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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

For the quarterly period ended August 3, 2002

OR

For the transition period from                              to                             

Commission file number 001-09338

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

8000 Bent Branch Drive
Irving, Texas 75063
P.O. Box 619566
DFW, Texas 75261-9566
(Address of principal executive offices, including zip code)

(972) 409-1300
(Registrant's telephone number, including area code)

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

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

MICHAELS STORES, INC.
FORM 10-Q

Part I—FINANCIAL INFORMATION

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MICHAELS STORES, INC.

Part I—FINANCIAL INFORMATION

Item 1. Financial Statements.

MICHAELS STORES, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

See accompanying notes to consolidated financial statements.

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MICHAELS STORES, INC.

CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share data)

(Unaudited)

See accompanying notes to consolidated financial statements.

4

MICHAELS STORES, INC.

CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share data)

(Unaudited)

See accompanying notes to consolidated financial statements.

5

MICHAELS STORES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

See accompanying notes to consolidated financial statements.

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MICHAELS STORES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the Six Months Ended August 3, 2002

(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 3, 2002 are not indicative of the results to be expected for the entire year.

        The balance sheet at February 2, 2002 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 2, 2002.

        All references herein to "fiscal 2002" relate to the 52 weeks ending February 1, 2003 and all references to "fiscal 2001" relate to the 52 weeks ended February 2, 2002. In addition, all references herein 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, and all references to "the second quarter of fiscal 2001" and "the first six months of fiscal 2001" relate to the 13 and 26 weeks ended August 4, 2001, respectively.

Note 2. Common Stock and Earnings per Share

        On October 31, 2001, our Board of Directors declared a two-for-one common stock split effected in the form of a stock dividend to stockholders of record as of the close of business on November 12, 2001, payable on November 26, 2001. An amount equal to the par value of shares issued in the split has been transferred from paid-in capital to the common stock account. All references to the number of shares of Common Stock (except for shares authorized), per share prices, and earnings per share amounts in the consolidated financial statements and accompanying notes included in this Quarterly Report on Form 10-Q have been adjusted to reflect the split on a retroactive basis.

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

        Our purchase and subsequent retirement of 392,100 shares of our Common Stock in the second quarter of fiscal 2002 reduced the number of weighted average shares outstanding by 24,330 shares for the second quarter of fiscal 2002 and 12,165 shares for the first six months of fiscal 2002.

Note 3. Senior Notes

        In July 2001, we issued $200 million in principal amount of 9¹/4% Senior Notes due July 1, 2009 in a private placement under Securities and Exchange Commission Rule 144A to a limited number of qualified institutional buyers. The Senior Notes due 2009 are unsecured and interest thereon is payable semi-annually on each January 1 and July 1, beginning on January 1, 2002. In August 2001, as required by the contract with the purchasers of the Senior Notes due 2009, we made an offer to exchange all of the privately placed Senior Notes due 2009 for an equal principal amount of Senior Notes due 2009 having substantially identical terms, the sale of which was registered under the Securities Act of 1933. As of October 1, 2001, all of the privately placed Senior Notes due 2009 were exchanged for the Senior Notes due 2009 having substantially identical terms.

Note 4. Credit Agreement

        Effective May 1, 2001, we signed a new $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

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$25 million competitive bid feature and a $70 million letter of credit sub-facility. Effective May 24, 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. Borrowings outstanding under the Credit Agreement were $20.4 million as of August 3, 2002 with no borrowings outstanding as of August 4, 2001. Borrowings available under the Credit Agreement are reduced by the aggregate amount of letters of credit outstanding under the Credit Agreement ($16.7 million as of August 3, 2002). In the first six months of fiscal 2002, borrowings under the Credit Agreement were outstanding for five days, with average outstanding borrowings of $16.4 million and a weighted average interest rate of 4.75%.

Note 5. Legal Proceedings

Raniwala Proceeding

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

        On June 6, 2001, we negotiated a tentative settlement of the purported class action with Raniwala. As a result, we recorded a litigation settlement charge of $3.2 million in the first quarter of fiscal 2001, covering all claims, attorneys' fees, and estimated payroll taxes. The settlement, in exchange for a full release of claims, received final approval from the Alameda County Superior Court on November 20, 2001, and as a result, the case against us was dismissed effective November 20, 2001. The distribution of the settlement proceeds was made on January 19, 2002.

Collins Proceeding

        On April 16, 1999, Suzanne Collins, a former assistant manager of our subsidiary, Aaron Brothers, Inc., filed a class action complaint against Aaron Brothers on behalf of Aaron Brothers' former store managers, assistant store managers, and managers-in-training. The Collins Complaint was filed in the Los Angeles County Superior Court, California and alleged that Aaron Brothers violated various California laws by erroneously treating its store managers, assistant store managers, and managers-in-training as "exempt" employees who were not entitled to overtime compensation. Based on these allegations, the Collins Complaint asserted that Aaron Brothers: (1) violated various California Labor Codes; (2) violated Section 17200 of the California Business and Professions Code; and (3) engaged in conversion. The Collins Complaint sought back wages, interest, penalties, punitive damages, and attorneys' fees.

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        On March 15, 2002, Aaron Brothers negotiated a definitive settlement of the purported class action with Collins, subject to final court approval. The Court granted preliminary approval of the settlement on March 29, 2002. As a result, Aaron Brothers recorded a litigation settlement charge of $5.0 million in the fourth quarter of fiscal 2001, covering all claims, attorneys' fees, and estimated payroll taxes. On June 12, 2002, the Court approved the settlement and the judgment was entered. The appeal period expired on August 12, 2002. No appeals were filed with the Court. The settlement payments were delivered to the settlement administrator on August 16, 2002 for distribution.

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, and there can be no assurance that future costs of such litigation would not be material to our financial position or results of operations.

Note 6. Recent Accounting Pronouncements

        In October 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No. 144 addresses the accounting and reporting for the impairment or disposal of long-lived assets and supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of, and Accounting Principles Board Opinion No. 30, Reporting the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions. SFAS No. 144 establishes a single accounting model for long-lived assets to be disposed of by sale and resolves implementation issues related to SFAS No. 121. SFAS No. 144 is effective for financial statements issued for fiscal years beginning after December 15, 2001. In the first quarter of fiscal 2002, we adopted the provisions of SFAS No. 144, and they had no material impact on our consolidated operating results or financial position.

        In June 2001, the FASB issued SFAS No. 141, Business Combinations, and No. 142, Goodwill and Other Intangible Assets, effective for fiscal years beginning after December 15, 2001. Under the provisions of SFAS No. 141 and No. 142, goodwill and intangible assets deemed to have indefinite lives will no longer be amortized but will be subject to annual impairment tests. Other intangible assets with finite useful lives will continue to be amortized over their useful lives. We adopted these provisions in the first quarter of fiscal 2002. During the first quarter of fiscal 2002, we performed the first of the required impairment tests of goodwill and indefinite lived intangible assets, and the tests did not result in an impairment charge.

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        The following pro forma financial information reflects net income and diluted earnings per common share as if goodwill were not subject to amortization in the second quarter and first six months of fiscal 2001:

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

        Certain statements contained in this discussion and analysis (or elsewhere in this Quarterly Report on Form 10-Q), which are not historical facts, are forward-looking statements that reflect our plans, estimates, and beliefs. Words such as "anticipates," "plans," "expects," "believes," and similar expressions often identify forward-looking statements. Our actual results could materially differ from those discussed in these forward-looking statements, which involve risks and uncertainties, including, but not limited to, customer demand and trends in the arts and crafts industry, impact of competitors' locations, pricing, and products, related inventory risks due to shifts in customer demand, impact of economic conditions, the availability of acceptable locations for new stores, difficulties in implementing information system technologies, supply constraints, results of financing efforts, effectiveness of advertising strategies, and other risks detailed in our Securities and Exchange Commission filings.

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

        Discussions relating to our Common Stock reflect the effects of the two-for-one Common Stock split effected in the form of a stock dividend to stockholders of record as of the close of business on November 12, 2001.

General

        All references herein to "fiscal 2002" relate to the 52 weeks ending February 1, 2003 and all references to "fiscal 2001" relate to the 52 weeks ended February 2, 2002. In addition, all references herein 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, and all references to "the second quarter of fiscal 2001" and "the first six months of fiscal 2001" relate to the 13 and 26 weeks ended August 4, 2001, respectively.

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

---

(Notes on following page)

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(Notes from table on preceding page)

(1)

EBITDA is calculated as income before income taxes plus interest, depreciation, and amortization. EBITDA is presented because it is a widely accepted financial indicator of a company's ability to incur and service debt, but is not a financial measurement recognized by generally accepted accounting principles, and therefore, may not be comparable to similarly titled measures used by other entities. EBITDA should not be considered by an investor as an alternative to net income, as an indicator of our operating performance, or as an alternative to cash flow as a measure of liquidity.

(2)

Adjusted EBITDA is calculated as income before income taxes plus interest, depreciation, amortization, and unusual, non-recurring charges. Adjusted EBITDA for the second quarter of fiscal 2001 excludes a $347,000 adjustment to reduce the one-time charge recorded in the first quarter of fiscal 2001 related to senior executive severance. Adjusted EBITDA for the first six months of fiscal 2001 excludes costs of approximately $1.0 million related to senior executive severance and a litigation settlement charge of $3.2 million.