The customer is the ultimate judge of our progress. The customer research we conducted in 1996 gave us clear direction as to what our customers wanted from a Michaels store - broader craft assortments, better pricing, wider aisles, a speedier checkout and answers to their questions.

We went to work in 1996 with our first store prototype change, refined it again in 1997 and once more in 1998. We now feel we have the store for our future.

1998 saw a return to new store expansion. The 50 new stores opened in 1998 represent the largest number of new store openings in the Company's recent history.

This year we plan to open 70 new Michaels stores and relocate or expand up to 25. We will also add 15 new Aaron Brothers stores and relocate 5. By the end of the year we will have approximately 660 stores in 47 states, Canada and Puerto Rico versus 574 in 1998.

We have successfully completed new systems integration in all of our distribution centers. Prior to this change, we had four distribution centers running three different software programs performing at unsatisfactory levels. With the installation of new software we are better able to manage the flow of merchandise in and out of our distribution centers.

At the end of 1998, we had almost 12,000 basic items in our distribution centers. We plan to increase this to 20,000 by the end of fiscal 1999. We will then have approximately 70% of our store basic merchandise sales being serviced from our warehouses. Our goal is to maintain a warehouse in-stock position of 90+%. Having a substantial number of items in the warehouses allows us to replenish store inventory very quickly, improve our store in-stocks, reduce operating costs and maximize store sales.

We implemented point-of-sale (pos) systems in all of Michaels stores in 1996. This technology has provided us with an invaluable source of knowledge. We now provide each of these stores with their store-specific unit sales history. Using a radio frequency gun, stores reference this information and replenish their merchandise by taking into account past unit sales history and future trend rate of sale, and as a result our store in-stocks are improving daily and store inventory investment is coming down. We are now much better at being in-stock on the items the customers want when they want them.

We are implementing the state-of-the-art retek Merchandising Management System. retek will provide the means for Michaels to meet its strategic goals of effectively allocating and replenishing goods through the use of perpetual inventories, allocating seasonal goods based on sales trends and effectively managing margin components through the use of a retail stock ledger.

Many of our systems are new enough that they are Year 2000 compliant. We are also fortunate that the majority of software packages we use are standard packages as opposed to programs written specifically for our use. We currently anticipate all Year 2000 modifications and conversions will be complete by the end of the third quarter of 1999.

Customers select their craft store based on convenience of the location and the size of the merchandise assortment. Managing an extensive assortment can be very risky without the technology to manage it effectively - in fact for a large chain it is impossible.

This initiative (just like Modern Systems) began with the rollout of store point-of-sale (pos) equipment in the fall of 1996.

A year later, we had comparable history of item sales from pos and we could begin to use the data to drive order and allocation quantities of seasonal product.

In January 1999, we took another major step by making each store's individual item sales data available to it via the radio frequency order gun. For the first time in our Company's history, we now have the tools to manage our inventory.

We created a separate inventory management department with the sole responsibility of improving our store in-stock position while reducing our overall investment in store inventory.

We now have the organization and the tools in place that can start to reduce our investment in inventory. We are projecting our average per store inventory to be flat compared to last year by August 1 and 5% below last year at year-end. This accomplishment would result in an inventory investment savings of up to $25 million versus last year. There will be significantly less inventory in the stores, helping us clean up our stores and open up the aisles and making the stores easier to shop.

Aaron Brothers, our West Coast subsidiary, offers a complete assortment of ready-made frames and mats for the do-it-yourself customer, fine art supplies for the student and professional artist, and complete custom framing services.

1998 was a time of continued growth and development for Aaron Brothers. Five stores were relocated and 5 new stores were opened including 2 in Portland, Oregon for a total of 78 operating stores at year-end. We also enhanced our prototype and improved our operating, merchandising and marketing strategies. Our promotional efforts continued to be reduced and we successfully implemented an "everyday low price" strategy in custom framing.

Growth will be accelerated in 1999 with 15 stores being added, along with the entry into another new market - Seattle, Washington. Relocated stores will be set to our current prototype. By the end of 1999, over 50% of our stores will have the features of our new prototype that we first introduced in 1996.

Artistree is a light manufacturing division of Michaels that manufactures an upscale selection of framed art and ready-made frames, and provides other custom framing services principally for Michaels and Aaron Brothers. Custom frame orders are entered and electronically transmitted daily from each store. Less than 24 hours later, Artistree ships the appropriate frame to the store for store framing personnel to combine with the customer's artwork into a final product. This process, which is unique to Michaels and Aaron Brothers, provides our customers with a consistently high-quality finished product and allows stores to handle increased volumes with reduced store training and staffing requirements. Our facility in Kernersville, North Carolina manufactures approximately 25% and directly imports another 25% of the picture framing mouldings sold at Michaels and Aaron Brothers.