Michaels Stores, Inc.

8000 Bent Branch Drive

Irving, Texas 75063

May 12, 2005

Dear Stockholder:

      You are cordially invited to attend the Annual Meeting of Stockholders of Michaels Stores, Inc. to be held at the Four Seasons Resort and Club, 4150 North MacArthur Boulevard, Irving, Texas 75038 on Thursday, June 16, 2005, at 10:30 a.m., central daylight savings time.

      The attached Notice of Annual Meeting of Stockholders and Proxy Statement describe fully the formal business to be transacted at the Annual Meeting. During the Annual Meeting, stockholders will consider and vote upon the election of six members to the Board of Directors, the ratification of the selection of Ernst & Young LLP as our independent registered public accounting firm and the approval of the Michaels Stores, Inc. 2005 Incentive Compensation Plan.

      Certain directors and officers will be present at the Annual Meeting and will be available to respond to any questions you may have. I hope you will be able to attend.

      We urge you to review carefully the accompanying material and to return the enclosed proxy card promptly. Please sign, date and return the enclosed proxy card without delay. If you attend the Annual Meeting, you may vote in person even if you have previously mailed a proxy.

Michaels Stores, Inc.

8000 Bent Branch Drive

Irving, Texas 75063

NOTICE OF ANNUAL MEETING OF STOCKHOLDERS

To Be Held On June 16, 2005

      NOTICE IS HEREBY GIVEN that the Annual Meeting of Stockholders (the “Annual Meeting”) of Michaels Stores, Inc. will be held at the Four Seasons Resort and Club, 4150 North MacArthur Boulevard, Irving, Texas 75038 on Thursday, June 16, 2005, at 10:30 a.m., central daylight savings time, for the following purposes:

      Information concerning the matters to be acted upon at the Annual Meeting is set forth in the accompanying Proxy Statement.

      The close of business on April 25, 2005 has been fixed as the record date for determining the stockholders entitled to notice of, and to vote at, the Annual Meeting or any adjournments thereof. For a period of at least 10 days prior to the Annual Meeting, a complete list of stockholders entitled to vote at the Annual Meeting will be open for examination by any stockholder during ordinary business hours at our offices located at 8000 Bent Branch Drive, Irving, Texas 75063.

      We urge stockholders to complete, date, sign and return the enclosed proxy card in the accompanying envelope, which does not require postage if mailed in the United States.

Irving, Texas

May 12, 2005

PROXY STATEMENT

TABLE OF CONTENTS

Michaels Stores, Inc.

8000 Bent Branch Drive

Irving, Texas 75063

PROXY STATEMENT

For

ANNUAL MEETING OF STOCKHOLDERS

To Be Held On June 16, 2005

GENERAL QUESTIONS AND ANSWERS

PROPOSAL FOR ELECTION OF DIRECTORS

      Our Board of Directors has six members, a majority of whom are independent directors. All directors serve until the next annual meeting of stockholders and until their successors are duly elected and qualified or until the earlier of their resignation, death or removal. In order to be elected as a director, a nominee must receive a plurality of the votes of the shares of common stock having voting power present or represented by proxy at the Annual Meeting.

      Our Governance and Nominating Committee has recommended, and our Board has approved, the nomination of the six nominees listed below. The nominees have indicated their willingness to serve as members of the Board if elected; however, in case any nominee becomes unavailable for election to the Board for any reason not presently known or contemplated, the proxy holders have discretionary authority to vote proxies for a substitute nominee or nominees. Proxies cannot be voted for more than six nominees.

      Set forth below is information as to the nominees for election at the Annual Meeting, including their ages, present principal occupations, other business experiences during the last five years, membership on committees of the Board and directorships in other public companies.

      Mr. Charles J. Wyly, Jr. became a director of Michaels in 1984. He served as Vice Chairman of the Board of Michaels 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.

      Mr. Sam Wyly has served as Vice Chairman of the Board of Michaels since July 2001 and a director of Michaels since 1984. He served as Chairman of the Board from 1984 until July 2001. Mr. Wyly is an entrepreneur and investor who has created and managed several public and private companies. He was a manager of Ranger Capital, Ltd., a Dallas-based hedge fund management company, from November 2001 until June 2004. 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 product 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. Hanlon has served as a director of Michaels since April 1990. He retired as Senior Vice President— Investor Relations from AOL Time Warner, Inc. in September 2002, having held that position since January 2001 when that media and communications company was formed. From February 1995 until January 2001, he was a senior executive of America Online, Inc., the world’s largest provider of Internet online services. From March 1993 until February 1995, Mr. Hanlon was President of Hanlon & Co., which provided consulting services in shareholder and investor relations, and from 1988 until 1993 was Vice President— Corporate Communications and Secretary of LEGENT Corporation, a major enterprise software company.

      Mr. Marcus became a director of Michaels in July 1999. He currently serves as a management consultant to various organizations and, since January 1997, has served as Senior Advisor to Peter J. Solomon Company, an investment banking company. From December 1994 through December 1995, Mr. Marcus served as Chief Executive Officer of Plaid Clothing Group, a manufacturer of men’s tailored clothing. Prior to these activities, Mr. Marcus was with Neiman Marcus for 27 years and served as Chairman and Chief Executive Officer from 1979 through 1988. He is currently the Chairman of the Board of Zale Corporation.

      Ms. Minyard became a director of Michaels in March 2002. From 1988 to 2004, Ms. Minyard served as Co-Chairman of the Board and, from 1998 to 2004, as Co-Chief Executive Officer of Minyard Food Stores, Inc., a retail grocer. She is currently an advisory director to TXU Corp.

      Ms. Smith became a director of Michaels in October 2002. She is Managing General Partner of Phillips-Smith-Machens Venture Partners, a venture capital firm that invests in retail and consumer businesses and that she co-founded in 1986. She is currently on the board of directors of Brinker International, Inc. Ms. Smith served as a director from 1992 to 1997 and as Chairman from 1994 to 1996 of the Federal Reserve Bank of Dallas.

PRINCIPAL STOCKHOLDERS AND MANAGEMENT OWNERSHIP

      The following table presents information regarding the number of shares of Michaels common stock beneficially owned as of March 31, 2005 by each of Michaels’ directors and Named Executives (as defined in the section of this Proxy Statement entitled “Management Compensation — Summary Compensation Table”), and the current directors and executive officers of Michaels as a group. In addition, the table presents information about each person or entity known to Michaels to beneficially own 5% or more of Michaels common stock. Unless otherwise indicated by footnote, the beneficial owner exercises sole voting and investment power over the shares. The percentage of beneficial ownership for our directors and executive officers, both individually and as a group, is calculated based on 136,680,719 shares of Michaels common stock outstanding as of March 31, 2005.

CORPORATE GOVERNANCE

      Our Board is responsible for providing effective governance over Michaels’ affairs. Michaels’ corporate governance practices are designed to align the interests of the Board and management with those of Michaels’ stockholders and to promote honesty and integrity throughout the company. Highlights of Michaels’ corporate governance practices are described below.

      A copy of the current charter, as approved by our Board, for each of our Audit Committee, Governance and Nominating Committee and Compensation Committee and a copy of our Corporate Governance Guidelines and Code of Business Conduct and Ethics are available on our Internet website at www.michaels.com under “Corporate Information.” Copies are also available to stockholders upon request from our Investor Relations Department. Furthermore, we will post any amendments to our Code of Business Conduct and Ethics, or waivers of the Code for our directors or executive officers, on our Internet website at www.michaels.com under “Corporate Information.”

Stockholder Communications with the Board

      Stockholders may communicate with the Board by mail, with the envelope containing the communication addressed as follows: Board Communication, c/o Secretary, Michaels Stores, Inc., 8000 Bent Branch Drive, Irving, Texas 75063. Michaels’ Secretary will review all such communications and will, within a reasonable period of time after receiving the communications, forward all such communications to the Chairman of the Board, other than those communications that are merely solicitations for products or services or relate to matters that are of a type which render them improper or irrelevant to the functioning of the Board and Michaels. The Chairman of the Board will relay to the full Board those communications that have been forwarded to him.

Board and Committee Matters

      During fiscal 2004, our Board held 10 meetings and acted by unanimous written consent seven times. In addition to meetings of the full Board, directors attended meetings of Board committees. Each incumbent director attended at least 75% of the aggregate number of meetings of the Board and the committees on which he or she served. Michaels expects its directors to attend its annual meetings of stockholders. In 2004, all members of the Board attended the annual meeting of stockholders.

Director Independence

      Our Corporate Governance Guidelines require that a majority of the members of our Board of Directors satisfy the independence requirements set forth in the rules of the New York Stock Exchange. In 2005, our Board adopted revised categorical independence standards for determining the independence of our directors to address certain clarifying amendments made to the director independence requirements of the New York Stock Exchange in November 2004. The revised standards provide that an independent director is a director who:

      The categorical independence standards also provide that, in making a determination regarding a director’s independence, any interest or relationship of a director of a type described in Item 404 of Regulation S-K that is not required to be disclosed pursuant to Item 404 shall be presumed not to be inconsistent with the independence of such director, except to the extent otherwise expressly provided with respect to a particular interest or relationship in the rules established by the New York Stock Exchange.

      Our Board has determined that each of our four independent directors, Richard E. Hanlon, Richard C. Marcus, Liz Minyard and Cece Smith, meets the categorical independence standards set forth above.

Meetings of Non-Management and Independent Directors

      Our Corporate Governance Guidelines require our non-management directors to meet at regularly scheduled executive sessions without management. The Guidelines further provide that the position of presiding director for executive sessions of non-management directors shall be rotated for each meeting among the non-management directors on an alphabetical basis. If one or more non-management directors do not satisfy applicable independence requirements set forth in the rules of the New York Stock Exchange and under applicable law, then at least once each year an executive session including only independent directors will be held. Stockholders may communicate with the non-management directors by mail, with the envelope containing the communication addressed as follows: Non-Management Directors, c/o Secretary, Michaels Stores, Inc., 8000 Bent Branch Drive, Irving, Texas 75063. Michaels’ Secretary will review all such communications and will, within a reasonable period of time after receiving the communications, forward all such communications to the non-management directors, other than those communications that are merely solicitations for products or services or relate to matters that are of a type which render them improper or irrelevant to the functioning of the Board and Michaels.

Board Committees

      As required by our Corporate Governance Guidelines, our Board has three active standing committees, each of which is required by its charter to consist of no fewer than three directors satisfying the applicable current independence criteria of the New York Stock Exchange. The three members of the Governance and Nominating Committee are Richard C. Marcus (Chairman), Richard E. Hanlon and Cece Smith. The three members of the Compensation Committee are Richard E. Hanlon (Chairman), Richard C. Marcus and Liz Minyard. The three members of the Audit Committee are Cece Smith (Chairman), Richard C. Marcus and Liz Minyard.

Governance and Nominating Committee

      Michaels believes that placing the responsibility for nominating directors in the hands of an independent committee, along with charging that committee with the responsibility of taking a leadership role in shaping Michaels’ corporate governance matters, enhances the independence and quality of its Board and of its corporate governance practices. Therefore, under the terms of its amended and restated charter, the Governance and Nominating Committee is charged with the responsibility of identifying individuals qualified to become Board members by recommending to the Board candidates to fill vacancies and newly-created positions on the Board and recommending to the Board director nominees for election by the stockholders at the annual meeting of stockholders, including recommendations as to whether incumbent members of the Board should be nominated for re-election to the Board. The Governance and Nominating Committee reviews the qualifications of, and makes recommendations to the Board concerning, director nominees submitted by stockholders. At any annual meeting, stockholders may nominate a person for election as a director but only upon notice to the Secretary of Michaels given in accordance with the notice provisions in Michaels’ Restated Certificate of Incorporation.

      The Governance and Nominating Committee has also adopted policies and procedures by which Michaels’ stockholders may submit director candidates to the Governance and Nominating Committee for consideration. If the Governance and Nominating Committee receives, by a date not later than the 120th calendar day before the anniversary of the date that Michaels’ proxy statement was released to its stockholders in connection with its previous year’s annual meeting, a recommendation for a director nominee (a “Director Candidate”) from a stockholder or group of stockholders that beneficially owned more than 5% of Michaels’ outstanding common stock for at least one year as of the date of the recommendation, then such Director Candidate will be considered and evaluated by the Governance and Nominating Committee for the annual meeting immediately succeeding the date that proper written notice was timely delivered to and received by the Governance and Nominating Committee. Where the date of Michaels’ annual meeting of stockholders changes by more than 30 calendar days from the previous year’s annual meeting, such written notice of the recommendation for the Director Candidate will be considered timely if, and only if, it is received by the Governance and Nominating Committee no later than the close of business on the 10th calendar day following the first day on which notice of the date of the upcoming annual meeting is publicly disclosed by Michaels, unless such notice specifies a different date for stockholder recommendations for a Director Candidate to be timely.

      Written notice from an eligible stockholder or group of eligible stockholders to the Governance and Nominating Committee recommending a Director Candidate must contain or be accompanied by:

      To ensure flexibility with respect to the director nominee evaluation process, the Governance and Nominating Committee has not established specific, minimum qualifications that an individual must meet in order to become a member of the Board. However, the Governance and Nominating Committee believes that Michaels is best served when the members of the Board:

      The Governance and Nominating Committee is also charged with the responsibility of developing and recommending corporate governance principles applicable to Board members and Michaels’ employees. The Governance and Nominating Committee Charter requires the committee to develop and recommend guidelines for that purpose consistent with federal and state law and the rules of the Securities and Exchange Commission and the New York Stock Exchange, giving appropriate attention to “best corporate governance practices.” In response to that requirement, the Governance and Nominating Committee developed and recommended, and the Board has adopted, the amended and restated Corporate Governance Guidelines available on our Internet website. The Governance and Nominating Committee also (i) oversees the evaluation of the performance of the Board and Michaels’ management against the Corporate Governance Guidelines, and (ii) reviews possible conflicts of interest. During fiscal 2004, the Governance and Nominating Committee met three times and acted by unanimous written consent once.

Compensation Committee

      To further enhance the effectiveness of Michaels’ corporate policies and practices, under the terms of its amended and restated charter, the Compensation Committee reviews, approves and administers Michaels’ policies, programs, procedures and objectives for compensating its executive officers. The Compensation Committee determines and approves the compensation of Michaels’ Chief Executive Officer and reports that determination to the Board. The Compensation Committee also reviews and approves the compensation levels of all other executive officers. In addition to these compensation determinations, the Compensation Committee makes recommendations to the Board with respect to the approval and adoption

of all cash- and equity-based incentive compensation plans in which any of Michaels’ executive officers participate. The Compensation Committee reviews Board compensation policies, but only the Board may determine compensation for directors. The Compensation Committee acts as the committee of the Board that administers the 1997 Employees Stock Purchase Plan, 1997 Stock Option Plan, 2001 Employee Stock Option Plan and 2001 General Stock Option Plan. With respect to the 1997 Stock Option Plan, the 2001 Employee Stock Option Plan and the 2001 General Stock Option Plan, the Compensation Committee has the power to grant options under those plans. Additionally, with respect to the 1997 Stock Option Plan, the Compensation Committee determines when options will be exercisable under that plan. During fiscal 2004, the Compensation Committee met seven times and acted by unanimous written consent 13 times.

Compensation Committee Interlocks and Insider Participation

      During fiscal 2004, Richard E. Hanlon, Richard C. Marcus and Liz Minyard served as members of the Compensation Committee. None of the members of the Compensation Committee (i) was an officer or employee of Michaels during the fiscal year, (ii) was formerly an officer of Michaels, or (iii) had any relationships requiring disclosure by Michaels under the Securities and Exchange Commission’s rules with respect to certain relationships and related party transactions. Furthermore, none of our executive officers serves as a member of the board of directors or compensation committee of any entity that has one or more executive officers serving on our Board or Compensation Committee.

Audit Committee

      Our Audit Committee Charter requires that all members of the Audit Committee satisfy the independence criteria of the New York Stock Exchange and the Securities Exchange Act of 1934 and all rules and applicable standards promulgated by the New York Stock Exchange or the Securities and Exchange Commission. The charter also requires that the Audit Committee members meet the financial literacy requirements of the New York Stock Exchange rules, that at least one Audit Committee member satisfy the accounting or related financial management expertise standards of the New York Stock Exchange rules and that at least one Audit Committee member satisfies the criteria for an “audit committee financial expert,” as that term is defined in Securities and Exchange Commission rules. All three members of the Audit Committee meet (i) the independence requirements and the financial literacy requirements of the New York Stock Exchange and (ii) the independence requirements of the Securities Exchange Act of 1934. Our Board has determined that Cece Smith, the Chairman of the Audit Committee, satisfies the accounting or related financial management expertise standards of the New York Stock Exchange and satisfies the criteria adopted by the Securities and Exchange Commission to serve as the “audit committee financial expert” of Michaels.

      Under its charter, the Audit Committee is generally responsible for overseeing Michaels’ financial reporting process and assists the Board in fulfilling the Board’s oversight responsibilities with respect to: (i) the integrity of Michaels’ financial statements; (ii) Michaels’ compliance with legal and regulatory requirements; (iii) the qualifications and independence of Michaels’ independent registered public accounting firm; and (iv) the performance of the independent registered public accounting firm and of Michaels’ internal audit function. In fulfilling its obligations, the Audit Committee directly appoints, retains, terminates and determines the compensation of Michaels’ independent registered public accounting firm. The Audit Committee is also responsible for the resolution of disagreements between management and the independent registered public accounting firm along with the pre-approval and approval of all audit and non-audit engagement fees, terms and services with the independent registered public accounting firm in a manner consistent with the Sarbanes-Oxley Act of 2002 and all rules and applicable standards promulgated by the Securities and Exchange Commission or the New York Stock Exchange. Michaels’ independent registered public accounting firm is required to report directly to the Audit Committee concerning, among other things, the independent registered public accounting firm’s internal quality control procedures, the independence of the accountants and the plans for, and the scope and conduct of, annual audits. The Audit Committee has developed procedures for (i) receiving and dealing with complaints regarding accounting, internal accounting controls or auditing matters and (ii) the confidential submission

by employees of concerns regarding questionable accounting or auditing matters. These procedures are disclosed on Michaels’ website at www.michaels.com under “Corporate Information.” During fiscal 2004, the Audit Committee met 10 times.

PROPOSAL FOR RATIFICATION OF THE SELECTION OF OUR INDEPENDENT REGISTERED

PUBLIC ACCOUNTING FIRM

      Pursuant to the Audit Committee Charter, the Audit Committee has the sole authority to retain Michaels’ independent registered public accounting firm. The Board requests that the stockholders ratify the Audit Committee’s selection of Ernst & Young LLP as Michaels’ independent registered public accounting firm for fiscal 2005.

      The Audit Committee will not be bound by the ratification of, or failure to ratify, the selection of Ernst & Young LLP, but the Audit Committee will consider any failure to ratify the selection of Ernst & Young LLP in connection with the appointment of our independent registered public accounting firm in the following fiscal year.

      The Board recommends a vote “FOR” ratification of the Audit Committee’s selection of Ernst & Young LLP as Michaels’ independent registered public accounting firm for fiscal 2005.

AUDIT COMMITTEE REPORT

      The Audit Committee Charter requires our Audit Committee to undertake a variety of activities designed to assist our Board in fulfilling its oversight role regarding our independent registered public accounting firm’s independence, our financial reporting process, our systems of internal controls and our compliance with applicable laws, rules and regulations. These activities are briefly summarized in this Proxy Statement under the caption “Corporate Governance — Audit Committee.” The Audit Committee Charter also makes it clear that the independent registered public accounting firm is ultimately accountable to the Board and the Audit Committee, not management.

      The internal accountants of Michaels prepare Michaels’ consolidated financial statements and Michaels’ independent registered public accounting firm is responsible for auditing those financial statements. The Audit Committee monitors and reviews the financial reporting processes implemented by management but does not conduct any auditing or accounting reviews. The members of the Audit Committee are not employees of Michaels and do not represent themselves as experts in the field of accounting or auditing. Instead, the Audit Committee relies, without independent verification, on management’s representation that the financial statements have been prepared in conformity with generally accepted accounting principles and on the representations of our independent registered public accounting firm included in its report on our financial statements. The Audit Committee’s oversight does not provide them with an independent basis for determining whether management has maintained appropriate accounting and financial reporting principles or policies or appropriate internal controls and procedures designed to assure compliance with accounting standards and applicable laws and regulations. Furthermore, the Audit Committee’s discussions with management and its accountants do not ensure that the financial statements are presented in accordance with generally accepted accounting principles, that the audit of the financial statements has been carried out in accordance with generally accepted auditing standards or that our independent registered public accounting firm is in fact “independent.”

      We have engaged Ernst & Young LLP as our independent registered public accounting firm to audit and report to our stockholders on our financial statements for fiscal 2005. During fiscal 2004, there were no disagreements with Ernst & Young LLP on any matter of accounting principle or practice, financial statement disclosure or auditing scope or procedure, which, if not resolved to the satisfaction of Ernst & Young LLP, would have caused them to make a reference to the subject matter of the disagreement in connection with its reports.

      The Audit Committee has reviewed and discussed with our management and Ernst & Young LLP the audited financial statements of Michaels contained in our Annual Report on Form 10-K for the fiscal year ended January 29, 2005. The Audit Committee has also discussed with our independent registered public accounting firm the matters required to be discussed pursuant to SAS No. 61 (Codification of Statements on Auditing Standards, Communication with Audit Committees).

      The Audit Committee has also received and reviewed the written disclosures and the letter from Ernst & Young LLP required by Independence Standards Board Standard No. 1 (Independence Discussions with Audit Committees) and has discussed with Ernst & Young LLP its independence.

      Based on the review and discussions referred to above, the Audit Committee recommended to the Board that the audited financial statements be included in our Annual Report on Form 10-K for the fiscal year ended January 29, 2005, as filed with the Securities and Exchange Commission.

      The Audit Committee considered whether, and concluded that, the provision by Ernst & Young LLP of the services referred to under “Tax Fees” and “All Other Fees” below is compatible with maintaining the independence of Ernst & Young LLP.

      This report is submitted by the members of the Audit Committee of the Board of Directors:

INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM’S FEES

      The following table presents fees for professional audit services rendered by Ernst & Young LLP for the audit of Michaels’ annual financial statements for each of fiscal 2003 and 2004, and fees billed for other services rendered by Ernst & Young LLP.

      The Audit Committee Charter requires that the Audit Committee pre-approve all audit and non-audit engagements, fees, terms and services in a manner consistent with the Sarbanes-Oxley Act of 2002 and all rules and applicable listing standards promulgated by the Securities and Exchange Commission and the New York Stock Exchange, except that such non-audit services need not be pre-approved if (i) the aggregate amount of all such non-audit services provided to Michaels constitutes not more than 5% of the total amount of fees paid by Michaels to its independent registered public accounting firm during the fiscal year in which the non-audit services are provided, (ii) such services were not recognized by Michaels at the time of engagement to be non-audit services, and (iii) such services were promptly brought to the attention of the Audit Committee and approved by the Audit Committee or by one or more members of the Audit Committee to whom authority to grant such approvals has been delegated by the Audit Committee. The Audit Committee may delegate the authority to grant any pre-approvals to one or more members of the Audit Committee, provided that such member(s) reports any pre-approvals to the Audit Committee at its next scheduled meeting. The Audit Committee has delegated pre-approval authority to its chairman.

      Representatives of Ernst & Young LLP are expected to be present at the Annual Meeting and will have the opportunity to make a statement if they desire to do so and will be available to respond to appropriate questions.

COMPENSATION OF DIRECTORS

      During fiscal 2004, Michaels compensated Charles J. Wyly, Jr., for his service as Chairman of the Board, as indicated under “Management Compensation — Summary Compensation Table” and “Management Compensation — Option Grants During Fiscal 2004.” During fiscal 2004, Michaels compensated Sam Wyly for his service as Vice Chairman of the Board with (i) $18,750 per month, (ii) options to purchase 135,000 shares of common stock (including the automatic grant of 35,000 shares of common stock made to each director as described below), and (iii) $14,544 for the personal use of a company-owned automobile. Michaels also provided the services of an administrative assistant employed by the company to Mr. Wyly in order to support him in his role as Vice Chairman of the Board.

      Mr. Hanlon, Mr. Marcus, Ms. Minyard and Ms. Smith each receive an annual fee of $48,000 as members of the Board and a fee of $1,500 for attendance at each regular or special Board meeting and for attendance at each meeting of a committee of which they are a member. We also reimburse directors for expenses incurred in attending meetings.

      Currently, upon first election to the Board and immediately following each annual meeting of stockholders thereafter, each director receives an automatic grant of options exercisable for 35,000 shares of common stock under our 2001 General Stock Option Plan. Upon approval of the Michaels Stores, Inc. 2005 Incentive Compensation Plan by our stockholders, compensatory awards to our directors will be awarded under this new plan and the automatic grants to directors currently made under the 2001 General Stock Option Plan will cease, including the automatic grant of options to directors that would otherwise be awarded immediately following the 2005 Annual Meeting.

      The stock option grant information disclosed above as part of our directors’ compensation has been adjusted to 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 September 27, 2004.

COMPENSATION COMMITTEE REPORT

What is our compensation philosophy?

      The objectives of our executive officer compensation program are to:

      We believe in a total compensation approach, with an emphasis on variable components of pay including bonus and equity-based awards. Executive officers performing at a high level should be well compensated through cash compensation sufficient to retain such executives and through equity-based awards that align such executives with the interests of the stockholders and stimulate focus on long-term stockholder value enhancement.

How is compensation determined?

      The Compensation Committee is responsible for determining our Chief Executive Officer’s compensation level. On the recommendation of Michaels’ senior management, the Compensation Committee also reviews, determines and approves the compensation level of all other executive officers of Michaels. In determining compensation levels for Michaels’ executive officers, the Compensation Committee considers the scope of an individual’s responsibilities, external competitiveness of total compensation, an individual’s performance and prior experience, the performance of the company and the attainment of planned financial and strategic initiatives. These factors are evaluated by the Compensation Committee with no particular weight given to any one factor. The Compensation Committee also considers the prevailing compensation levels in relevant markets for executive-level employees when considering the compensation levels of our executive officers; however, this compensation data is merely used as a guide by the committee in making its compensation determinations. In connection with making its 2005 compensation determinations, a customized study analyzing the total compensation elements for a specific retail peer group was prepared for and reviewed by the Compensation Committee. The Compensation Committee also consulted executive compensation experts in the course of evaluating the compensation levels for our executive officers.

      Base salaries for our executive officers are established based on the scope of their responsibilities, individual performance and prior experience, Michaels’ operating and financial performance and the attainment of planned financial and strategic initiatives, taking into account competitive market compensation paid by similar companies for similar positions. The Compensation Committee sets base salaries at a level designed to attract and retain highly qualified individuals who make contributions that result in Michaels meeting its operating and financial goals. Base salaries are reviewed annually and adjusted as deemed appropriate by the Compensation Committee.

      In approving the annual plans for executive officer bonuses, the Compensation Committee provides financial incentives to those members of management who can make an important contribution to our success by tying the bonuses to the attainment of certain financial, operational and strategic objectives.

These objectives may be different from individual to individual. Each participating executive officer is entitled to a bonus equal to a certain percentage of that executive officer’s salary based upon the attainment of the established objectives.

      In compensating executive officers through equity-based awards, the Compensation Committee, pursuant to certain established guidelines, makes discretionary awards based upon the level of responsibility and performance of the individual receiving the award. The Compensation Committee reviews and approves the guidelines used for such discretionary awards.

      Our executive compensation also includes certain other benefits and perquisites. These benefits include annual matching contributions to executives officers’ deferred compensation and 401(k) accounts, the payment of life insurance premiums, company-paid medical benefits and, in some cases, reimbursement for income taxes on taxable benefits. The perquisites for our most senior executives may also include the personal use of company-owned automobiles and payment of or reimbursement for club membership dues. For more detailed information regarding benefits and perquisites provided to our executive officers, please see the section of this Proxy Statement entitled “Management Compensation — Summary Compensation Table.”

How are our incentive compensation programs used to focus management on increasing stockholder value?

      We currently maintain stock option plans for our directors, officers and key employees. We believe that the grant of options and similar equity-based awards aligns executive and stockholder long-term interests by creating a strong and direct link between executive compensation and stockholder return. The grant of options and similar equity-based awards also allows executive officers to develop and maintain a long-term ownership position in Michaels. Upon approval by Michaels’ stockholders, the Compensation Committee intends to utilize the various equity-based compensation awards provided for under the Michaels Stores, Inc. 2005 Incentive Compensation Plan as a component of our overall executive incentive compensation program.

How have we responded to the IRS limits on deductibility of compensation?

      Options granted under our 1997 Stock Option Plan and 2001 General Stock Option Plan are intended to meet the performance based compensation exception to the annual $1,000,000 limitation on the tax deduction we may claim for compensation of certain executive officers. Although our current executive officer bonus program does not meet the exception to the IRS deduction limitation, awards and bonuses under our proposed 2005 Incentive Compensation Plan are intended to satisfy this exception. While the Compensation Committee is cognizant of the tax deduction limitations applicable to our executives officer compensation program, the committee may from time to time set compensation levels outside the deduction limitations if it deems such departure is warranted.

How is our Chief Executive Officer compensated?

      The Compensation Committee determines the compensation level of our Chief Executive Officer, Mr. Rouleau. Mr. Rouleau received a base salary of $771,808 during fiscal 2004, and the Compensation Committee believes this level of base salary is necessary in order to retain a qualified Chief Executive Officer for a company the size of Michaels. Mr. Rouleau’s incentive compensation bonus for fiscal 2004 was based upon the attainment of specified performance goals and objectives. With respect to fiscal 2004, Mr. Rouleau received $450,000 in a cash bonus. In fiscal 2004, Mr. Rouleau also received stock options which, after giving effect to a two-for-one stock split in the form of a stock dividend to stockholders of record as of the close of business on September 27, 2004, are exercisable for 200,000 shares of common

stock. In determining whether to award such options, the Compensation Committee considered not only his contribution to Michaels’ success in past years, but also all outstanding options held by Mr. Rouleau.

      Mr. Rouleau’s compensation package also includes other compensation under an employment agreement he has with Michaels, a summary of which is set out in the “Management Compensation — Employment and Severance Agreements” section of this Proxy Statement. Such compensation has historically included matching contributions to his deferred compensation and 401(k) accounts, life insurance premiums paid by Michaels, company-paid medical benefits and reimbursement for income taxes paid by Mr. Rouleau relating to certain taxable benefits provided to him. Mr. Rouleau also receives the use of a company-owned automobile together with the periodic transfer of title to his previously used company-owned automobile as part of his compensation package. A tally sheet for Mr. Rouleau, setting forth the material components of his overall compensation and affixing dollar amounts relating to the compensation components (to the extent the benefit to Mr. Rouleau was reasonably quantifiable), was prepared for and reviewed by the Compensation Committee in connection with making a determination regarding Mr. Rouleau’s current compensation level.

      In determining Mr. Rouleau’s compensation level for 2005, the Compensation Committee also considered Mr. Rouleau’s role in achieving certain objectives important to our company, including (i) the successful implementation of our perpetual inventory and automated merchandise replenishment systems, (ii) the strengthening of our executive management team, and (iii) Michaels’ record financial performance for eight consecutive years.

How are the other executive officers compensated?

      Our other executive officers usually receive base salaries, annual cash bonuses, long-term incentive compensation in the form of stock options and various other benefits. On the recommendation of Michaels’ senior management, the Compensation Committee reviews, determines and approves the compensation level for our executive officers. In determining the compensation levels for our Named Executives (as defined in the section of this Proxy Statement entitled “Management Compensation — Summary Compensation Table”) for fiscal 2005, a tally sheet for each Named Executive, setting forth the material components of each Named Executive’s overall compensation and affixing dollar amounts relating to the compensation components (to the extent each such benefit was reasonably quantifiable), was prepared for and reviewed by the Compensation Committee. The Compensation Committee, in administering the 1997 Stock Option Plan and the 2001 General Stock Option Plan, may also evaluate the executive officers’ performance in the Compensation Committee’s determination of stock option grants to our executive officers. Similar evaluation will be used in determining grants of equity-based compensation awards under our new 2005 Incentive Compensation Plan upon approval of the plan by Michaels’ stockholders.

      This report is submitted by the members of the Compensation Committee, which also performs the additional duties of administering Michaels’ 1997 Employees Stock Purchase Plan, 1997 Stock Option Plan, 2001 Employee Stock Option Plan and the 2001 General Stock Option Plan:

MANAGEMENT COMPENSATION

Summary Compensation Table

      The following table sets forth certain information regarding compensation paid or accrued by Michaels to our Chief Executive Officer, each of our four other most highly compensated executive officers and two executive officers during the course of the fiscal year who would have been among the four most highly compensated executive officers had they been executive officers at the end of the fiscal year (collectively, the “Named Executives”).

      Although the Securities and Exchange Commission has established thresholds that must be exceeded before certain company-provided perquisites received by our Named Executives are required to be specifically disclosed in the table below, we have, in the interest of greater transparency, included information regarding perquisites in the table regardless of whether they exceed the established disclosure thresholds.

Option Grants During Fiscal 2004

      The following table provides information related to options granted to the Named Executives during fiscal 2004.

Option Exercises During Fiscal 2004 and Fiscal Year-End Option Values

      The following table provides information related to options exercised by the Named Executives during fiscal 2004 and the number and value of options held at fiscal year-end. Michaels does not have any outstanding stock appreciation rights.

Employment and Severance Agreements

      In July 2004, Michaels entered into an amended and restated employment agreement with R. Michael Rouleau, the President and Chief Executive Officer of Michaels. The employment agreement is for a term expiring on January 31, 2008 with provisions for annual automatic one-year extensions unless Michaels gives notice of non-extension 120 days prior to any expiration date. Under the employment agreement, Mr. Rouleau is entitled to receive an annual base salary of $675,000, or such higher amount as

the Board of Directors or Compensation Committee shall from time to time determine, and standard executive officer benefits. Additionally, Mr. Rouleau is allowed to participate in a bonus plan in any year in which a bonus plan is established. For fiscal 2004, Mr. Rouleau received a bonus of $450,000 pursuant to a bonus plan based upon the attainment by Michaels of specified financial or performance goals and objectives. Upon a change of control of Michaels or if Michaels terminates Mr. Rouleau’s employment (other than for cause) prior to the expiration of the employment agreement, Mr. Rouleau is entitled to continue to receive his base salary and other benefits until January 31, 2008 and a prorated bonus for the fiscal year in which the termination occurs if Mr. Rouleau would have earned a bonus in that year. If Mr. Rouleau’s employment is terminated for any reason, at any time, (i) all unvested stock options then held by him will immediately become fully exercisable and, if Mr. Rouleau is terminated for any reason other than for cause, the expiration date for those options will automatically be extended to the date that is one day prior to the fifth anniversary of his termination date, (ii) Mr. Rouleau will have the option to purchase the company-owned automobile in his possession at the depreciated book value of said automobile, and (iii) Mr. Rouleau will automatically become the owner of his company-paid whole life insurance policies.

      Michaels has an agreement with Ronald S. Staffieri, effective August 5, 2004, which provides for the payment of certain compensation by Michaels to Mr. Staffieri after the termination of his employment with Michaels on August 11, 2004. Pursuant to this agreement, Michaels agrees to make bi-weekly payments equivalent to the amount of Mr. Staffieri’s base salary on the termination date for up to 18 months subject to all applicable or customary withholding requirements, beginning August 12, 2004 and ending on the earliest to occur of: (i) February 11, 2006; (ii) the date prior to February 11, 2006 upon which Mr. Staffieri becomes employed by or performs services on behalf of certain competitors of Michaels; or (iii) the date upon which Mr. Staffieri first materially violates any term or provision of the agreement. For fiscal 2004, these payments to Mr. Staffieri totaled $172,308. In addition to these payments, Mr. Staffieri, in accordance with the provisions of the agreement and a pre-established bonus plan, received a bonus of $240,000 for fiscal 2004.

EQUITY COMPENSATION PLAN INFORMATION

      The following table provides information as of January 29, 2005 with respect to shares of Michaels common stock that may be issued under our existing equity compensation plans, including the 1997 Employees Stock Purchase Plan, the 1997 Stock Option Plan, the 2001 Employee Stock Option Plan and the 2001 General Stock Option Plan. Options to acquire shares of Michaels common stock set forth in this table have been adjusted to 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 September 27, 2004.

STOCK PERFORMANCE CHART

      The following chart compares the yearly changes in the total stockholder return on our common stock against two other measures of performance. The comparison is on a cumulative basis for our last five fiscal years. The two other performance measures are the Dow Jones US Total Market Index (previously known as the Dow Jones Equity Market Index) and the Dow Jones US Specialty Retailers Index (previously known as the Dow Jones Retail — Other Specialty Index). In each case, we assumed an initial investment of $100 on January 28, 2000 and reinvestment of all dividends. Dates on the following chart represent the last trading day of the indicated fiscal year. We paid cash dividends during the second, third and fourth quarters of fiscal 2003 and each quarter of fiscal 2004.

PROPOSAL FOR THE APPROVAL OF THE MICHAELS STORES, INC.

2005 INCENTIVE COMPENSATION PLAN

General

      Based on a recommendation from our Compensation Committee (comprised entirely of independent directors), our Board adopted, subject to stockholder approval, the Michaels Stores, Inc. 2005 Incentive Compensation Plan (the “2005 Plan”). The Board has approved the 2005 Plan as a flexible incentive compensation plan that will allow Michaels to utilize different forms of compensation awards to attract, retain and reward eligible participants under the 2005 Plan and strengthen the mutuality of interests between management and Michaels’ stockholders.

      Upon the adoption of the 2005 Plan by our stockholders, the awards under that plan will be the cornerstone of Michaels’ overall incentive compensation program, certain key features of which are described below.

      Set forth below is a summary of the 2005 Plan, which is qualified in its entirety by the specific language of the 2005 Plan. A copy of the 2005 Plan is attached to this Proxy Statement as Annex A.

Summary of the 2005 Plan

      Purpose: The purpose of the 2005 Plan is to attract and retain the best available talent and to encourage the highest level of performance by directors, executive officers and selected employees, and to provide them incentives to set forth maximum efforts for the success of Michaels’ business, in order to serve the best interests of Michaels and its stockholders.

      Term: The 2005 Plan will expire on the tenth anniversary of the date on which it is approved by the stockholders. No further awards will be made under the 2005 Plan on or after such tenth anniversary. Awards that are outstanding on the date the 2005 Plan terminates will remain in effect according to their terms and the provisions of the 2005 Plan.

      Administration: Unless the administration of the 2005 Plan has been expressly assumed by the Board pursuant to a resolution of the Board, the 2005 Plan will be administered by the Compensation Committee of the Board (the “Committee”). The Committee has the full authority and discretion to administer the 2005 Plan and to take any action that is necessary or advisable in connection with the administration of the Plan.

      Types of Awards: The 2005 Plan authorizes the granting of awards in any of the following forms:

      Eligible Participants: Executive officers, key employees and directors of Michaels or a subsidiary of Michaels are eligible to participate in the 2005 Plan. We estimate that approximately 1,485 individuals will be eligible to be selected by the Committee to receive awards under the 2005 Plan. This group of eligible participants includes six directors, six executive officers and 41 non-executive officers.

      Shares Available Under the 2005 Plan: Subject to certain adjustments that may be required from time to time to prevent dilution or enlargement of the rights of participants in the 2005 Plan, a maximum of 12 million shares will be available for grants of all equity awards under the 2005 Plan. Shares of our common stock issued pursuant to the 2005 Plan may be shares of original issuance or treasury shares or a combination of the foregoing.

      Limitations on Awards: Awards under the 2005 Plan will be subject to the following limitations:

      Stock Options: The Committee may from time to time authorize grants to any participant of options to purchase shares of common stock upon such terms and conditions as it may determine in accordance with the terms of the 2005 Plan. The exercise price of each stock option granted may not be less than 100% of the market value per share on the date of grant. Generally, all stock options will terminate after a five-year period from the date of grant, unless a longer period is permitted by the Committee in the event of the death, disability or retirement of a participant. Vesting of stock options will be based on the required period or periods of continuous service of the participant, and may also be contingent upon the participant’s achievement of certain management objectives. Except as may be approved by the Committee (i) in connection with stock options granted to our directors (solely in their capacity as directors) or (ii) in the case of the death, disability or retirement of a participant, stock options will not be exercisable at a rate that is faster than one-third of the shares of common stock subject to the stock options on each anniversary of the date of grant unless specified measurable performance objectives established by the Committee in connection with the grant are achieved.

      Appreciation Rights: The Committee may also from time to time authorize grants to any participant of appreciation rights upon such terms and conditions as it may determine in accordance with the provisions of the 2005 Plan. Appreciation rights may be granted in tandem with stock options or separate and apart from a grant of stock options. An appreciation right will be a right of the participant to receive from Michaels upon exercise an amount which will be determined by the Committee at the date of grant and will be expressed as a percentage of the spread (not exceeding 100%) at the time of exercise. The “spread” of an appreciation right is the difference between (i) the aggregate fair market value at the time of exercise of the shares of Michaels common stock subject to the appreciation right and (ii) the aggregate price per share of Michaels common stock at which the appreciation right was granted. An appreciation right granted in tandem with a stock option may be exercised only by surrender of the related stock option. The amount payable to a participant receiving a grant of appreciation rights under the 2005 Plan may be paid in cash, in shares of common stock or in a combination thereof, as determined by the Committee. No appreciation right will be exercisable more than ten years from the date of grant.

      Vesting of appreciation rights will be based on the required period or periods of continuous service of the participant and may also be contingent upon the participant’s achievement of certain management objectives. Except as may be approved by the Committee (i) in connection with appreciation rights granted to our directors (solely in their capacity as directors) or (ii) in the case of the death, disability or retirement of a participant, appreciation rights will not be exercisable at a rate that is faster than one-third of the shares of common stock subject to the appreciation rights on each anniversary of the date of grant unless specified measurable performance objectives established by the Committee in connection with the grant are achieved.

      Restricted Shares: Restricted shares are shares of Michaels common stock that are issued to a participant subject to such restrictions on transfer and vesting requirements as may be determined by the Committee in accordance with the 2005 Plan. Each grant or sale of restricted shares will constitute an immediate transfer of the ownership of shares of common stock to the participant in consideration of the performance of services, entitling such participant to voting and other ownership rights, but will remain subject to the restrictions established by the Committee in accordance with the terms of the 2005 Plan. Each grant or sale may limit a participant’s dividend rights during the period in which the restricted shares are subject to any such restrictions. The termination of restrictions applicable to restricted shares may also be subject to the participant’s achievement of specified management objectives. Except as may be

approved by the Committee (i) in connection with restricted shares granted to our directors (solely in their capacity as directors) or (ii) in the case of the death, disability or retirement of a participant, the restrictions imposed on restricted shares will not terminate at a rate that is faster than one-third of the restricted shares on each anniversary of the date of grant unless specified measurable performance objectives established by the Committee in connection with the grant are achieved.

      Restricted Stock Units: The Committee may also from time to time authorize grants or sales to any participant of restricted stock units upon such terms and conditions as it may determine in accordance with the terms of the 2005 Plan. Each grant or sale will constitute the agreement by Michaels to issue or transfer shares of common stock to the participant in the future in consideration of the performance of services, subject to the fulfillment during the deferral period of such conditions as the Committee may specify. During the applicable deferral period for a given restricted stock unit award, the participant will not have any right to transfer the rights associated with the restricted stock units and will have no ownership or voting rights with respect to the restricted stock units or the underlying shares of Michaels common stock associated with the restricted stock units. Except as may be approved by the Committee (i) in connection with restricted stock units granted to our directors (solely in their capacity as directors) or (ii) in the case of the death, disability or retirement of a participant, the deferral period relating to restricted stock units will not terminate at a rate that is faster than with respect to one-third of the restricted stock units on each anniversary of the date of grant unless specified measurable performance objectives established by the Committee in connection with the grant are achieved.

      Performance Shares and Performance Units: The 2005 Plan authorizes the Committee to grant performance shares and performance units to participants, which will become payable upon achievement of specified management objectives, and such other terms and conditions as the Committee may determine in accordance with the terms of the 2005 Plan. The payment of performance shares or performance units which become payable to a participant may be made in cash, in shares of Michaels common stock or in a combination thereof, as determined by the Committee.

      Senior Executive Plan Bonuses: The Committee may authorize payment of annual incentive compensation to a participant who is, or is determined by the Committee to be likely to become, a “covered employee” within the meaning of Section 162(m) of the Code (or any successor provision), which incentive compensation will become payable upon the achievement of specified management objectives by the participant. Senior executive plan bonuses will be payable upon such terms and conditions as the Committee may determine in accordance with the provisions of the 2005 Plan. The payment of a senior executive plan bonus which becomes payable to a participant may be made in cash, in shares of Michaels common stock or in a combination thereof, as determined by the Committee.

      Management Objectives: Management objectives may be described in terms of company-wide objectives (i.e., the performance of Michaels and all of its subsidiaries) or in terms of objectives that are related to the performance of the individual participant or of the division, subsidiary, department, region or function within Michaels or a subsidiary of Michaels in which the participant receiving the award is employed or upon which the participant’s efforts have the most influence. The achievement of the management objectives established by the Committee for any performance period will be determined without regard to the effect on such management objectives of any acquisition or disposition by Michaels of a trade or business, or of substantially all of the assets of a trade or business, during the performance period and without regard to any change in accounting standards by the Financial Accounting Standards Board or any successor entity.

      The management objectives applicable to any award to a participant who is, or is determined by the Committee to be likely to become, a “covered employee” within the meaning of Section 162(m) of the Code (or any successor provision) will be limited to specified levels of, growth in, or performance relative to peer company performance in, one or more of the following performance measures (excluding the effect

of extraordinary or nonrecurring items unless the Committee specifically includes any such extraordinary or nonrecurring item at the time such award is granted):

      If the Committee determines that, as a result of a change in the business, operations, corporate structure or capital structure of Michaels, or the manner in which Michaels conducts its business, or any other event or circumstance, the management objectives are no longer suitable, the Committee may in its discretion modify such management objectives or the related minimum acceptable level of achievement, in whole or in part, with respect to a performance period as the Committee deems appropriate and equitable.

      Transferability: No award may be sold, pledged, assigned or transferred in any manner other than by will or the laws of descent and distribution, pursuant to a qualified domestic relations order or, with the consent of the Committee, by gifts to family members of the participant, including to trusts to which family members of the participant own more than 50% of the beneficial interests, to foundations in which family members of the participant control or the participant controls the management of assets, to other entities in which more than 50% of the voting interests are owned by family members of the participant or the participant and to charitable organizations described in Section 170(c) of the Code. No stock option or appreciation right granted to a participant will be exercisable during the participant’s lifetime by any person other than the participant, the participant’s guardian or legal representative or any permitted transferee.

      Withholding Taxes: To the extent that Michaels is required to withhold federal, state, local or foreign taxes in connection with any payment made or benefit realized by a participant or other person under the 2005 Plan, and the amounts available to Michaels for such withholding are insufficient, it will be a condition to the receipt of such payment or the realization of such benefit that the participant or such other person make arrangements satisfactory to Michaels for payment of the balance of such taxes required to be withheld. In addition, if permitted by the Committee, a participant may elect to have any withholding obligation of Michaels satisfied with shares of common stock that would otherwise be transferred to the participant in payment of the participant’s award.

      Amendments: The 2005 Plan may be amended from time to time by the Committee or the Board but may not be amended without further approval by the stockholders if such amendment would result in the 2005 Plan no longer satisfying any applicable requirements of the New York Stock Exchange, Rule 16b-3 of the Securities Exchange Act of 1934 or Section 162(m) of the Code. Neither the Committee nor the Board will authorize the amendment of any outstanding stock option to reduce the option price without the further approval of the stockholders. Furthermore, no stock option will be cancelled and replaced with stock options having a lower option price without further approval of the stockholders.

      Termination: The 2005 Plan may be terminated at any time by action of the Board. The termination of the 2005 Plan will not affect the terms of any outstanding award.

Material U.S. Federal Income Tax Consequences

      The following discussion of the principal U.S. federal income tax consequences with respect to awards under the 2005 Plan is based on statutory authority and judicial and administrative interpretations as of the date of this Proxy Statement, which are subject to change at any time (possibly with retroactive effect) and may vary in individual circumstances. Therefore, the following discussion is designed to provide a general understanding of the federal income tax consequences (state, local and other tax consequences are

not addressed below). This discussion is limited to the U.S. federal income tax consequences to individuals who are citizens or residents of the U.S. The U.S. federal income tax law is technical and complex and the discussion below represents only a general summary.

      Non-Qualified Stock Options: In general, no income will be recognized by a participant at the time a non-qualified stock option is granted. At the time of exercise of the stock option, the participant will recognize ordinary income if the shares are not subject to a substantial risk of forfeiture (as defined in Section 83 of the Code). The amount of such income will be equal to the difference between the option exercise price and the fair market value of the shares on the date of exercise. At the time of the sale of the shares of common stock acquired pursuant to the exercise of a non-qualified stock option, appreciation (or depreciation) in value of the shares after the date of exercise will be treated as either short-term or long-term capital gain (or loss) depending on how long the shares have been held. Long-term capital gains may be eligible for reduced rates if applicable holding period requirements are satisfied.

      Incentive Stock Options: In general, no income will be recognized by a participant upon the grant or exercise of an option intended to be an incentive stock option, as defined under Section 422 of the Code. The exercise of an incentive stock option, however, may result in alternative minimum tax liability. If shares of common stock are issued to the participant pursuant to the exercise of an incentive stock option, and if no disqualifying disposition of the shares is made by the participant within two years after the date of grant or within one year after the transfer of such shares to the participant, then upon the sale of the shares, any amount realized in excess of the option price will be taxed to the participant as a capital gain and any loss sustained will be a capital loss.

      If shares of common stock acquired upon the exercise of an incentive stock option are disposed of prior to the expiration of either holding period described above, the participant generally will recognize ordinary income in the year of disposition in an amount equal to the excess (if any) of the fair market value of such shares at the time of exercise (or, if less, the amount realized on the disposition of such shares if a sale or exchange) over the option price paid for the shares. Any further gain (or loss) realized by the participant generally will be taxed as a capital gain (or loss).

      Restricted Shares: A recipient of restricted shares generally will be subject to tax at ordinary income rates on the fair market value of the restricted shares (reduced by any amount paid by the participant for the restricted shares) at such time as the shares are no longer subject to forfeiture or restrictions on transfer for purposes of Section 83 of the Internal Revenue Code. However, a recipient who makes an election under Section 83(b) of the Code within 30 days of the date of transfer of the shares will have taxable ordinary income on the date of transfer of the shares equal to the excess of the fair market value of such shares (determined without regard to the restrictions) over the purchase price, if any, of the restricted shares. If a Section 83(b) election has not been made, any dividends received with respect to restricted shares that are subject to the restrictions generally will be treated as compensation that is taxable as ordinary income to the participant.

      Appreciation Rights: Generally, the recipient of a stock appreciation right will not recognize income when the right is granted. Upon exercise of an appreciation right, the amount of any cash received and the fair market value on the exercise date of any shares of common stock received are taxable to the recipient as ordinary income.

      Restricted Stock Units: A participant generally will not recognize income upon the grant of restricted stock units. Any subsequent transfer of shares of common stock in satisfaction of the grant will generally result in the participant recognizing ordinary income at the time of transfer, in an amount equal to the fair market value of the shares at the time of such transfer, reduced by any amount paid by the participant. If the shares transferred constitute substantially non-vested property within the meaning of Section 83 of the Code, the rules described above for restricted shares will generally apply to such shares.

      Performance Shares and Performance Units: No income generally will be recognized upon the grant of performance shares or performance units. The participant generally will be required to include as ordinary income in the year of receipt an amount equal to the amount of cash received and the fair market

value of any non-restricted shares of common stock received in satisfaction of a grant of performance shares or performance units.

      Senior Executive Plan Bonuses: The participant generally will be required to include as ordinary income in the year of receipt an amount equal to the amount of cash received and the fair market value of any non-restricted shares of common stock received as payment of a bonus.

      Tax Consequences to Michaels: To the extent that a participant recognizes ordinary income in the circumstances described above, Michaels will be entitled to a corresponding deduction provided that, among other things, the income meets the test of reasonableness, is an ordinary and necessary business expense, is not an “excess parachute payment” within the meaning of Section 280G of the Code and is not disallowed by the $1 million limitation on certain executive compensation under Section 162(m) of the Code.

      Section 409A of the Code: To the extent that any award granted under the 2005 Plan constitutes a deferral of compensation within the meaning of Section 409A of the Code, the Committee intends to cause the award to comply with the requirements of Section 409A and avoid the imposition of penalty taxes and interest upon the participant receiving the award.

New Plan Benefits

      Awards under the 2005 Plan are discretionary; therefore, Michaels cannot currently determine the number or type of awards that will be granted under the 2005 Plan to participants for the 2005 fiscal year.

Recommendation

      The Board recommends a vote “FOR” approval of the Michaels Stores, Inc. 2005 Incentive Compensation Plan.

CERTAIN TRANSACTIONS

      In fiscal 2004, we paid $256,369 in salary to Donald R. Miller, Jr., Vice President — Market Development. Mr. Miller also earned (i) a bonus of $124,759, (ii) $17,238 for the personal use of a company-owned automobile, and (iii) $2,655 for other employee benefits. In addition, Michaels (i) reimbursed Mr. Miller $10,139 for golf/health club membership dues and the related tax gross-up, and (ii) paid life insurance premiums for Mr. Miller in the amount of $599. In fiscal 2004, Michaels granted options to Mr. Miller which, after giving effect to a two-for-one stock split in the form of a stock dividend to stockholders of record as of the close of business on September 27, 2004, are exercisable for 50,000 shares of common stock at an exercise price of $25.59 per share, the fair market value of a share of our common stock on the date of grant. Mr. Miller is the son-in-law of Charles J. Wyly, Jr.

      The compensation paid by Michaels to Sam Wyly, Vice Chairman of the Board, during fiscal 2004 is set forth in the section of this Proxy Statement entitled “Compensation of Directors.” Sam Wyly is the brother of Charles J. Wyly, Jr.

      In fiscal 2004, Michaels paid to C&S Aviation, Ltd., a Texas limited liability company of which Sam Wyly and Charles J. Wyly, Jr. are managing members, approximately $49,000 for the rental of an airplane used for corporate purposes. C&S Aviation, Ltd. is a commercial carrier under regulations established by the Federal Aviation Administration.

SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

      Section 16(a) of the Securities Exchange Act of 1934 requires our officers and directors and persons who own more than 10% of a registered class of our equity securities to file initial reports of ownership and reports of changes in ownership with the Securities and Exchange Commission. Such persons are required by regulation of the Securities and Exchange Commission to furnish us with copies of all Section 16(a) forms they file. Based solely on our review of the copies of such forms or written representations from certain reporting persons received by us with respect to fiscal 2004, we believe that our officers and directors and persons who own more than 10% of a registered class of our equity securities have complied with all applicable filing requirements, except in the following instances: (i) Ms. Liz Minyard filed a late Statement of Changes in Beneficial Ownership of Securities on Form 4 reporting the sale of shares of common stock by Ms. Minyard’s spouse on February 3, 2004; and (ii) each of Mr. Charles J. Wyly, Jr. and Mr. Sam Wyly has informed Michaels that he will file a late Statement of Changes in Beneficial Ownership of Securities on Form 4 reporting transactions in our common stock and related derivative securities by certain non-U.S. entities of which securities he may be deemed to be the beneficial owner.

OTHER MATTERS

      We do not know of any other matters to be presented or acted upon at the Annual Meeting. If any other matter is presented at the Annual Meeting on which a vote may properly be taken, the shares represented by proxies will be voted in accordance with the judgment of the proxy holders.

FORM 10-K

      Copies of our Annual Report on Form 10-K (excluding exhibits) filed with the Securities and Exchange Commission are available, without charge, upon written request to Michaels Stores, Inc., 8000 Bent Branch Drive, Irving, Texas 75063, Attention: Investor Relations Department. Exhibits to the Form 10-K will be furnished upon payment of a fee of $0.50 per page to cover our expenses in furnishing the exhibits.

STOCKHOLDER PROPOSALS

      To be considered for inclusion in our proxy statement for our 2006 annual meeting of stockholders, proposals of stockholders must be in writing and received by us no later than January 12, 2006. To be presented at the 2006 annual meeting of stockholders without inclusion in our proxy statement for such meeting, proposals of stockholders must be in writing and received by us no later than March 13, 2006 and no earlier than February 10, 2006, in accordance with procedures set forth in our bylaws. Such proposals should be mailed to Michaels Stores, Inc., P.O. Box 619566, DFW, Texas 75261-9566 and directed to the Secretary of Michaels.

Irving, Texas

May 12, 2005

Annex A

MICHAELS STORES, INC.

2005 INCENTIVE COMPENSATION PLAN

MICHAELS STORES, INC.

2005 INCENTIVE COMPENSATION PLAN

MICHAELS STORES, INC.

2005 INCENTIVE COMPENSATION PLAN

      Michaels Stores, Inc., a Delaware corporation (the “Company”), establishes the Michaels Stores, Inc. 2005 Incentive Compensation Plan (the “Plan”), effective as of June 16, 2005, subject to stockholder approval.

      1.     Purpose. The purpose of the Plan is to attract and retain the best available talent and encourage the highest level of performance by directors, executive officers and selected employees, and to provide them incentives to put forth maximum efforts for the success of the Company’s business, in order to serve the best interests of the Company and its stockholders.

      2.     Term. The Plan will expire on the tenth anniversary of the date on which it is approved by the stockholders of the Company. No further Awards will be made under the Plan on or after such tenth anniversary. Awards that are outstanding on the date the Plan terminates will remain in effect according to their terms and the provisions of the Plan.

      3.     Definitions. The following terms, when used in the Plan with initial capital letters, will have the following meanings:

      4.     Shares Available Under Plan. The number of shares of Common Stock that may be (i) subject to an Award of Appreciation Rights or Stock Options (ii) issued or transferred as Restricted Shares and released from all restrictions or in payment of Performance Shares, Performance Units, Restricted Stock Units or Senior Executive Plan Bonuses will not exceed in the aggregate 12 million shares. Such shares may be shares of original issuance or treasury shares or a combination of the foregoing. The number of shares of Common Stock available under this Section 4 will be subject to adjustment as provided in Section 13 and will be further adjusted to include shares that relate to Awards that expire or are forfeited. The number of shares of Common Stock available under this Section 4 will not be adjusted to include (i) any shares withheld by, or tendered to, the Company in payment of the Option Price with respect to a Stock Option or in satisfaction of the taxes required to be withheld in connection with any Award granted under the Plan or (ii) any shares subject to an Appreciation Right that are not transferred to a Participant upon exercise of the Appreciation Right.

      5.     Limitations on Awards. Awards under the Plan will be subject to the following limitations:

      6.     Stock Options. The Committee may from time to time authorize grants of options to any Participant to purchase shares of Common Stock upon such terms and conditions as it may determine in accordance with this Section 6. Each Participant who is a key employee of the Company or any Subsidiary will be eligible to receive a grant of Stock Options that are intended to qualify as incentive stock options within the meaning of Section 422 of the Code. Each grant of Stock Options may utilize any or all of the authorizations, and will be subject to all of the requirements, contained in the following provisions:

      7.     Appreciation Rights. The Committee may also from time to time authorize grants to any Participant of Appreciation Rights upon such terms and conditions as it may determine in accordance with this Section 7. Appreciation Rights may be granted in tandem with Stock Options or separate and apart from a grant of Stock Options. An Appreciation Right will be a right of the Participant to receive from the Company upon exercise an amount which will be determined by the Committee at the Date of Grant and will be expressed as a percentage of the Spread (not exceeding 100%) at the time of exercise. An Appreciation Right granted in tandem with a Stock Option may be exercised only by surrender of the related Stock Option. Each grant of an Appreciation Right may utilize any or all of the authorizations, and will be subject to all of the requirements, contained in the following provisions:

      8.     Restricted Shares. The Committee may also from time to time authorize grants or sales to any Participant of Restricted Shares upon such terms and conditions as it may determine in accordance with this Section 8. Each grant or sale will constitute an immediate transfer of the ownership of shares of Common Stock to the Participant in consideration of the performance of services, entitling such Participant to voting and other ownership rights, but subject to the restrictions set forth in this Section 8. Each such grant or sale may utilize any or all of the authorizations, and will be subject to all of the requirements, contained in the following provisions:

      9.     Restricted Stock Units. The Committee may also from time to time authorize grants or sales to any Participant of Restricted Stock Units upon such terms and conditions as it may determine in accordance with this Section 9. Each grant or sale will constitute the agreement by the Company to issue or transfer shares of Common Stock to the Participant in the future in consideration of the performance of services, subject to the fulfillment during the Deferral Period of such conditions as the Committee may specify. Each such grant or sale may utilize any or all of the authorizations, and will be subject to all of the requirements, contained in the following provisions:

      10.     Performance Shares and Performance Units. The Committee may also from time to time authorize grants to any Participant of Performance Shares and Performance Units, which will become payable upon achievement of specified Management Objectives, upon such terms and conditions as it may determine in accordance with this Section 10. Each such grant may utilize any or all of the authorizations, and will be subject to all of the requirements, contained in the following provisions:

      11.     Senior Executive Plan Bonuses. The Committee may from time to time authorize the payment of annual incentive compensation to a Participant who is, or is determined by the Committee to be likely to become, a “covered employee” within the meaning of Section 162(m) of the Code (or any successor provision), which incentive compensation will become payable upon achievement of specified Management Objectives. Subject to Section 5(e), Senior Executive Plan Bonuses will be payable upon such terms and conditions as the Committee may determine in accordance with the following provisions:

      12.     Transferability. No Award may be sold, pledged, assigned or transferred in any manner other than by will or the laws of descent and distribution, pursuant to a qualified domestic relations order or, with the consent of the Committee, by gifts to family members of the Participant, including to trusts in which family members of the Participant own more than 50% of the beneficial interests, to foundations in which family members of the Participant or the Participant controls the management of assets, to other entities in which more than 50% of the voting interests are owned by family members of the Participant or the Participant and to charitable organizations described in Section 170(c) of the Code. No Stock Option or Appreciation Right granted to a Participant will be exercisable during the Participant’s lifetime by any person other than the Participant or the Participant’s guardian or legal representative or any permitted transferee.

      13.     Adjustments.

      14.     Fractional Shares. The Company will not be required to issue any fractional share of Common Stock pursuant to the Plan. The Committee may provide for the elimination of fractions or for the settlement of fractions in cash.

      15.     Withholding Taxes. To the extent that the Company is required to withhold federal, state, local or foreign taxes in connection with any payment made or benefit realized by a Participant or other person under the Plan, and the amounts available to the Company for such withholding are insufficient, it will be a condition to the receipt of such payment or the realization of such benefit that the Participant or such other person make arrangements satisfactory to the Company for payment of the balance of such taxes required to be withheld. In addition, if permitted by the Committee, the Participant or such other person may elect to have any withholding obligation of the Company satisfied with shares of Common Stock that would otherwise be transferred to the Participant or such other person in payment of the Participant’s Award. However, without the consent of the Committee, shares of Common Stock will not be withheld in excess of the minimum number of shares required to satisfy the Company’s withholding obligation.

      16.     Administration of the Plan.

      17.     Amendments and Other Matters.

      18.     Governing Law. The Plan, all Awards and all actions taken under the Plan and the Awards will be governed in all respects in accordance with the laws of the State of Delaware, including without limitation, the Delaware statute of limitations, but without giving effect to the principles of conflicts of laws of such State.

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Proxy – Michaels Stores, Inc.

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PROXY SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS
FOR THE 2005 ANNUAL MEETING OF STOCKHOLDERS
JUNE 16, 2005

The undersigned hereby appoints Jeffrey N. Boyer and Mark V. Beasley, each with power to act without the other and with full power of substitution, as proxies to vote, as designated below, all stock of Michaels Stores, Inc. owned by the undersigned at the 2005 Annual Meeting of Stockholders to be held at the Four Seasons Resort and Club, 4150 North MacArthur Boulevard, Irving, Texas 75038 on Thursday, June 16, 2005, at 10:30 a.m. central daylight savings time, or any adjournment thereof, upon such business as may properly come before the meeting or any adjournment thereof.

UNLESS OTHERWISE MARKED, THIS PROXY WILL BE VOTED FOR THE ELECTION OF EACH OF THE NOMINEES NAMED, FOR THE RATIFICATION OF THE AUDIT COMMITTEE’S SELECTION OF ERNST & YOUNG LLP AS OUR INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM FOR FISCAL 2005, FOR THE APPROVAL OF THE MICHAELS STORES, INC. 2005 INCENTIVE COMPENSATION PLAN AND IN THE DISCRETION OF THE PROXY HOLDERS ON ANY OTHER MATTER THAT MAY PROPERLY COME BEFORE THE MEETING OR ANY ADJOURNMENT THEREOF.

YOUR VOTE IS IMPORTANT!

PLEASE VOTE, SIGN, DATE AND RETURN THIS PROXY CARD PROMPTLY USING THE ENCLOSED ENVELOPE.

(Continued and to be signed and dated on reverse side)

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Instruction Card — Michaels Stores, Inc.

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CONFIDENTIAL VOTING INSTRUCTIONS
TO THE INVESTMENT COMMITTEE (“COMMITTEE”)
UNDER THE MICHAELS STORES, INC. EMPLOYEES 401(K) PLAN (“PLAN”)
FOR THE 2005 ANNUAL MEETING OF STOCKHOLDERS
JUNE 16, 2005

The undersigned hereby instructs the Committee to direct the Trustee of the Plan to vote in person or by proxy all shares of Common Stock of Michaels Stores, Inc. credited to my account which are entitled to vote under the Plan at the 2005 Annual Meeting of Stockholders to be held at the Four Seasons Resort and Club, 4150 North MacArthur Boulevard, Irving, Texas 75038 on Thursday, June 16, 2005, at 10:30 a.m. central daylight savings time, or any adjournment thereof, upon such business as may properly come before the meeting or any adjournment thereof.

UNLESS OTHERWISE MARKED, THIS INSTRUCTION CARD WILL BE VOTED FOR THE ELECTION OF EACH OF THE NOMINEES NAMED, FOR THE RATIFICATION OF THE AUDIT COMMITTEE’S SELECTION OF ERNST & YOUNG LLP AS OUR INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM FOR FISCAL 2005, FOR THE APPROVAL OF THE MICHAELS STORES, INC. 2005 INCENTIVE COMPENSATION PLAN AND IN THE DISCRETION OF THE COMMITTEE ON ANY OTHER MATTER THAT MAY PROPERLY COME BEFORE THE MEETING OR ANY ADJOURNMENT THEREOF.

YOUR VOTE IS IMPORTANT!

PLEASE VOTE, SIGN, DATE AND RETURN THIS INSTRUCTION CARD PROMPTLY USING THE ENCLOSED ENVELOPE.

(Continued and to be signed and dated on reverse side)