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UNITED STATES

FORM 10-K

Commission file number 001-09338

MICHAELS STORES, INC.

8000 Bent Branch Drive

(972) 409-1300

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

Title of Each Class

Name of Each Exchange on Which Registered

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

     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 [ ]

     Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  [ ]

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

     As of August 1, 2003, the aggregate market value of the voting equity held by non-affiliates of the Registrant was approximately $2,465,404,507 based on the closing price of the Registrant’s Common Stock on such date, $37.70, as reported on the New York Stock Exchange. Shares of the Registrant’s Common Stock owned by its directors and executive officers were excluded from this aggregate market value calculation; however, such exclusion does not represent a conclusion by the Registrant that any or all of such directors and executive officers are affiliates of the Registrant.

     As of March 24, 2004, 68,308,505 shares of the Registrant’s Common Stock were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE.

     Part III of this report incorporates information from the Registrant’s definitive Proxy Statement relating to the Registrant’s Annual Stockholders Meeting to be held on June 17, 2004.

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PART I

      Unless otherwise noted, all amounts contained in this document are as of January 31, 2004.

General

      With over $3.0 billion in sales in fiscal 2003, Michaels Stores, Inc. (together with its subsidiaries, unless the context otherwise indicates) is the largest national arts and crafts specialty retailer providing materials, ideas, and education for creative activities. Michaels Stores, Inc. was incorporated in Delaware in 1983, and as of March 24, 2004, we operate 812 Michaels retail stores in 48 states, as well as in Canada, averaging 18,300 square feet of selling space. Our stores offer arts and crafts supplies and products for the do-it-yourself home decorator. We also operate 158 Aaron Brothers stores as of March 24, 2004, in nine states, averaging 5,800 square feet of selling space, offering photo frames, a full line of ready-made frames, custom framing services, and a wide selection of art supplies. ReCollections, our scrapbooking/ paper crafting retail concept, operates two stores, located in Dallas, Texas and Frisco, Texas, providing merchandise, accessories, and a variety of scrapbooking and paper crafting support services in a community learning environment. In addition, we own and operate two Star Wholesale stores, located in Dallas, Texas and Atlanta, Georgia, offering merchandise primarily to interior decorators/ designers, wedding/ event planners, florists, hotels, restaurants, and commercial display companies. We also own and operate Artistree, a vertically integrated frame and moulding manufacturing operation that supplies moulding and framing to our Michaels and Aaron Brothers stores nationwide.

      Our mission is to help people express themselves creatively. Through our broad product assortments, friendly and knowledgeable sales associates, educational in-store events, and project sheets and displays, we offer a shopping experience that encourages creativity. We also offer classes and demonstrations that teach basic and advanced skills and provide a hands-on experience in a community environment.

      We will make available our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports, filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, free of charge through our Internet website at www.michaels.com under the heading “Corporate Information” as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission.

      Additionally, charters for the Audit, Compensation, and Corporate Governance and Nominating Committees of our Board of Directors and our Corporate Governance Guidelines and Code of Business Conduct and Ethics can be found on our Internet website at www.michaels.com under the heading “Corporate Information.” Stockholders may obtain copies of these documents by printing them from our Internet website or by writing to the Investor Relations Department at 8000 Bent Branch Drive, Irving, Texas 75063.

Recent History

      During the early 1990s, we embarked on an aggressive national expansion program. By 1995, we had tripled our store base to over 500 stores through new store openings and acquisitions, accomplishing our goal of becoming the nation’s largest specialty retailer in our industry. However, as a result of inadequate information systems and infrastructure to support our rapid growth, our financial performance weakened. Beginning in 1996, we focused on increasing the profitability of our existing stores by implementing a variety of operating initiatives. These initiatives included installing point-of-sale (POS) systems chain-wide to record item-level sales, implementing planograms, eliminating non-core merchandise, reducing costs through centralization of functions, and strengthening the quality and depth of our management team.

      Over the following few years, we improved our operations by building the infrastructure that we were missing. We invested in technology, our supply chain, and our associates to implement best practices and process management. We also resumed a new store opening strategy that continues today. See “–Store Expansion and Relocation.”

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      As a result of our initiatives, we have achieved a 10.1% compounded annual Michaels store growth rate since fiscal 1997 while maintaining a 13.4% compounded annual sales growth rate and a 34.5% compounded annual earnings growth rate. In addition, we have reported annual comparable store sales growth for the past seven consecutive fiscal years.

Industry Overview– Competition

      We are the largest specialty retailer providing materials, ideas, and education for creative activities in home décor, art, and craft projects. We believe we are well positioned to benefit from favorable demographics, particularly a more affluent baby boomer population; continued strength in investments in the home and purchases of new homes; and an increasing focus on home-based, family activities. According to an industry consumer participation survey published in 2002, our typical customer is:

•	Female– Over 92% are women and 62% are married.
•	Relatively young– Seventy-seven percent of crafters are under 55 with half of them between the ages of 35 and 54.
•	Better educated– Ninety-two percent are high school graduates, with almost 60% of them having attended college.
•	Affluent– Seventy-two percent of crafters have household incomes greater than $40,000, and 45% of them have household incomes over $60,000.
•	Loyal– Fifty-three percent of crafters shop for craft supplies at least twice a month and 24% shop at least once a week.

      We compete across many industries, including arts and crafts, home décor, party supplies, candles, photo frames, and custom framing. A research report published in January 2001 estimated that the size of the markets in which we compete totals more than $30 billion.

      The markets in which we compete are highly fragmented, containing thousands of stores nationwide operated primarily by small, independent retailers along with a few regional chains. We are the largest national retailer dedicated to serving the arts and crafts market, and we believe that there are only four other major arts and crafts retailers in the United States with annual sales in excess of $200 million. Moreover, we believe that our fiscal 2003 sales were more than twice as large as those of our largest direct competitor.

      Customers tend to choose where to shop based upon store location, breadth of selection, price, quality of merchandise, availability of product, and customer service. We compete with many different types of retailers and classify our competition within the following categories:

•	Multi-store chains. This category includes several multi-store chains each operating more than 30 stores and comprises: Hobby Lobby, which operates approximately 320 stores in 27 states, primarily in the Midwestern and Southern United States; A.C. Moore Arts & Crafts, Inc., which operates approximately 80 stores in the mid-Atlantic and Northeast regions; Jo-Ann superstores (operated by Jo-Ann Stores, Inc.), which operates approximately 89 stores across the country; and Garden Ridge Corporation, which operates approximately 36 stores in 13 states, primarily in the Midwestern and Southern United States. All of these chains are significantly smaller than Michaels with respect to number of stores and total net sales.
•	Small, local specialty retailers. This category includes thousands of local “Mom & Pop” arts and crafts retailers. Typically, these are single store operations managed by the owner. The stores generally offer a limited selection and have limited resources for advertising, purchasing, and distribution. Many of these stores have established a loyal customer base within a given community and compete with us based on relationships and customer service.
•	Mass merchandisers. This category includes companies such as Wal-Mart Stores, Inc. and other mass merchandisers. These retailers typically dedicate only a small portion of their selling space to a limited selection of home décor, art and craft supplies, and seasonal merchandise. In addition, these mass merchandisers generally have limited customer service staffs with little or no experience in crafting projects.

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Business Strategy

      We intend to increase our revenues and profits by strengthening our position as the largest national retailer within the arts and crafts and home décor sector through the following strategies:

•

Increase Sales and Productivity of Michaels Stores. Michaels stores that have been open longer than 36 months currently average approximately $3.9 million in sales per store. We believe we can increase average sales in these stores to $5.0 million. We intend to achieve this objective by increasing our merchandise in-stock position, improving our merchandise offering, and enhancing our marketing execution, primarily through the utilization of our new perpetual inventory and automated replenishment systems.

	–	Increasing our merchandise in-stock position. We expect to increase our overall store in-stock position from approximately 83% at the beginning fiscal 2003 to 95-97% on an on-going basis, through the use of our perpetual inventory and automated replenishment systems. During fiscal 2003, comparable store sales for items on automated replenishment were generally higher than items not on automated replenishment as a result of improved merchandise in-stock levels.
	–	Improving our merchandise offering. We will be able to improve our merchandise assortments by analyzing SKU productivity information that is now available from our perpetual inventory system. We will also have greater capability to introduce and manage key trend items in a timely manner.
	–	Enhancing our marketing execution. We are currently targeting increased customer traffic and demand for our products through traditional retail advertising, multimedia channels, and various in-store promotional activities. We are implementing this strategy by:

	•	advertising in newspapers and through direct mail;
	•	holding in-store classes, demonstrations, and other events, including Kids Club;
	•	promoting craft ideas and projects in our bimonthly Michaels Create! magazine and on our www.michaels.com website; and
	•	participating in industry-wide promotion campaigns, such as National Craft Month and Warm-up America.

	We will enhance our execution of these marketing programs by utilizing our perpetual inventory information to drive promotions focused on key items and by ensuring better merchandise in-stock levels.

•	Enhance Michaels Stores’ Merchandise Margins. We intend to enhance merchandise margins through continued improvement of our inventory management and supply chain processes. We plan to utilize our technology systems to maximize margins on: (1) seasonal products by allocating merchandise more efficiently among our stores and (2) promotional sales products by determining more accurately the most profitable promotional price for each product. Inventory management enhancements are also expected to improve merchandise margins by reducing our clearance sales levels. In addition, we continue to evaluate opportunities to further reduce our merchandise costs and ensure adequate supplies through vertical integration.
•	Grow Through New Michaels Store Openings. We believe the United States and Canadian markets can support up to 1,100 Michaels stores. We plan to open approximately 45 new Michaels stores per year, extending into the foreseeable future, funded primarily through cash from operating activities. From the beginning of fiscal 1998 through March 24, 2004, we have opened or relocated 503 Michaels stores using our standard operating procedures, which have ensured store openings with a merchandise assortment and presentation consistent with our existing stores. We have developed and are refining our Michaels store prototype to constantly incorporate improved merchandising techniques and store layouts.
•	Expand Aaron Brothers. We plan to open approximately five to 10 new Aaron Brothers stores per year, extending into the foreseeable future, also funded primarily through cash from operating activities. We believe the United States and Canadian markets can support up to 600 Aaron Brothers stores.

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•	Expand the Wholesale Business Concept. In May 2000, in connection with our strategy of developing a wholesale business concept, we acquired Star Wholesale in Dallas, Texas. As part of our expansion strategy, we opened a second Star Wholesale in Atlanta, Georgia, in September 2003. The target customers for this concept are interior decorators/ designers, wedding/ event planners, florists, hotels, restaurants, and commercial display companies. Star Wholesale stores average 43,000 square feet of selling space and offer approximately 18,000 SKUs. This is a concept that we see as an additional growth area in which we can expand our customer base and leverage our experience and vendor base.
•	Explore Additional Growth Opportunities. In fiscal 2002, we began testing a smaller market retail concept by opening three Village Crafts by Michaels stores. In fiscal 2003, we opened an additional eight stores. These stores average 13,000 square feet in single-store markets with populations of approximately 60,000 to 90,000 people. Despite being about half the size, these stores carry approximately 80% of the selection of a typical Michaels store. During the fourth quarter of fiscal 2003, we reevaluated the Village Crafts concept and continue to believe that a smaller market concept remains attractive. However, we have decided to pursue this opportunity utilizing the Michaels name and advertising program.

	In fiscal 2003, we began testing a new scrapbooking/ paper crafting retail concept by opening two stores named ReCollections, providing merchandise, accessories, and support services in a community learning environment. These stores average 4,600 square feet of selling space, feature two large classrooms, and offer more than 10,000 SKUs of scrapbooking and paper crafting products. We plan to open six to eight ReCollections stores in fiscal 2004.
	We believe that both the smaller market and scrapbooking/ paper crafting retail concepts could offer additional sources of growth for us.

Merchandising and Marketing

      Our Michaels store merchandising strategy is to provide a broad selection of products in a convenient location with an appealing store environment. Each Michaels store offers approximately 40,000 basic SKUs in a number of product categories. The following table shows a breakdown of sales for Michaels stores by department as a percentage of total sales:

	We offer the following selection of merchandise in our Michaels stores:

•	products for the do-it-yourself home decorator, including wall décor, candles, containers, baskets, and potpourri; custom framing services, ready-made frames, mat boards, glass, framed art, and photo albums; and “silk” flowers, dried flowers, and artificial plants sold separately or in ready-made and custom floral arrangements, accessories needed for floral arranging, and other floral items, such as wreaths;
•	art supplies, including scrapbooking materials; surfaces and pads; adhesives and finishes; and pastels, watercolors, oil paints, acrylics, easels, brushes, paper, canvas, and stenciling materials; and

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•

craft supplies, including beads, wood, doll making supplies, jewelry making supplies, rubber stamps, apparel crafts, books and magazines, and plaster; needlecraft items including stitchery supplies, hand-knitting yarns, needles, canvas, and related supplies for needlepoint, embroidery and cross stitching, knitting, crochet, rug making kits, and quilt and afghan kits; ribbon and wedding accessories; gifts; hobby items including plastic model kits and related supplies, kids’ craft materials, plush toys, and paint-by-number kits; party needs including paper party goods, balloons, gift wrap, candy making supplies, and cake decorating supplies; and soap and candle making supplies.

      Our Michaels stores regularly feature seasonal merchandise that complements our core merchandising strategy. Seasonal merchandise is offered for several holiday periods, including Valentine’s Day, Easter, Mother’s Day, Halloween, Thanksgiving, and Christmas. For example, seasonal merchandise for the Christmas season includes home decorating items such as artificial trees, wreaths, candles, lights, and ornaments.

      During the Christmas selling season, a significant portion of floor and shelf space in a typical Michaels store is devoted to Christmas crafts, Christmas decorations, and gift making merchandise. Because of the project-oriented nature of these products, the Christmas selling season begins in August and extends through December. Accordingly, a fully developed seasonal merchandising program, including inventory, merchandise layout, and instructional ideas, is implemented in each Michaels store at the beginning of the third quarter of each year. This program requires additional inventory accumulation so that each store is fully stocked during the peak season to meet higher demand from increased customer traffic.

      We routinely identify merchandise that requires some price reduction to accelerate sales of the product. The need for this reduction is generally attributable to either seasonal product remaining at the end of the season or product that is being displaced from its assigned location in the store to make room for new merchandise. Additional product candidates for repricing are identified using the POS sales and perpetual inventory data. In each case, the appropriate repricing is determined at our corporate office and sent to the stores with instructions on how to accelerate sales of the repriced product.

      Our Aaron Brothers stores offer on average 5,700 SKUs, including photo frames, a full line of ready-made frames, and a wide selection of art supplies and custom framing services. Our merchandising strategy for our Aaron Brothers stores is to provide a unique, upscale framing assortment and shopping experience. In addition, we strive to provide a fashion forward framing merchandise selection in an appealing environment with an emphasis on customer service.

      We believe that customer service is an important component of our merchandising strategy. Many of the craft supplies sold in Michaels stores can be assembled into unique end products with an appropriate amount of guidance and direction. Accordingly, we have displays in every store to stimulate new project ideas and supply free project sheets with detailed instructions on how to assemble the finished product. We also offer project sheets on our Internet site, www.michaels.com, and in our Michaels Create! magazine. In addition, many Michaels sales associates are craft enthusiasts who are able to help customers with ideas and instructions. We regularly offer inexpensive classes and demonstrations utilizing merchandise available in our stores as a means of promoting craft trends and expanding our customer base.

      We focus primarily on circular advertising. We have found full-color circular advertising as an insert into newspapers to be our most effective medium of advertising. The circulars advertise numerous products in order to emphasize the wide selection of products available at Michaels stores. We believe that our ability to advertise through circulars throughout the year in each of our markets provides us with an advantage over our smaller competitors and reinforces and strengthens our brand name.

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Store Design and Operations

      Our store design encourages purchases in a friendly, creative environment. Store design is developed centrally and implemented at the store level through the use of planograms, which provide store associates with detailed descriptions and illustrations with respect to store layout and merchandise presentation. Planograms are also used to cluster various products that can be combined to create individual projects.

      We strive to complement our innovative store design with customer service that provides an enjoyable shopping experience. We believe that knowledgeable associates and prompt and enthusiastic service fosters customer loyalty and can differentiate us from our competition.

      A Michaels store is typically managed by a store manager, one assistant manager, and three department managers. The field organization for Michaels is headed by an executive vice president and is divided into six geographic zones. Each zone has its own vice president and 10 to 12 district managers. There are a total of 66 districts in the United States and Canada. Typically, an Aaron Brothers store is managed by a store manager and one or two assistant managers. The field organization for Aaron Brothers is headed by a divisional senior vice president and is divided into 12 districts, each with a district manager. We believe this organizational structure enhances the communication among the individual stores and between the stores and corporate headquarters.

Purchasing and Inventory Management

      We purchase merchandise from over 1,400 suppliers. We believe that our buying power and ability to make centralized purchases enable us to acquire products on favorable terms. Central merchandising management teams for Michaels and Aaron Brothers negotiate with vendors on behalf of their respective stores in order to obtain the lowest net merchandise costs and improve control over product mix and inventory. In fiscal 2003, our top 10 vendors accounted for approximately 23% of total purchases with no single vendor accounting for more than 4% of total purchases.

      In addition to purchasing from outside suppliers, our Michaels and Aaron Brothers stores purchase ready-made frames from our manufacturing division. This division, which manufactures and sells custom framing materials and services to our stores, consists of a manufacturing facility and three regional processing centers to support our retail stores.

      Substantially all of the products sold in Michaels stores are manufactured in Asia, Canada, Mexico, and the United States. Goods manufactured in Asia generally require long lead times and are ordered four to six months in advance of delivery. Those products are either imported directly by us or acquired from distributors based in the United States and their purchase prices are denominated in United States dollars.

      Our primary objectives for inventory management are maximizing the efficiency of the flow of product to the stores, maintaining high store in-stock levels, enhancing store labor efficiency, reducing clearance inventory levels, and optimizing our overall investment in inventory. We manage our inventory in several ways, including: in-store management using a radio frequency handheld ordering device (RF gun), daily tracking of inventory positions utilizing our new perpetual inventory and automated replenishment systems; the use of planograms to control the merchandise assortment and presentation; and the review of item-level sales information in order to track the performance and sell-through of seasonal and promotional items. The data that we obtain from our POS system is an integral component in the inventory management process. In addition, inventories are verified through periodic physical and cycle counts conducted throughout the year on a rotating systematic schedule.

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      We believe that the implementation of perpetual inventory and automated merchandise replenishment systems will allow us to better achieve our inventory management objectives. As of March 2004, our store associates reorder approximately 35% of our merchandise assortment using an RF gun, which calculates a SKU-specific recommended order quantity for that store based on its prior year selling patterns and our promotional activities. The RF gun transmits information to the in-store computer, which then generates a vendor order for SKUs not carried in our distribution centers or transmits a replenishment order to the corporate office for items carried in our distribution centers. Our new automated replenishment system, which is replacing our RF gun reordering process, uses perpetual inventory records to analyze individual store/ SKU on-hand quantities, as well as other pertinent information such as unfilled orders, seasonal selling patterns, promotional events, and vendor lead times, to generate recommended merchandise reorder information on a daily basis. These recommended orders are reviewed daily and purchase orders are delivered electronically to our vendors or replenishment orders are sent to our distribution centers.

      We began the rollout of perpetual inventory and automated replenishment systems for 1,100 SKUs in our Michaels stores in fiscal 2001 and expanded to 2,400 SKUs in fiscal 2002. We completed the rollout of our perpetual inventory system in fiscal 2003 and have approximately 65% of our SKUs on automated replenishment as of March 24, 2004. We will complete the rollout of our automated replenishment system by July 2004. In addition to improving our store in-stock position, once fully implemented, these systems will allow us to better forecast merchandise ordering quantities for our vendors and give us the ability to identify, order, and replenish the stores’ merchandise using less store associate labor. These systems will also allow us to react more quickly to selling trends and allow our store associates to devote more time to customer service, thereby maximizing inventory productivity and sales opportunities.

      In fiscal 2001, we implemented a new seasonal allocation system to better manage the distribution of seasonal merchandise to our stores. Utilizing this allocation system, we are able to allocate seasonal merchandise to our stores based on prior year sales and current store sales trends. For a discussion of the seasonal nature of our business, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations– Seasonality.”

Distribution

      We currently operate a distribution system that supplies our Michaels stores with merchandise, including substantially all seasonal and promotional items. Approximately 56% of Michaels stores’ merchandise is shipped through the Michaels distribution system, with the remainder being shipped directly from vendors. Approximately 66% of Aaron Brothers stores’ merchandise is shipped through the Aaron Brothers distribution center, with the remainder being shipped directly from our vendors. Our current distribution centers are located in California, Florida, Kentucky, Pennsylvania, and Texas. In fiscal 2002, we completed an expansion of our California distribution center and added a new distribution facility in Hazleton, Pennsylvania, which added approximately 1.0 million square feet of capacity. In fiscal 2003, we constructed a new distribution center located in the Chicago, Illinois area, from which we will begin shipping orders in June 2004. At the end of fiscal 2004, the lease on our Kentucky distribution center will end. The 686,000 square feet of our new Illinois distribution center, offset by the closing of our Kentucky distribution center, will add approximately 265,000 square feet to our approximately 3.0 million square feet of existing capacity. In addition to these distribution facilities, we utilize three third party warehouse facilities to store and supply our seasonal merchandise in preparation for the holiday season.

      Michaels stores generally receive deliveries from the distribution centers each week through an internal distribution network using a dedicated fleet of contract carriers. Aaron Brothers stores receive merchandise on a weekly or biweekly basis from their dedicated 159,000 square foot distribution center located in the Los Angeles, California area. Star Wholesale stores receive merchandise from direct vendor shipments.

      In February 2004, we completed the implementation of a new transportation management system to manage our transportation processes between our vendors, distribution centers, and stores. Once fully utilized, we expect to increase the visibility of merchandise shipments within our supply chain and improve our overall transportation efficiencies.

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      We believe that our distribution system, with its planned expansion and new transportation management system, will allow us to maintain sufficient inventory in each store to meet our customers’ demands while improving control over our overall investment in inventory. We currently have approximately 40% of our basic SKUs replenished through our distribution system. We intend to have approximately 80-90% of our basic SKUs replenished through our distribution system, which will reduce our overall supply chain costs and allow us to more effectively manage our inventory investment.

Store Expansion and Relocation

      Having become the largest national retailer of arts, crafts, and decorative items, we recognized in 1995 that we had the critical mass to achieve improved operating efficiencies that could result in higher returns on capital by focusing on key initiatives, such as strengthening our information systems and infrastructure to support future growth in the number of stores. In fiscal 1995, we announced a shift in focus from store growth to higher returns on capital and as a result, moderated our internal growth rate in number of stores. Since fiscal 1998, we have been on an accelerated new store opening program and have maintained that growth through fiscal 2003.

      The following table shows our store growth for the last five years:

      In keeping with our plans to continue increasing the number of our stores while realizing higher returns on capital, in fiscal 2004, we plan to open approximately 45 Michaels, six to eight Aaron Brothers, and six to eight ReCollections stores. We plan to open approximately 45 new Michaels stores per year in subsequent fiscal years, extending into the foreseeable future. In addition, we plan to expand the Aaron Brothers concept nationwide and open five to 10 new Aaron Brothers stores per year in subsequent fiscal years, extending into the foreseeable future.

      Our expansion strategy is to give priority to adding stores in existing markets in order to enhance economies of scale associated with advertising, distribution, field supervision, and other regional expenses. The anticipated opening of Michaels, Aaron Brothers, ReCollections, and Star Wholesale stores and the rate at which stores are opened will depend upon a number of factors, including the success of existing stores, the availability and the cost of capital for expansion, the availability of suitable store sites, and the ability to hire and train qualified managers.

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      We have developed a standardized procedure that allows for the efficient opening of new stores and their integration into our information and distribution systems. We develop the floor plan and merchandise layout and organize the advertising and promotions in connection with the opening of each new store. In addition, we maintain qualified store opening teams to provide new store personnel with in-store training.

      Costs for opening stores at particular locations depend upon the type of building and general cost levels in the area. In fiscal 2003, the average net cost of opening a new Michaels store included approximately $600,000 of leasehold improvements, furniture, fixtures and equipment, and pre-opening costs, and an estimated initial inventory investment, net of accounts payable, of approximately $500,000. The total cost of opening a new store depends on the store size, operating format, and the time of year in which the store is opened. The initial inventory investment in new Michaels stores is offset, in part, by vendor allowances.

      In addition to new store openings, we continue to pursue a store relocation program to improve the quality and performance of our existing store base. We relocated 18 and 16 Michaels stores in fiscal 2002 and 2003, respectively, and one Aaron Brothers store in fiscal 2002. We plan to relocate up to 30 Michaels stores during fiscal 2004.

      During fiscal 2002 and 2003, we closed seven and five Michaels stores, respectively, and in fiscal 2002, we closed four Aaron Brothers stores. We currently have no specific plans to close any Michaels stores, and plan to close one Aaron Brothers store, in fiscal 2004.

Investment in Information Technology

      We are committed to utilizing technology to increase operating efficiencies and to improve our ability to satisfy the needs of our customers. The installation of the POS system gave us the ability to better understand the demands of the customer, emerging merchandise trends, and inventory replenishment requirements. During fiscal 1998, we completed installation of a networked computer system in every store to handle data communications, price management, enhanced radio frequency terminal applications for inventory management, faster credit card authorizations, and gift card processing. In addition, a standardized warehouse management system utilizing radio frequency terminals with bar code scanning technology was installed in all distribution centers. In connection with our supply chain initiatives, in fiscal 2001, we implemented a new seasonal allocation system to better manage the allocation of seasonal merchandise to our stores based on prior year sales and current store sales trends. In addition, in February 2004, we completed the implementation of a new transportation management system to manage our transportation processes between our vendors, distribution centers, and stores. Once fully utilized, we expect to increase efficiency and visibility of merchandise shipments within our supply chain. In fiscal 2003, we completed the rollout of our perpetual inventory system, and will complete the rollout of our automated replenishment system by July 2004. Once our perpetual inventory and automated replenishment systems are fully implemented, we expect to improve our stores’ in-stock positions, enhance store labor efficiency, and improve forecasting of merchandise ordering quantities for our vendors. We believe the implementation of these systems will continue to enhance our inventory management capabilities.

      In addition to the information technology enhancements discussed above, we completed the installation of a new integrated financial management package in fiscal 1999 to provide an efficient platform for future growth and utilize financial best practices and controls. In fiscal 2003, we completed the rollout of a new human resource management system to all Michaels stores. In fiscal 2004, we will complete the rollout of our human resource management system to our Aaron Brothers stores.

Foreign Sales

      All of our current international business is in Canada and accounted for approximately 4% of total sales in fiscal 2001 and 2002 and 5% in fiscal 2003. During the last three years, less than 5% of our assets have been located outside of the United States.

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Service Marks

      The names “Michaels,” “Aaron Brothers,” “ReCollections,” “Star Decorator’s Wholesale Warehouse,” and “Artistree Art Frame & Design” and the Michaels logo are each federally registered service marks.

Employees

      As of March 24, 2004, we employed approximately 38,800 associates, approximately 26,300 of whom were employed on a part-time basis. The number of part-time associates is substantially increased during the Christmas selling season. Of our full-time associates, approximately 2,550 are engaged in various executive, operating, training, distribution, and administrative functions in our corporate and division offices and distribution centers, and the remainder are engaged in store operations. None of our associates are members of labor unions.

Executive Officers of the Registrant

      Our current executive officers, their ages as of March 24, 2004, and their business experience during at least the past five years are set forth below.

      Mr. Charles J. Wyly, Jr. became a director in 1984. He served as Vice Chairman of the Board from 1985 until 2001 when he became Chairman of the Board. He co-founded Sterling Software, Inc., a worldwide supplier of software products, in 1981 and, until its acquisition in 2000 by another company, had served as a director and since 1984 as Vice Chairman of the Board. Mr. Wyly served as a director of Sterling Commerce, Inc., a worldwide provider of electronic commerce software and services, from December 1995 until its acquisition in 2000 by another company. Mr. Wyly was a director of Scottish Annuity & Life Holdings, Ltd., a variable life insurance and reinsurance company, from October 1998 until November 2000. Mr. Wyly served from 1964 to 1975 as an officer and director, including serving as President from 1969 to 1973, of University Computing Company. Mr. Wyly and his brother, Sam Wyly, founded Earth Resources Company, an oil refining and silver mining company, and Charles J. Wyly, Jr. served as Chairman of the Board of that company from 1968 to 1980. He was also a founding partner of Maverick Capital, Ltd., a manager of equity hedge funds.

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      Mr. Sam Wyly has served as Vice Chairman of the Board since July 2001 and a director of Michaels since 1984. He served as Chairman of the Board from 1984 until 2001. Mr. Wyly is an entrepreneur who has created and managed several public and private companies. He is a manager of Ranger Capital, Ltd., a Dallas-based hedge fund management company. He founded Maverick Capital, Ltd., another hedge fund manager, in 1990. Mr. Wyly is also a director of Green Mountain Energy Company, a clean energy provider. He founded University Computing Company, which became one of the first computer utility networks and one of the first software products companies. He was a founder and, until its acquisition in 2000 by another company, was Chairman and a director of Sterling Software, Inc. He also was Chairman of the Executive Committee and a director of Sterling Commerce, Inc., until its acquisition in 2000 by another company, and was Chairman and a director of Scottish Annuity & Life Holdings, Ltd. from October 1998 until June 2000.

      Mr. Rouleau has served as Chief Executive Officer since April 1996, and has also served as President from April 1997 to June 1999 and again since March 2001. Prior to joining us, Mr. Rouleau had served as Executive Vice President of Store Operations for Lowe’s Companies, Inc. from May 1992 until April 1996 and in addition as President of Lowe’s Contractor Yard Division from February 1995 until April 1996. Prior to joining Lowe’s, Mr. Rouleau was a co-founder and President and Chief Executive Officer of Office Warehouse, which subsequently merged into Office Max. Mr. Rouleau also served with the Target Stores division of Dayton Hudson Corporation for 20 years, from its inception in 1961.

      Mr. Staffieri became President– Michaels Stores Group in December 2002. Prior to joining us, Mr. Staffieri held various positions with Borders Group, Inc., where he served as President of Waldenbooks Stores from April 1999 until December 2002, Chief Administrative Officer of Borders Group, Inc. from January 1998 to April 1999, and President of Borders Outlet from July 1997 to January 1998.

      Mr. Boyer became Executive Vice President– Chief Financial Officer in January 2003. Prior to joining us, Mr. Boyer was Executive Vice President and Chief Financial Officer of Kmart Corporation from May 2001 until November 2001. In January 2002, Kmart Corporation filed a voluntary petition for reorganization under Chapter 11 of the United States Bankruptcy Code. Prior to joining Kmart, he held various positions with Sears, Roebuck and Co., where he served as Senior Vice President and Chief Financial Officer from October 1999 to May 2001, Corporate Controller from June 1998 to October 1999, and Vice President, Finance– Full Line Stores from June 1996 to June 1998. Prior experience includes Vice President of Business Development at The Pillsbury Company from 1995 to 1996 and over six years with Kraft Foods, a unit of Altria, in various senior financial positions.

      Mr. Sadler became Executive Vice President– Store Operations in October 1999. From June 1995 until 1999, he was Regional Vice President and subsequently Senior Vice President– Stores of Caldor. Prior to Caldor, Mr. Sadler served with Target for 19 years, most recently as Vice President– Store Operations.

      Mr. Sandfort became Executive Vice President– General Merchandise Manager in January 2004. From 2002 to 2003, Mr. Sandfort served as Vice-Chairman and Co-CEO of Kleinert’s Inc. (d/b/a Buster Brown) where he was directly responsible for all aspects of Kleinert’s sleepwear, playwear, and retail divisions. In May 2003, Kleinert filed a voluntary petition for reorganization under Chapter 11 of the United States Bankruptcy Code, which was subsequently converted to a liquidation under Chapter 7. Prior to that, Mr. Sandfort served as Vice President, General Merchandise Manager– Children’s Apparel, Furniture, Toys, and Electronic Games for Sears, Roebuck and Co. for four years.

      Mr. Sullivan became Executive Vice President– Development in April 1997. He joined Michaels in 1987 and has served in a variety of capacities, overseeing our store operations, distribution, store opening, real estate, legal, and personnel functions, including serving as President from August 1995 to April 1997. Prior to joining us, Mr. Sullivan had served with Family Dollar Stores, Inc. for 11 years, most recently as Vice President– Real Estate.

      Mr. Tucker became Executive Vice President– Chief Information Officer in June 1997. From 1994 until joining us, Mr. Tucker held the positions of Vice President of MIS and subsequently Senior Vice President and Chief Information Officer for Shopko Stores, Inc. Prior to 1994, Mr. Tucker held the position of Vice President– Management Information Services for Trans World Music Corp.

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      Mr. Beasley became Senior Vice President, General Counsel and Secretary in March 2003. Mr. Beasley had served as Vice President, General Counsel and Secretary from April 1990 to March 2003 and General Counsel and Secretary from September 1987 to April 1990. Prior to joining us, Mr. Beasley had served with Zale Corporation for three years as Assistant General Counsel and Assistant Secretary, before which he practiced law with the firm of Johnson & Swanson from 1979 through 1984.

      Mr. DeCaro became Senior Vice President– Inventory Management in August 2000. From 1998 until joining us, he was Vice President– Merchandise for Disneyland Resort. Prior to this, he held the position of Senior Vice President– Merchandise Planning and Allocation for Kohl’s Department Stores from February 1996 to April 1998. In addition, Mr. DeCaro has held various positions in Merchandise Planning and Allocation and Finance for The Disney Store, The Limited Stores, May Department Stores, and Sanger Harris Department Stores.

      Ms. Elliott became Senior Vice President– Human Resources in October 2000. From May 1998 until joining us, she was Senior Vice President– Human Resources for Luby’s, Inc. Prior to that, she held the positions of Vice President– Human Resources and subsequently Senior Vice President– Italianni’s Brand for Carlson Restaurants Worldwide from January 1993 to May 1998. In addition, Ms. Elliott has held various human resources and operations positions at PepsiCo (KFC Restaurants).

      Mr. Gartner joined us as Senior Vice President– Supply Chain Management in May 2001. From September 1998 until November 2000, Mr. Gartner held the position of Executive Vice President– Supply Chain Management for DSC Logistics, Inc. Prior to DSC Logistics, Mr. Gartner served with The Pillsbury Company for 20 years, most recently as Vice President– Distribution Operations.

      Mr. Hiemenz became Senior Vice President– New Business Development in October 1999, after joining us as a Zone Vice President in July 1996 and serving as Executive Vice President– Store Operations from August 1996 to October 1999. Prior to joining Michaels, Mr. Hiemenz had served with Lowe’s Companies, Inc. for nine years, most recently as a Regional Vice President.

      Ms. White-Keating became Senior Vice President– Marketing in November 2003. From 1992 until 2002, Ms. White-Keating served with Meier & Frank, a division of The May Department Stores Company, most recently as Senior Vice President, Advertising & Marketing where she was responsible for all aspects of marketing and advertising for the division.

      Mr. Wellen joined us as Head of Strategic Planning & Initiatives in September 2000. From June 1997 until joining us, Mr. Wellen held a variety of positions for Computer Sciences Corporation (CSC), most recently as a principal in the Consumer Products & Retail practice where he assisted clients, including Michaels, with strategic, supply chain, and business process initiatives. From September 1994 until joining CSC, he held a variety of positions with Electronic Data Systems (EDS). In addition, Mr. Wellen has held various positions at Haggar Apparel Company and Gimbels Midwest Department Stores.

      Mr. Greenwood holds the position of President– Artistree, a division of Michaels. He has served in that role since 1996. Mr. Greenwood joined us in 1992 as Director of Framing. Prior to joining us, he served as Vice President of Operations for Creative World Marketing.

      Mr. Kanter became President– Aaron Brothers, a subsidiary of Michaels, in April 2003. From 1995 until joining us, Mr. Kanter held various positions with Eddie Bauer, Inc. From 2002 until 2003, he was Managing Director of the Home and Non-Apparel divisions and from 1998 until 2002, he was Managing Director of the Home division. As a Managing Director, Mr. Kanter was responsible for retail, catalog and Internet merchandising, sourcing, planning, allocation, and design and visual presentation. In March 2003, Spiegel, Inc. and certain of its principal operating subsidiaries, including Eddie Bauer, Inc., filed a voluntary petition for reorganization under Chapter 11 of the United States Bankruptcy Code.

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      We lease substantially all of the sites for our Michaels, Aaron Brothers, ReCollections, and Star Wholesale stores, with lease terms generally ranging from five to 10 years. The base rental rates for Michaels stores generally range from $155,000 to $360,000 per year. Rental expense for stores open for the full 12-month period of fiscal 2003 averaged $232,000 for our Michaels stores and $134,000 for our Aaron Brothers stores. The leases are generally renewable, with increases in lease rental rates. Lessors have made leasehold improvements to prepare our stores for opening under a majority of our existing leases. As of January 31, 2004, we had signed 65 leases for new or relocating Michaels stores and three leases for new Aaron Brothers stores that we plan to open in fiscal 2004.

      In addition to our stores, we also lease and occupy the following:

      The following table indicates the number of our retail stores and wholesale operations located in each state or province as of March 24, 2004:

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      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 alleged 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. On January 28, 2004, the case was dismissed.

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

      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 a purported Michaels stockholder requesting that the Board commence an action against certain former and current officers and directors. The purported bases of the demand were similar to those made in the purported stockholder class actions and stockholder derivative lawsuit described above. After investigating such matters alleged in the demand letter and consulting with independent counsel and other professionals, the Board (excluding the Board member referenced in the demand letter) determined at a special meeting held on March 31, 2004 that the allegations raised in the demand letter were without merit. As a result, the Board determined that it was not in the best interests of Michaels or its stockholders to pursue a civil action against those individuals named in the demand letter.

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

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

      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.

      We did not submit any matter to a vote of security holders during the fourth quarter of the fiscal year covered by this report.

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PART II

Market Information

      Our Common Stock is listed on the New York Stock Exchange under the ticker symbol “MIK.”

      The following table sets forth the high and low sale prices of our Common Stock for each quarterly period within the two most recent fiscal years.

Holders

      As of March 24, 2004, there were 521 holders of record of our Common Stock.

Dividends

      In June 2003, our Board of Directors declared our first-ever quarterly cash dividend of $0.10 per share of our Common Stock. Quarterly cash dividends of $0.10 per share were also declared in September and December 2003. On March 16, 2004, our Board of Directors approved a cash dividend of $0.12 per share, to be paid on April 30, 2004, to stockholders of record at the close of business on April 15, 2004. These dividends reflect our growing long-term value and our Board of Director’s commitment to encouraging long-term investment by a diverse stockholder base. We did not pay any dividends on our Common Stock during fiscal 2001 or 2002. Our bank credit facility agreement and the indenture governing our 9 1/4% Senior Notes due 2009 permit dividends to be paid, but there are restrictions as to the amounts which could be paid based on a formulation set forth in each agreement.

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Issuer Purchase of Equity Securities

      On December 5, 2000, our Board of Directors authorized the repurchase of up to 2.0 million shares of our outstanding Common Stock. By later resolutions, our Board of Directors provided that proceeds of the exercise of options under our 2001 General Stock Option Plan may be used to repurchase shares under the 2000 repurchase plan and that the maximum number of shares authorized to be repurchased under the 2000 repurchase plan may be increased to the extent necessary to so use the proceeds from such option exercises.

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

      The following table sets forth our repurchases of Common Stock for each fiscal month in the fourth quarter of fiscal 2003.

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      The following financial information for the five most recent fiscal years has been derived from our consolidated financial statements. This information should be read in conjunction with the consolidated financial statements and related notes thereto included elsewhere herein.

      All references to the number of shares of Common Stock and earnings per share amounts in this Annual Report on Form 10-K have been adjusted to retroactively reflect a two-for-one stock split effected in the form of a stock dividend to stockholders of record as of the close of business on November 12, 2001.