |       |  |   |       
|                                   | Denominator for diluted earnings per common
    share-weighted average shares adjusted for dilutive securities |                                       |   | 69,883           |       |           |   | 70,591    |       |  |   | 69,518 |       |  |   | 70,383 |      
|                                   |                                                                                                                |                                       |   |                  |       |           |   |           |       |  |   |        |       |  |   |       
|Basic earnings per common share:   |                                                                                                                |                                       |   |                  |       |           |   |           |       |  |   |        |       |  |   |       
|                                   | Income before cumulative effect of accounting
    change                                                       |                                       | $ | 0.36             |       |           | $ | 0.32      |       |  | $ | 0.67   |       |  | $ | 0.60   |      
|                                   | Cumulative effect of accounting change, net of
    income tax                                                  |                                       |   |                 |       |           |   |          |       |  |   |       |       |  |   | 0.11   |      
|                                   |                                                                                                                |                                       |   |                  |       |           |   |           |       |  |   |        |       |  |   |       
|                                   | Net income                                                                                                     |                                       | $ | 0.36             |       |           | $ | 0.32      |       |  | $ | 0.67   |       |  | $ | 0.49   |      
|                                   |                                                                                                                |                                       |   |                  |       |           |   |           |       |  |   |        |       |  |   |       
|Diluted earnings per common share: |                                                                                                                |                                       |   |                  |       |           |   |           |       |  |   |        |       |  |   |       
|                                   | Income before cumulative effect of accounting
    change                                                       |                                       | $ | 0.35             |       |           | $ | 0.30      |       |  | $ | 0.65   |       |  | $ | 0.57   |      
|                                   | Cumulative effect of accounting change, net of
    income tax                                                  |                                       |   |                 |       |           |   |          |       |  |   |       |       |  |   | 0.11   |      
|                                   |                                                                                                                |                                       |   |                  |       |           |   |           |       |  |   |        |       |  |   |       
|                                   | Net income                                                                                                     |                                       | $ | 0.35             |       |           | $ | 0.30      |       |  | $ | 0.65   |       |  | $ | 0.46   |      
|                                   |                                                                                                                |                                       |   |                  |       |           |   |           |       |  |   |        |       |  |   |       

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 1.0 million and 704,166 shares for the
second quarter and first six months of fiscal 2003, respectively.



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

7



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##### Table of Contents



MICHAELS STORES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (Continued)


For the Six Months Ended August 2,
2003

(Unaudited)




|        |                                         
|------- | ----------------------------------------
|Note 4. | Stock-Based
    Compensation (Continued)

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                         |        | Six Months Ended
|                                                   |                                                                 |                                       |        |                 
|                                                   |                                                                 | August 2,                             |        | August 3,        |  | August 2, |        | August 3,
|                                                   |                                                                 | 2003                                  |        | 2002             |  | 2003      |        | 2002(1)  
|                                                   |                                                                 |                                       |        |                  |  |           |        |          
|                                                   |                                                                 |                                      
|                                                   |                                                                 | (In thousands, except per share data)
|Net income, as reported                            |                                                                 | $                                     | 24,262 |                  |  | $         | 21,096 |           |  | $ | 45,076 |        |  | $ | 32,559 |       
|Stock-based employee compensation cost:            |                                                                 |                                       |        |                  |  |           |        |           |  |   |        |        |  |   |        |       
|                                                   | As if the fair value method were applied, net of
    income tax |                                       |        | 3,397            |  |           |        | 3,080     |  |   |        | 6,641  |  |   |        | 6,045  | 
|                                                   |                                                                 |                                       |        |                  |  |           |        |           |  |   |        |        |  |   |        |       
|Pro forma net income                               |                                                                 | $                                     | 20,865 |                  |  | $         | 18,016 |           |  | $ | 38,435 |        |  | $ | 26,514 |       
|                                                   |                                                                 |                                       |        |                  |  |           |        |           |  |   |        |        |  |   |        |       
|Earnings per common share, as
    reported:        |                                                                 |                                       |        |                  |  |           |        |           |  |   |        |        |  |   |        |       
|                                                   | Basic                                                           |                                       | $      | 0.36             |  |           | $      | 0.32      |  |   | $      | 0.67   |  |   | $      | 0.49   | 
|                                                   |                                                                 |                                       |        |                  |  |           |        |           |  |   |        |        |  |   |        |       
|                                                   | Diluted                                                         |                                       | $      | 0.35             |  |           | $      | 0.30      |  |   | $      | 0.65   |  |   | $      | 0.46   | 
|                                                   |                                                                 |                                       |        |                  |  |           |        |           |  |   |        |        |  |   |        |       
|Pro forma earnings per common share:               |                                                                 |                                       |        |                  |  |           |        |           |  |   |        |        |  |   |        |       
|                                                   | Basic                                                           |                                       | $      | 0.31             |  |           | $      | 0.27      |  |   | $      | 0.57   |  |   | $      | 0.40   | 
|                                                   |                                                                 |                                       |        |                  |  |           |        |           |  |   |        |        |  |   |        |       
|                                                   | Diluted                                                         |                                       | $      | 0.31             |  |           | $      | 0.26      |  |   | $      | 0.57   |  |   | $      | 0.39   | 
|                                                   |                                                                 |                                       |        |                  |  |           |        |           |  |   |        |        |  |   |        |       
|Pro forma weighted average shares
    outstanding: |                                                                 |                                       |        |                  |  |           |        |           |  |   |        |        |  |   |        |       
|                                                   | Basic                                                           |                                       |        | 66,673           |  |           |        | 66,355    |  |   |        | 66,878 |  |   |        | 66,157 | 
|                                                   | Diluted                                                         |                                       |        | 68,239           |  |           |        | 68,679    |  |   |        | 67,942 |  |   |        | 68,437 | 



---



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



|        |                 
|------- | ----------------
|Note 5. | 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
replaced the previous $100 million unsecured revolving bank
credit facility. The Credit Agreement had an original term of
three years (with a maturity extension for one additional year
available under certain conditions) and contains a
$25 million competitive bid feature and a $70 million
letter of credit sub-facility. Effective May 21, 2002,
pursuant to the terms of the Credit Agreement, our lenders
agreed to extend the term of the Credit Agreement from
April 30, 2004 to April 30, 2005.

We are in compliance with all terms and
conditions of the Credit Agreement. No borrowings were
outstanding under the Credit Agreement as of August 2, 2003
or at any time during the first six months of fiscal 2003.
Borrowings outstanding under the Credit Agreement were
$20.4 million as of August 3, 2002. Borrowings
available under the Credit Agreement are reduced by the
aggregate amount of letters of credit outstanding under the
Credit Agreement ($26.2 million as of August 2, 2003).

8



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##### Table of Contents



MICHAELS STORES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (Continued)


For the Six Months Ended August 2,
2003

(Unaudited)




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



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

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



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

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



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

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

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



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

9



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##### Table of Contents



MICHAELS STORES, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (Continued)


For the Six Months Ended August 2,
2003

(Unaudited)




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

Ontario Superior Court of Justice and alleges
that the defendants violated employment standards legislation in
Ontario and other provinces and territories of Canada by failing
to pay overtime compensation as required by that legislation.
The Cotton claim also alleges that this conduct was in breach of
the contracts of employment of those individuals. The Cotton
claim seeks a declaration that the defendants have acted in
breach of applicable legislation, payment to current and former
employees for overtime, damages for breach of contract,
punitive, aggravated and exemplary damages, interest, and costs.
We believe we have certain meritorious defenses and intend to
defend this lawsuit vigorously.



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

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



|        |                                 
|------- | --------------------------------
|Note 7. | Recent Accounting Pronouncements

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

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

10



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##### Table of Contents








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

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

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

General

All references herein to fiscal 2003
relate to the 52 weeks ending January 31, 2004 and all
references to fiscal 2002 relate to the
52 weeks ended February 1, 2003. In addition, all
references herein to the second quarter of fiscal
2003 and the first six months of fiscal 2003
relate to the 13 and 26 weeks ended August 2, 2003,
respectively, and all references to the second quarter of
fiscal 2002 and the first six months of fiscal
2002 relate to the 13 and 26 weeks ended
August 3, 2002, respectively.

11



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##### Table of Contents



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

|                                   |                                           |               |   |                  |   |           |   |           |   |  |   |       |   |  |   |       |  
|---------------------------------- | ----------------------------------------- | ------------- | - | ---------------- | - | --------- | - | --------- | - |  | - | ----- | - |  | - | ----- | -
|                                   |                                           |               |   |                 
|                                   |                                           | Quarter Ended |   | Six Months Ended
|                                   |                                           |               |   |                 
|                                   |                                           | August 2,     |   | August 3,        |   | August 2, |   | August 3,
|                                   |                                           | 2003          |   | 2002             |   | 2003      |   | 2002     
|                                   |                                           |               |   |                  |   |           |   |          
|Michaels stores:                   |                                           |               |   |                  |   |           |   |           |   |  |   |       |   |  |   |      
|                                   | Retail stores open at end of period       |               |   | 773              |   |           |   | 728       |   |  |   | 773   |   |  |   | 728   |  
|                                   | Retail stores opened during the period    |               |   | 8                |   |           |   | 18        |   |  |   | 22    |   |  |   | 36    |  
|                                   | Retail stores closed during the period    |               |   |                 |   |           |   | 2         |   |  |   | 1     |   |  |   | 3     |  
|                                   | Retail stores relocated during the period |               |   | 4                |   |           |   | 1         |   |  |   | 9     |   |  |   | 9     |  
|Aaron Brothers stores:             |                                           |               |   |                  |   |           |   |           |   |  |   |       |   |  |   |      
|                                   | Retail stores open at end of period       |               |   | 157              |   |           |   | 147       |   |  |   | 157   |   |  |   | 147   |  
|                                   | Retail stores opened during the period    |               |   | 4                |   |           |   | 7         |   |  |   | 9     |   |  |   | 10    |  
|                                   | Retail stores closed during the period    |               |   |                 |   |           |   | 2         |   |  |   |      |   |  |   | 2     |  
|                                   | Retail stores relocated during the period |               |   |                 |   |           |   | 1         |   |  |   |      |   |  |   | 1     |  
|Village Crafts by Michaels stores: |                                           |               |   |                  |   |           |   |           |   |  |   |       |   |  |   |      
|                                   | Retail stores open at end of period       |               |   | 8                |   |           |   | 1         |   |  |   | 8     |   |  |   | 1     |  
|                                   | Retail stores opened during the period    |               |   | 1                |   |           |   |          |   |  |   | 5     |   |  |   | 1     |  
|ReCollections store:               |                                           |               |   |                  |   |           |   |           |   |  |   |       |   |  |   |      
|                                   | Retail store open at end of period        |               |   | 1                |   |           |   |          |   |  |   | 1     |   |  |   |      |  
|                                   | Retail store opened during the period     |               |   | 1                |   |           |   |          |   |  |   | 1     |   |  |   |      |  
|Star Wholesale store:              |                                           |               |   |                  |   |           |   |           |   |  |   |       |   |  |   |      
|                                   | Wholesale store open at end of period     |               |   | 1                |   |           |   | 1         |   |  |   | 1     |   |  |   | 1     |  
|Other operating data:              |                                           |               |   |                  |   |           |   |           |   |  |   |       |   |  |   |      
|                                   | Average inventory per Michaels store(1)   |               | $ | 1,208            |   |           | $ | 1,240     |   |  | $ | 1,208 |   |  | $ | 1,240 |  
|                                   | Comparable store sales increase(2)        |               |   | 1                | % |           |   | 9         | % |  |   | 2     | % |  |   | 7     | %



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Average inventory per Michaels store calculation
    includes Michaels and Village Crafts by Michaels stores, but
    excludes Aaron Brothers, ReCollections, and Star Wholesale
    stores.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   
|(2) | Comparable store sales increase represents the
    increase in net sales for stores open the same number of months
    in the indicated period and the comparable period of the
    previous year, including stores that were relocated or expanded
    during either period. A store is deemed to become comparable in
    its 14th full month of operation in order to eliminate
    grand opening sales distortions. Beginning in fiscal 2003, we
    began including the effect of deferring the recognition of
    custom frame sales for orders that have not been picked up by
    the customer at the end of the period in our comparable store
    sales calculation. As a result, we have retroactively applied
    the custom frame sales deferral to our comparable store sales
    increase for the second quarter and first six months of fiscal
    2002. There was no change in the comparable store sales increase
    percentage for the second quarter and first six months of fiscal
    2002 from the amount previously reported as a result of this
    adjustment.

Change in Accounting Principle

In November 2002, the EITF reached consensus on
Issue 02-16, Accounting by a Customer (Including a
Reseller) for Cash Consideration Received from a Vendor.
Issue 02-16 addresses the accounting for cash consideration
received by a customer from a vendor (e.g., slotting fees,
cooperative advertising payments, buydowns) and rebates or
refunds from a vendor that are payable only if the customer
completes a specified cumulative level of purchases or remains a
customer for a specified time period. Issue 02-16 became
effective for new arrangements or modifications to existing
arrangements entered into after December 31, 2002, although
early adoption was permitted. We elected to adopt early,
effective February 3, 2002, the provisions of
Issue 02-16 in the preparation of our Annual Report on
Form 10-K for the fiscal year ended February 1, 2003.
Accordingly, in fiscal 2002, we recorded a cumulative effect of
accounting change of $12.6 million, $7.4 million net
of income tax, for the impact of this adoption on prior fiscal
years. The adoption of the provisions of Issue 02-16
resulted in the ongoing deferral of our cooperative advertising
allowances into inventory, with the allowances being recognized
as

12



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##### Table of Contents



the associated inventory is sold. This adoption
also resulted in the reclassification of our cooperative
advertising payments earned in fiscal 2002 from selling,
general, and administrative expense to cost of sales and
occupancy expense retroactively as of the beginning of fiscal
2002. Results for the second quarter and first six months of
fiscal 2002 have been restated to reflect our new accounting
policy for cooperative advertising allowances and, as a result,
income before cumulative effect of accounting change for the
second quarter and first six months of fiscal 2002 was reduced
by $358,000 and $2.1 million, respectively.


Results of Operations

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

|                                                                                                     |  |               |       |                  |  |           |       |           |  |  |       |   |  |  |       |  
|---------------------------------------------------------------------------------------------------- |  | ------------- | ----- | ---------------- |  | --------- | ----- | --------- |  |  | ----- | - |  |  | ----- | -
|                                                                                                     |  |               |       |                 
|                                                                                                     |  | Quarter Ended |       | Six Months Ended
|                                                                                                     |  |               |       |                 
|                                                                                                     |  | August 2,     |       | August 3,        |  | August 2, |       | August 3,
|                                                                                                     |  | 2003          |       | 2002             |  | 2003      |       | 2002     
|                                                                                                     |  |               |       |                  |  |           |       |          
|Net sales                                                                                            |  |               | 100.0 | %                |  |           | 100.0 | %         |  |  | 100.0 | % |  |  | 100.0 | %
|Cost of sales and occupancy expense                                                                  |  |               | 62.1  |                  |  |           | 62.4  |           |  |  | 63.1  |   |  |  | 63.7  |  
|                                                                                                     |  |               |       |                  |  |           |       |           |  |  |       |   |  |  |       |  
|Gross profit                                                                                         |  |               | 37.9  |                  |  |           | 37.6  |           |  |  | 36.9  |   |  |  | 36.3  |  
|Selling, general, and administrative expense                                                         |  |               | 30.3  |                  |  |           | 30.2  |           |  |  | 30.0  |   |  |  | 29.5  |  
|Store pre-opening costs                                                                              |  |               | 0.2   |                  |  |           | 0.4   |           |  |  | 0.2   |   |  |  | 0.3   |  
|                                                                                                     |  |               |       |                  |  |           |       |           |  |  |       |   |  |  |       |  
|Operating income                                                                                     |  |               | 7.4   |                  |  |           | 7.0   |           |  |  | 6.7   |   |  |  | 6.5   |  
|Interest expense                                                                                     |  |               | 0.8   |                  |  |           | 0.9   |           |  |  | 0.8   |   |  |  | 0.9   |  
|Other (income) and expense, net                                                                      |  |               | (0.1  | )                |  |           | (0.1  | )         |  |  | (0.1  | ) |  |  | (0.1  | )
|                                                                                                     |  |               |       |                  |  |           |       |           |  |  |       |   |  |  |       |  
|Income before income taxes and cumulative
    effect of accounting change                            |  |               | 6.7   |                  |  |           | 6.2   |           |  |  | 6.0   |   |  |  | 5.7   |  
|Provision for income taxes                                                                           |  |               | 2.8   |                  |  |           | 2.5   |           |  |  | 2.5   |   |  |  | 2.3   |  
|                                                                                                     |  |               |       |                  |  |           |       |           |  |  |       |   |  |  |       |  
|Income before cumulative effect of accounting
    change                                             |  |               | 3.9   |                  |  |           | 3.7   |           |  |  | 3.5   |   |  |  | 3.4   |  
|Cumulative effect of accounting change for
    cooperative advertising allowances, net of income tax |  |               |      |                  |  |           |      |           |  |  |      |   |  |  | 0.6   |  
|                                                                                                     |  |               |       |                  |  |           |       |           |  |  |       |   |  |  |       |  
|Net income                                                                                           |  |               | 3.9   | %                |  |           | 3.7   | %         |  |  | 3.5   | % |  |  | 2.8   | %
|                                                                                                     |  |               |       |                  |  |           |       |           |  |  |       |   |  |  |       |  

Quarter Ended August 2, 2003 Compared to
the Quarter Ended August 3, 2002

Net sales for the second quarter of fiscal 2003
increased $39.9 million, or 7%, over the second quarter of
fiscal 2002. At the end of the second quarter of fiscal 2003, we
operated 773 Michaels, 157 Aaron Brothers, eight
Village Crafts by Michaels, and one ReCollections retail store.
The results for the second quarter of fiscal 2003 included sales
from 50 Michaels, 12 Aaron Brothers, and seven Village
Crafts by Michaels, and one ReCollections retail stores that
were opened during the 12-month period ended August 2,
2003, more than offsetting lost sales from the closure of five
Michaels and two Aaron Brothers stores. Sales at the new stores
(net of closures) during the second quarter of fiscal 2003
accounted for $33.4 million of the increase in net sales.
Comparable store sales increased 1% in the second quarter of
fiscal 2003 compared to the second quarter of fiscal 2002, which
contributed $6.5 million to the net sales increase. The
improvement in comparable store sales was due to a strong
performance in our core categories of Summer seasonal, general
crafts, books, ribbon, and kids crafts. 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, for the second quarter of fiscal 2003
was 62.1%, a decrease of 0.3% compared to the second quarter of
fiscal 2003. This decrease was primarily attributable to
improved merchandise margins, partially offset by increased
store occupancy costs.

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Selling, general, and administrative expense was
$186.7 million, or 30.3% of net sales, in the second
quarter of fiscal 2003 compared with $174.3 million, or
30.2% of net sales, in the second quarter of fiscal 2002. This
increase, as a percentage of net sales, was primarily the result
of higher store employee benefits and workers compensation
costs. In addition, inventory counting service fees increased
from the second quarter of fiscal 2002 to the second quarter of
fiscal 2003 in connection with the rollout of our perpetual
inventory and automated merchandise replenishment systems. These
increases were largely offset by leveraging in advertising,
store compensation, corporate general and administrative, and
depreciation expenses as a result of higher net sales in the
second quarter of fiscal 2003 compared to the second quarter of
fiscal 2002.

We expense all store pre-opening costs as
incurred. Store pre-opening costs were $1.6 million, or
0.2% of net sales, in the second quarter of fiscal 2003 compared
to $2.1 million, or 0.4% of net sales, in the second
quarter of fiscal 2002. In the second quarter of fiscal 2003, we
opened or relocated 12 Michaels, four Aaron Brothers, one
Village Crafts by Michaels, and one ReCollections store compared
to 19 Michaels and eight Aaron Brothers stores opened or
relocated in the second quarter of fiscal 2002.

Operating income increased 12% to
$45.5 million, or 7.4% of net sales, in the second quarter
of fiscal 2003 from $40.5 million, or 7.0% of net sales, in
the second quarter of fiscal 2002.

Interest expense was $5.1 million, or 0.8%
of net sales, in the second quarter of fiscal 2003 and
$5.1 million, or 0.9% of net sales in the second quarter of
fiscal 2002. This decrease, as a percentage of net sales, was
primarily due to the leveraging of interest expense on higher
net sales in the second quarter of fiscal 2003 compared to the
second quarter of fiscal 2002.

The effective tax rate was 41% for both the
second quarter of fiscal 2003 and the second quarter of fiscal
2002.

Net income for the second quarter of fiscal 2003
was $24.3 million, or $0.35 per diluted share,
compared to $21.1 million, or $0.30 per diluted share,
for the second quarter of fiscal 2002.

First Six Months Ended August 2, 2003
Compared to the First Six Months Ended August 3,
2002

Net sales for the first six months of fiscal 2003
increased $93.1 million, or 8%, over the first six months
of fiscal 2002. Sales at the new stores (net of closures) during
the first six months of fiscal 2003 accounted for
$73.3 million of the increase in net sales. Comparable
store sales increased 2% in the first six months of fiscal 2003
compared to the first six months of fiscal 2002, which
contributed $19.8 million to the net sales increase. The
improvement in comparable store sales was due to a strong
performance in our core categories of Summer and Spring
seasonal, general crafts, ribbon, custom framing, and kids
crafts.

Cost of sales and occupancy expense, as a
percentage of net sales, for the first six months of fiscal 2003
was 63.1%, a decrease of 0.6% compared to the first six months
of fiscal 2002. This decrease was primarily attributable to
improved merchandise margins, partially offset by increased
store occupancy costs.

Selling, general, and administrative expense was
$381.3 million, or 30.0% of net sales, in the first six
months of fiscal 2003 compared with $347.5 million, or
29.5% of net sales, in the first six months of fiscal 2002. This
increase, as a percentage of net sales, was primarily the result
of higher store employee benefits, workers compensation, and
advertising costs. In addition, inventory counting service fees
increased from the first six months of fiscal 2002 to the first
six months of fiscal 2003 in connection with the rollout of our
perpetual inventory and automated merchandise replenishment
systems. These fees will also be higher in the fourth quarter of
fiscal 2003 compared to fiscal 2002 as we complete this
chain-wide rollout. These increases were partially offset by
decreases in store compensation and corporate general and
administrative costs as a percentage of net sales from the first
six months of fiscal 2002 to the first six months of fiscal 2003.

Store pre-opening costs were $3.3 million,
or 0.2% of net sales, in the first six months of fiscal 2003
compared to $3.8 million, or 0.3% of net sales, in the
first six months of fiscal 2002. In the first six months

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of fiscal 2003, we opened or relocated
31 Michaels, nine Aaron Brothers, five Village Crafts by
Michaels, and one ReCollections store compared to
45 Michaels and 11 Aaron Brothers stores opened or
relocated in the first six months of fiscal 2002.


Operating income increased 11% to
$85.0 million, or 6.7% of net sales, in the first six
months of fiscal 2003 from $76.7 million, or 6.5% of net
sales, in the first six months of fiscal 2002.

Interest expense was $10.1 million, or 0.8%
of net sales, in the first six months of fiscal 2003 and
$10.2 million, or 0.9% of net sales in the first six months
of fiscal 2002. This decrease, as a percentage of net sales, was
primarily due to the leveraging of interest expense on higher
net sales in the first six months of fiscal 2003 compared to the
first six months of fiscal 2002.

The effective tax rate was 41% for both the first
six months of fiscal 2003 and the first six months of fiscal
2002.

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

Net income for the first six months of fiscal
2003 was $45.1 million, or $0.65 per diluted share,
compared to $32.6 million, or $0.46 per diluted share,
for the first six months of fiscal 2002. Income before
cumulative effect of accounting change for the first six months
of fiscal 2002 was $40.0 million, or $0.57 per diluted
share.

Liquidity and Capital Resources

Changes in Cash and Equivalents

Cash flow used in operating activities during the
first six months of fiscal 2003 was $13.9 million compared
to $124.9 million during the first six months of fiscal
2002. The decrease in cash used in operating activities of
$111.0 million in the first six months of fiscal 2003
compared to the first six months of fiscal 2002 was primarily
attributable to a decrease in the net change in merchandise
inventories and accounts payable of $95.5 million and a
decrease in the change in income taxes payable and accrued
liabilities of $22.4 million. These decreases were
primarily a result of the timing of inventory purchases and
related payments and the payment of income taxes and other
obligations. Inventories per Michaels store decreased 2.5% from
August 3, 2002 to August 2, 2003. We anticipate
average inventory per Michaels store at the end of fiscal 2003
will remain consistent with average inventory per Michaels store
of $1.018 million we reported at the end of fiscal 2002.

Cash flow used in investing activities in the
first six months of fiscal 2003 was $40.9 million compared
to $71.3 million in the first six months of fiscal 2002. In
the first six months of fiscal 2003, we incurred capital
expenditures related to the construction of our new Illinois
distribution center, the opening of 22 Michaels, nine Aaron
Brothers, five Village Crafts by Michaels, and one ReCollections
store and the relocation of nine Michaels stores. In the first
six months of fiscal 2002, we incurred capital expenditures
related to the completion of our Hazleton, Pennsylvania
distribution center, the expansion of our Lancaster, California
distribution center, the opening of 36 Michaels,
10 Aaron Brothers, and one Village Crafts by Michaels
store, and the relocation of nine Michaels stores.

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##### Table of Contents



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

|                                                   |  |                  |        |           |  |   |        | 
|-------------------------------------------------- |  | ---------------- | ------ | --------- |  | - | ------ | 
|                                                   |  |                 
|                                                   |  | Six Months Ended
|                                                   |  |                 
|                                                   |  | August 2,        |        | August 3,
|                                                   |  | 2003             |        | 2002     
|                                                   |  |                  |        |          
|                                                   |  |                 
|                                                   |  | (In thousands)  
|New and relocated stores and stores not yet opened |  | $                | 16,861 |           |  | $ | 21,865 | 
|Existing stores                                    |  |                  | 8,936  |           |  |   | 12,676 | 
|Distribution system expansion                      |  |                  | 5,126  |           |  |   | 24,652 | 
|Information systems                                |  |                  | 6,752  |           |  |   | 9,156  | 
|Corporate and other                                |  |                  | 3,205  |           |  |   | 3,013  | 
|                                                   |  |                  |        |           |  |   |        | 
|                                                   |  | $                | 40,880 |           |  | $ | 71,362 | 
|                                                   |  |                  |        |           |  |   |        | 

We anticipate capital expenditures for fiscal
2003 to total approximately $125.0 million. In fiscal 2003,
we plan to open approximately 55 Michaels and 10 Aaron
Brothers stores and relocate 20 Michaels stores. In the
first quarter of fiscal 2003, we entered into an agreement to
purchase our Illinois distribution center once construction is
completed. The estimated purchase price is $28.9 million.
We plan to execute a sale/leaseback transaction for the
distribution center in conjunction with the purchase of the
property. We anticipate our Illinois distribution center will be
operational in fiscal 2004 and will replace our Lexington,
Kentucky distribution center.

Cash flow used in financing activities was
$26.1 million during the first six months of fiscal 2003
compared to cash provided by financing activities of
$19.7 million during the first six months of fiscal 2002.
This decrease in cash from financing activities was primarily
due to net borrowings under the Credit Agreement in the first
six months of fiscal 2002 of $20.4 million, an increase of
$13.1 million in the repurchases of our Common Stock from
the first six months of fiscal 2002 to the first six months of
fiscal 2003, and the payment of a cash dividend to stockholders
totaling $6.7 million in the second quarter of fiscal 2003.
In addition, proceeds from the exercise of stock options
decreased to $5.5 million for approximately
311,000 shares of our Common Stock in the first six months
of fiscal 2003 from $11.6 million for approximately
751,000 shares of our Common Stock in the first six months
of fiscal 2002.

Bank Credit Facility

Effective May 1, 2001, we signed a
$200 million unsecured revolving bank credit facility with
Fleet National Bank and other lending institutions, which
replaced the previous $100 million unsecured revolving bank
credit facility. The Credit Agreement had an original term of
three years (with a maturity extension for one additional year
available under certain conditions) and contains a
$25 million competitive bid feature and a $70 million
letter of credit sub-facility. Effective May 21, 2002,
pursuant to the terms of the Credit Agreement, our lenders
agreed to extend the term of the Credit Agreement from
April 30, 2004 to April 30, 2005.

We are in compliance with all terms and
conditions of the Credit Agreement. No borrowings were
outstanding under the Credit Agreement as of August 2, 2003
or at any time during the first six months of fiscal 2003.
Borrowings outstanding under the Credit Agreement were
$20.4 million as of August 3, 2002. Borrowings
available under the Credit Agreement are reduced by the
aggregate amount of letters of credit outstanding under the
Credit Agreement ($26.2 million as of August 2, 2003).

Equity

On June 18, 2003, our Board of Directors
authorized the repurchase of up to 1.0 million shares of
our outstanding Common Stock in addition to shares available for
repurchase under the 2000 and 2002

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##### Table of Contents



repurchase plans. The following table sets forth
information regarding our Common Stock repurchase plans as of
August 2, 2003:


|                                   |  |                |           |             |  |               |            |      |  |  |           |    
|---------------------------------- |  | -------------- | --------- | ----------- |  | ------------- | ---------- | ---- |  |  | --------- | ---
|                                   |  | Shares         |           |             |  | Shares       
|                                   |  | Authorized for |           | Shares      |  | Available for
|                                   |  | Repurchase     |           | Repurchased |  | Repurchase   
|                                   |  |                |           |             |  |              
|December 5, 2000 repurchase plan   |  |                | 2,000,000 | (1)         |  |               | (2,000,000 | )(2) |  |  |          | (1)
|September 11, 2002 repurchase plan |  |                | 1,000,000 |             |  |               | (442,100   | )(3) |  |  | 557,900   |    
|June 18, 2003 repurchase plan      |  |                | 1,000,000 |             |  |               |           |      |  |  | 1,000,000 |    
|                                   |  |                |           |             |  |               |            |      |  |  |           |    
|                                   |  |                | 4,000,000 |             |  |               | (2,442,100 | )    |  |  | 1,557,900 |    
|                                   |  |                |           |             |  |               |            |      |  |  |           |    



---



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

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

General

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

Recent Accounting Pronouncements

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

In December 2002, the FASB issued
SFAS No. 148, Accounting for Stock-Based
CompensationTransition and Disclosure, as an amendment
to SFAS No. 123 and to provide alternative methods of
transition for a voluntary change to the fair value based method
of accounting for stock-based employee compensation. In
addition, SFAS No. 148 amends the disclosure
requirements of SFAS No. 123 to

17



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##### Table of Contents



require prominent disclosures in both annual and
interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method
used on reported results. Our policy is to account for
stock-based employee compensation using the intrinsic value
method in accordance with APB Opinion No. 25. Prior to the
adoption of the disclosure provisions of SFAS No. 148,
we reported the pro forma effect of the fair value method of
accounting for stock-based employee compensation under the
provisions of SFAS No. 123. We adopted the disclosure
provisions of SFAS No. 148 in the preparation of our
Annual Report on Form 10-K for the fiscal year ended
February 1, 2003. While this adoption does not change our
policy of accounting for stock-based employee compensation using
the intrinsic value method, we have disclosed our stock-based
employee compensation in Note 4 of Notes to Consolidated
Financial Statements and have revised our presentation format of
the pro forma effect of the fair value method of accounting.







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

We have market risk exposure arising from changes
in interest rates. The interest rates on the Credit Agreement
are repriced frequently, at market prices, which would result in
carrying amounts that approximate fair value. We had no
borrowings outstanding under the Credit Agreement at
August 2, 2003. In July 2001, we issued $200 million
of the Senior Notes due 2009 with a fixed interest rate of
9 1/4%. Generally, the fair market value of our fixed
interest rate long-term debt will increase as interest rates
fall and decrease as interest rates rise. Our market risk is
described in more detail in our Annual Report on Form 10-K
for the fiscal year ended February 1, 2003.






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

Evaluation of Disclosure Controls and
Procedures

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

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.

Brown Claim

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

Stockholder Class Actions

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

Derivative Claims

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

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

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

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defendants have acted in breach of applicable
legislation, payment to current and former employees for
overtime, damages for breach of contract, punitive, aggravated
and exemplary damages, interest, and costs. We believe we have
certain meritorious defenses and intend to defend this lawsuit
vigorously.


General

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






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

Our 2003 Annual Meeting of Stockholders was held
on June 19, 2003. The following item of business, as
proposed in the Proxy Statement dated May 6, 2003, was
presented to the stockholders:

Election of Directors

The six director nominees, information with
respect to which was set forth in the Proxy Statement under the
caption titled Proposal for Election of Directors,
were elected. The vote with respect to the election of these
directors was as follows:

|                     |  |            |            |            |  |             |           |           |  |  |   |  |  |  |   | 
|-------------------- |  | ---------- | ---------- | ---------- |  | ----------- | --------- | --------- |  |  | - |  |  |  | - | 
|                     |  |            |            | Total Vote |  |             |           |          
|                     |  | Total Vote |            | Withheld   |  |             |           |          
|                     |  | for Each   |            | for Each   |  |             |           | Broker   
|                     |  | Director   |            | Director   |  | Abstentions |           | Non-Votes
|                     |  |            |            |            |  |             |           |          
|Charles J. Wyly, Jr. |  |            | 63,375,230 |            |  |             | 594,433   |           |  |  |  |  |  |  |  | 
|Sam Wyly             |  |            | 63,369,463 |            |  |             | 600,200   |           |  |  |  |  |  |  |  | 
|Richard E. Hanlon    |  |            | 63,086,981 |            |  |             | 882,682   |           |  |  |  |  |  |  |  | 
|Richard C. Marcus    |  |            | 62,713,945 |            |  |             | 1,255,718 |           |  |  |  |  |  |  |  | 
|Liz Minyard          |  |            | 62,713,672 |            |  |             | 1,255,991 |           |  |  |  |  |  |  |  | 
|Cece Smith           |  |            | 63,512,694 |            |  |             | 456,969   |           |  |  |  |  |  |  |  | 

Each elected director will serve until the next
annual meeting of stockholders and until his or her successor is
duly elected and qualified or until the earlier of his or her
resignation, death, or removal.

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

(a) Exhibits:

|     |  |                                                                                                                                                                                                                                      
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.1 |  | Michaels Stores, Inc. Amended and Restated 1997
    Stock Option Plan (previously filed as Exhibit 99.1 to
    Form 8-K, filed by Registrant on July 24, 2003, SEC
    File No. 001-09338).                                          
|10.2 |  | Michaels Stores, Inc. Amended and Restated 2001
    General Stock Option Plan (previously filed as Exhibit 99.2
    to Form 8-K, filed by Registrant on July 24, 2003, SEC
    File No. 001-09338).                                  
|10.3 |  | Michaels Stores, Inc. Second Amended and Restated
    2001 Employee Stock Option Plan (previously filed as
    Exhibit 99.3 to Form 8-K, filed by Registrant on
    July 24, 2003, SEC File No. 001-09338).                          
|10.4 |  | Michaels Stores, Inc. Deferred Compensation Plan,
    as amended and restated effective as of July 18, 2003
    (previously filed as Exhibit 99.4 to Form 8-K, filed
    by Registrant on July 24, 2003, SEC File
    No. 001-09338).
|31.1 |  | Certifications of R. Michael Rouleau pursuant to
    §302 of the Sarbanes-Oxley Act of 2002 (filed herewith).                                                                                                                        
|31.2 |  | Certifications of Jeffrey N. Boyer pursuant to
    §302 of the Sarbanes-Oxley Act of 2002 (filed herewith).                                                                                                                          
|32.1 |  | Certification pursuant to 18 U.S.C.
    §1350, as adopted pursuant to §906 of the
    Sarbanes-Oxley Act of 2002 (filed herewith).                                                                                                   

(b) Reports on Form 8-K filed during
the quarter ended August 2, 2003:

|   |  |                                                                                                                                                        
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------
|1. |  | Report on Form 8-K, dated and filed with the
    Securities and Exchange Commission on May 8, 2003,
    reporting Items 7 and 9 (pursuant to Item 12). 
|2. |  | Report on Form 8-K, dated and filed with the
    Securities and Exchange Commission on May 29, 2003,
    reporting Items 7 and 9 (pursuant to Item 12).
|3. |  | Report on Form 8-K, dated and filed with the
    Securities and Exchange Commission on June 19, 2003,
    reporting Items 5 and 7.                     
|4. |  | Report on Form 8-K, dated and filed with the
    Securities and Exchange Commission on July 24, 2003,
    reporting Items 5 and 7.                     

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MICHAELS STORES, INC.




SIGNATURES


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

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

Dated: September 11, 2003

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INDEX TO EXHIBITS

|        |      |                        |  |                                                                                                                                                                                                                                      
|------- | ---- | ---------------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |      |                       
|Number  |      | Description of Exhibit
|        |      |                       
|        | 10.1 |                        |  | Michaels Stores, Inc. Amended and Restated 1997
    Stock Option Plan (previously filed as Exhibit 99.1 to
    Form 8-K, filed by Registrant on July 24, 2003, SEC
    File No. 001-09338).                                          
|        | 10.2 |                        |  | Michaels Stores, Inc. Amended and Restated 2001
    General Stock Option Plan (previously filed as Exhibit 99.2
    to Form 8-K, filed by Registrant on July 24, 2003, SEC
    File No. 001-09338).                                  
|        | 10.3 |                        |  | Michaels Stores, Inc. Second Amended and Restated
    2001 Employee Stock Option Plan (previously filed as
    Exhibit 99.3 to Form 8-K, filed by Registrant on
    July 24, 2003, SEC File No. 001-09338).                          
|        | 10.4 |                        |  | Michaels Stores, Inc. Deferred Compensation Plan,
    as amended and restated effective as of July 18, 2003
    (previously filed as Exhibit 99.4 to Form 8-K, filed
    by Registrant on July 24, 2003, SEC File
    No. 001-09338).
|        | 31.1 |                        |  | Certifications of R. Michael Rouleau pursuant to
    §302 of the Sarbanes-Oxley Act of 2002 (filed herewith).                                                                                                                        
|        | 31.2 |                        |  | Certifications of Jeffrey N. Boyer pursuant to
    §302 of the Sarbanes-Oxley Act of 2002 (filed herewith).                                                                                                                          
|        | 32.1 |                        |  | Certification pursuant to
    18 U.S.C. §1350, as adopted pursuant to §906
    of the Sarbanes-Oxley Act of 2002 (filed herewith).