UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

þ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934

Claire’s Stores, Inc.

Registrant’s telephone number, including area code: (954) 433-3900

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

Title of each class

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

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

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

          As of July 30, 2004, the last business day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of the shares of Class A common stock and Common stock held by non-affiliates of the registrant was approximately $2.0 billion. All outstanding shares of Class A common stock and Common stock, except for shares held by executive officers and members of the Board of Directors and their affiliates, are deemed to be held by non-affiliates. The Class A common stock is not traded on an exchange.

          At March 15, 2005, there were outstanding 94,008,350 shares of registrant’s Common stock, $.05 par value, and 5,125,313 shares of the registrant’s Class A common stock, $.05 par value.

DOCUMENTS INCORPORATED BY REFERENCE

          The Proxy Statement for the 2005 Annual Meeting of Shareholders, to be filed no later than 120 days after the end of the registrant’s fiscal year covered by this report, is incorporated by reference into Part III of this report.

TABLE OF CONTENTS

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PART I.

Item 1. Business

General

We are a leading specialty retailer of value-priced fashion accessories for pre-teens and teenagers as well as young adults. We are organized based on our geographic markets, which include our North American operations and our International operations. As of January 29, 2005 we operated a total of 2,836 stores in all 50 states of the United States, Puerto Rico, Canada, the Virgin Islands, the United Kingdom, Switzerland, Austria, Germany (the latter three collectively referred to as “S.A.G.”), France and Ireland. The stores are operated mainly under the trade names “Claire’s Boutiques”, “Claire’s Accessories”, “Icing by Claire’s”, “Afterthoughts” and “The Icing”. We are in the process of transitioning our “Afterthoughts” stores to “Icing by Claire’s” stores to capitalize on the Claire’s brand name. We also operate 148 stores in Japan through a 50:50 joint venture with AEON Co. Ltd. (“Claire’s Nippon”). We account for the results of operations of Claire’s Nippon under the equity method whose results are included within “Interest and other income” in our Statement of Operations within our North American division. In addition, we license 57 stores in the Middle East under a licensing and merchandising agreement with Al Shaya Co. Ltd. and 4 stores in South Africa under similar agreements with the House of Busby Limited. We account for the goods we sell under the merchandising agreements within “Gross profit” in our North American division and the license fees we charge within “Interest and other income” within our International division in our Statement of Operations.

We incorporated in 1961 as a Delaware corporation. In June 2000, we completed our reincorporation from the state of Delaware to the State of Florida through a merger transaction with one of our wholly-owned subsidiaries. In May 2002, we disposed of our apparel segment.

Our executive offices are located at 3 S.W. 129^th Avenue, Pembroke Pines, Florida 33027, our telephone number is (954) 433-3900 and our internet address is www.claires.com. Through our website, we make available, as soon as reasonably practicable after such information has been filed or furnished to the Securities and Exchange Commission, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports. In addition, we have made our Corporate Governance Guidelines, the charters of our Audit, Compensation and Nominating and Corporate Governance Committees and our Code of Ethics available through our website. We will disclose any amendments to our Code of Ethics or waivers of any provision thereof on our website within four business days following the date of the amendment or waiver, and that information will remain available for at least a twelve-month period. Printed copies of these documents are also available to our shareholders upon written request to Investor Relations, Claire’s Stores, Inc., 350 Fifth Avenue, Suite 900, New York, NY 10118. The reference to our website does not constitute incorporation by reference of the information contained on our website, and the information contained on the website is not part of this Form 10-K.

Business Description

We have two store concepts: Claire’s Accessories, which caters to fashion-conscious girls and teens in the 7 to 17 age range, and Icing by Claire’s, which caters to fashion-conscious teens and young women in the 17 to 27 age range. Our merchandise typically ranges in price between $2 and $20, with the average product sold at approximately $4. Our stores share a similar format and our different store concepts and trade-names allow us to have multiple store locations in a single mall. Although we face competition from a number of small specialty store chains and others selling fashion accessories, we believe that our stores comprise one of the largest chains of specialty retail stores in the world devoted to the sale of value-priced fashion accessories for pre-teen, teenage and young adult females.

Our sales are divided into two principal product categories:

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The following table compares our sales of each product category for the last three fiscal years (dollars in thousands):

We refer to the fiscal years referenced above as Fiscal 2005, Fiscal 2004 and Fiscal 2003, respectively.

We are primarily organized based on geographic markets for which we operate. Under this organizational structure, we have two reportable segments: North America and International. A summary of North American and International operations is presented below (dollars in thousands):

Additional financial information for our two segments is set forth in Note 11 of our consolidated financial statements included in this Annual Report.

Strategy

Through our Claire’s Accessories and Icing by Claire’s store concepts, our mission is to be the most profitable specialty retailer selling accessories and costume jewelry to fashion-aware teens, tweens and young adults. We believe our customers want to stay current with or ahead of fashion trends and continually seek newness in their accessory wear. The key elements of our strategy are as follows:

Actively Manage Merchandise Trends and Display of Merchandise. We devote considerable effort to identifying emerging fashion trends. Through constant product testing and rapid placement of successful test items in our stores, we are able to respond to emerging fashion trends. We also devote considerable effort to how our merchandise is displayed in our stores, which we believe commands our customers’ attention, supports our image and promotes a consistent shopping environment for our customers. Our merchandising and distribution systems enhance our ability to make quick responses to new fashion trends. We typically deliver merchandise to our stores three to five times a week.

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Provide Attentive Customer Service. We are committed to offering courteous and professional customer service. We strive to give our customers the same level of respect that is generally given to adult customers at other retail stores, and to provide friendly and informed customer service for parents. Additionally, our stores provide a friendly and social atmosphere for our customers.

Store Growth Strategy. We opened our first store in Europe in 1996 and, as of January 29, 2005, operated 717 stores in Europe. Our European stores are typically smaller than our North American stores, which results in higher sales per square foot than our North American stores. We intend to continue our store growth through the opening of new stores in our international markets. Any future store openings in Asia are currently subject to our 50:50 joint venture arrangement under Claire’s Nippon.

Licensing Arrangements. We entered into our first licensing arrangement with a Kuwait company in Fiscal 2002 and a similar arrangement with a South African company in Fiscal 2005. We intend to continue to seek suitable licensees in order to open stores in certain international markets where we desire a limited financial investment.

Maintain Strong Supplier Relationships. We view our supplier relationships as important to our success, and promote personal interaction with our suppliers. We believe many of our suppliers view our stores as important distribution channels.

Capitalize on Our Brand Name. We believe that the Claire’s brand name is one of our most important assets. We intend to develop our brand through, among other things, in-store marketing and licensing arrangements.

Stores

Our stores in North America are located primarily in enclosed shopping malls. Our stores in North America operating as “Claire’s Boutiques” and “Claire’s Accessories” average approximately 1,100 square feet while those stores operating as “Icing by Claire’s”, “The Icing” and “Afterthoughts” average approximately 1,200 square feet. Our stores in the United Kingdom, S.A.G., France, Ireland and Japan average approximately 600 square feet and are located primarily in enclosed shopping malls and central business districts. Each store uses our proprietary displays, which permit the presentation of a wide variety of items in a relatively small space.

Our stores are distinctively designed for customer identification, ease of shopping and display of a wide selection of merchandise. Store hours are dictated by the mall operators and the stores are typically open from 10:00 A.M. to 9:00 P.M., Monday through Saturday, and, where permitted by law, from Noon to 5:00 P.M. on Sunday.

Approximately 73% of sales are made in cash, with the balance made by credit cards. We permit, with restrictions on certain items, returns for exchange or refund.

Purchasing and Distribution

We purchased our merchandise from approximately 755 domestic and international suppliers in Fiscal 2005. Approximately 82% of our merchandise in Fiscal 2005 was purchased from outside the United States, including approximately 50% purchased from China. We are not dependent on an individual supplier for merchandise purchased. All merchandise is shipped from suppliers to our distribution facility in Hoffman Estates, Illinois, a suburb of Chicago (which services the North American stores), the distribution facility in Birmingham, England (which services the stores in the United Kingdom, Ireland and France), or the distribution facilities in Zurich, Switzerland and Vienna, Austria (which service the stores in S.A.G.). After inspection, merchandise is shipped via common carrier to the individual stores. Stores typically receive three to five shipments a week, which provide our stores with a steady flow of new merchandise.

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Our business fluctuates according to changes in customer preferences, which are dictated in part by fashion and season. In addition, the cyclical nature of the retail business requires us to carry a significant amount of inventory, especially prior to peak selling seasons. As a result, we typically purchase merchandise from our suppliers well in advance of the applicable selling season, and sometimes before fashion trends are identified or evidenced by customer purchases.

We determine the allocation of merchandise to our stores based on an analysis of various factors, including size, location, demographics, sales and inventory history. Merchandise typically is sold at its original marked price, with the length of time varying by item. We review our inventory levels to identify slow-moving merchandise, and use markdowns to clear this merchandise. Markdowns may be used if inventory exceeds client demand for reasons of fashion, design, seasonal adaptation or changes in client preference, or if it is otherwise determined that the inventory will not sell at its currently marked price.

Store Management

Except as stated below, our Executive Vice President of Store Operations is responsible for managing our North American stores and reports to our Chief Operating Officer for North America, who in turn, reports to our Co-Chief Executive Officers. Our stores are organized and controlled on a district level. We currently employ 218 District Managers in North America, each of whom oversees and manages approximately 10 stores in his or her respective geographic area and reports to one of 22 Regional Managers. Each Regional Manager in North America reports to one of 6 Territorial Vice Presidents, who reports to the Executive Vice President of Store Operations. Each store is staffed by a Manager, an Assistant Manager and one or more part-time employees. The reporting structure for our stores in the International group is similar to the reporting structure in North America. The Presidents of Claire’s UK and S.A.G. report to our Co-Chief Executive Officer responsible for our International segment. The President of S.A.G is also responsible for France. In the International group, there are a total of 7 Regional Managers and 75 District Managers.

Store Openings, Closings and Future Growth

For Fiscal 2005, we opened 145 stores and closed 96 stores, for a total increase of 49 stores, net. Net stores refers to stores opened, net of closings, if any. In our International group, we decreased our operations by 17 stores, net, in the United Kingdom, resulting in a total of 442 stores, expanded our operations by 3 stores, net, in S.A.G., resulting in a total of 99 stores and increased our operations by 31 stores, net, in France, resulting in a total of 176 stores. In North America, we increased our operations by 7 stores, net to 2,119 stores. We believe our store growth will occur in our international markets, where we plan on opening 50 stores, net, in France and opening 1 store, net, in S.A.G. during the fiscal year ending January 28, 2006, which is referred to as Fiscal 2006. We plan on opening approximately 20 stores, net, in North America in Fiscal 2006 and closing 1 store, net, in the United Kingdom. In Fiscal 2005, Claire’s Nippon increased operations in Japan by 25 stores, net, to 148 stores. There are 25 store openings planned in Japan in Fiscal 2006.

We closed 363 stores in the last three fiscal years, primarily due to certain locations not meeting our established profit benchmarks, the unwillingness of landlords to renew leases on terms acceptable to us, and the elimination of stores in connection with our acquisition of Afterthoughts. Most of these stores were closed at or near lease expiration. We have not experienced any substantial difficulty in renewing desired store leases and have no reason to expect any such difficulty in the future. For each of the last three fiscal years, no individual store accounted for more than one percent of total sales.

We plan to continue opening stores when suitable locations are found and satisfactory lease negotiations are concluded. Our initial investment in new stores opened during Fiscal 2005, which includes leasehold improvements and fixtures, averaged approximately $146,000 per store. In addition, certain store locations in our International operations require the purchase of intangible assets. In these 38 cases, we invested approximately $188,000 per store in intangible assets during Fiscal 2005.

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Our continued growth depends on our ability to open and operate stores on a profitable basis. Our ability to expand successfully will be dependent upon a number of factors, including sufficient demand for our merchandise in existing and new markets, our ability to locate and obtain favorable store sites and negotiate acceptable lease terms, obtain adequate merchandise supply and hire and train qualified management and other employees.

Trademarks and Service Marks

We are the owner in the United States of various marks, including “Claire’s,” “Claire’s Accessories,” “Afterthoughts”, “Icing by Claire’s” and “The Icing.” We have also registered these marks outside of the United States. We believe our rights in our marks are important to our business and intend to maintain our marks and the related registrations.

Competition

The specialty retail business is highly competitive. We compete with department stores and chains on a national and international level. We also compete on a regional or local level with specialty and discount store chains and independent retail stores. Our competition also includes internet and catalog businesses. We cannot estimate the number of our competitors because of the large number of companies in the retail industry that fall into one of these categories. We believe the main competitive factors in our business are fashion, price, merchandise, store location and customer service.

Seasonality

Sales of each category of merchandise vary from period to period depending on current fashion trends. We experience traditional retail patterns of peak sales during the Christmas, Easter and back-to-school periods. Sales, as a percentage of total sales in each of the four quarters of the fiscal year ended January 29, 2005 were 22%, 24%, 23% and 31%, respectively.

Employees

On January 29, 2005, we had approximately 18,000 employees, 58% of whom were part-time. Part-time employees typically work up to 20 hours per week. We do not have collective bargaining agreements with any labor unions and we consider employee relations to be good.

Item 2. Properties

Our stores are located in all 50 states of the United States, Puerto Rico, Canada, the Virgin Islands, the United Kingdom, Switzerland, Austria, Germany, France and Ireland. We lease all of our 2,836 store locations, generally for terms ranging from five to 25 years. Under the terms of the leases, we pay a fixed minimum rent and/or rentals based on gross sales in excess of specified amounts. We also pay certain other expenses (e.g., common area maintenance charges and real estate taxes) under the leases. The internal layout and fixtures of each store are designed by management and constructed under contracts with third parties.

Most of our stores in North America and the International division are located in enclosed shopping malls, while other stores are located within central business districts, “open-air” outlet malls or “strip centers”. Our criteria for new stores includes geographic location, demographic aspects of communities surrounding the store site, quality of anchor tenants, advantageous location within a mall, appropriate space availability and rental rates. We believe that sufficient desirable locations are available to accommodate our expansion plans. We refurbish our existing stores on a regular basis.

We own central buying and store operations offices and the North American distribution center located in Hoffman Estates, Illinois which is on approximately 24.8 acres of land. The property has buildings with approximately 538,000 total square feet of space, of which 373,000 square feet is devoted to receiving and distribution and 165,000 square feet is devoted to office space.

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Our subsidiary, Claire’s Accessories UK Ltd., or “UK”, leases distribution and office space in Birmingham, England. The facility consists of 25,000 square feet of office space and 60,000 square feet of distribution space. The lease expires in December 2024 and UK has the right to assign or sublet this lease at any time during the term of the lease.

Our stores operated by our subsidiaries, Claire’s Switzerland, Claire’s Austria and Claire’s Germany, are serviced by distribution centers and offices in Zurich, Switzerland and Vienna, Austria. The facility maintained in Zurich, Switzerland consists of 13,700 square feet devoted to distribution and 8,500 square feet devoted to offices. The lease for this location expires on December 31, 2006. In Vienna, Austria, the facility consists of 18,100 square feet devoted to distribution and 3,400 square feet devoted to offices. The lease on this facility does not have an expiration date but can be terminated by Claire’s Austria with six months notice to the landlord.

We lease approximately 35,000 square feet in Pembroke Pines, Florida, where we maintain our executive, accounting and finance offices. See Note 9 entitled “Related Party Transactions” to our consolidated financial statements included in this Annual Report.

We also own 10,000 square feet of warehouse space in Miami, Florida. The property is being utilized as a storage facility. We also lease executive office space in New York City and are the owners of a cooperative apartment in New York City.

Item 3. Legal Proceedings

We are, from time to time, involved in routine litigation incidental to the conduct of our business, including litigation instituted by persons injured upon premises under our control, litigation regarding the merchandise that we sell, including product and safety concerns regarding metal content in our merchandise, litigation with respect to various employment matters, including litigation with present and former employees, and litigation to protect our trademark rights. Although litigation is routine and incidental to the conduct of our business, like any business of our size and employing a significant number of employees, such litigation can result in large monetary awards when judges, juries or other finders of facts do not agree with management’s evaluation of possible liability or outcome of litigation. Accordingly, the consequences of these matters cannot be finally determined by management. However, in the opinion of management, we believe that current pending litigation will not have a material adverse effect on our financial position, earnings or cash flows.

In May 2002, we sold 100% of the Common stock of Lux Corporation d/b/a Mr. Rags, and discontinued the operations of our apparel segment. In January 2003, Lux Corporation filed for bankruptcy, and on November 7, 2003, the Official Committee of Unsecured Creditors of Lux Corporation filed a complaint against us in the United States Bankruptcy Court for the Central District of California. This litigation has been settled for $5.0 million ($3.1 million net of income taxes). The settlement was approved by the bankruptcy court, without objection by any party in interest, on April 5, 2005. We expect that a final order will be entered later this month. Provided that no appeal is filed or rehearing sought within 10 days after entry, the order will become final 10 days after its entry. The settlement represents return of proceeds we received as a result of the sale, and has been recorded net of tax, in the fiscal year 2005 financial statements as “Net loss from discontinued operations.”

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

No matters were submitted to a vote of security holders during the fourth quarter of Fiscal 2005.

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PART II

We have two classes of common stock, par value $.05 per share, outstanding: common stock having one vote per share and Class A common stock having ten votes per share. The common stock is traded on the New York Stock Exchange, Inc. under the symbol CLE. The Class A common stock has only limited transferability and is not traded on any stock exchange or in any organized market. However, the Class A common stock is convertible on a share-for-share basis into common stock and may be sold, as common stock, in open market transactions. In December 2003, our Board of Directors declared a 2-for-1 stock split of the our Common stock and Class A common stock in the form of a 100% stock dividend. As a result, all share and per share amounts have been restated to reflect the stock split. The following table sets forth, for each quarterly period within the last two fiscal years, the high and low closing prices of the common stock on the NYSE Composite Tape. At March 15, 2005, the number of record holders of shares of common stock and Class A common stock was 1,261 and 401, respectively.

We have paid regular quarterly dividends to our shareholders on the common stock since 1985 and on the Class A common stock since July 1994. Our Board of Directors, in their sole discretion, determines the distribution rate based on our results of operations, economic conditions, tax considerations and other factors. In Fiscal 2004, we paid quarterly cash dividends on our common stock (one in the amount of $.06 per share, two in the amount of $.03 per share and one in the amount of $.02 per share) and Class A common stock (one in the amount of $.03 per share, two in the amount of $.015 per share and one in the amount of $.01 per share), or a total of $.14 per share on our common stock and $.07 per share on our Class A common stock. In Fiscal 2005, we paid quarterly cash dividends on our common stock (one in the amount of $.09 per share, one in the amount of $.08 per share, one in the amount of $.07 per share and one in the amount of $.06 per share) and Class A common stock (one in the amount of $.045 per share, one in the amount of $.04 per share, one in the amount of $.035 per share and one in the amount of $.03 per share), or a total of $.30 per share on our common stock and $.15 per share on our Class A common stock. As of March 15, 2005 our current dividend distribution amount per share is $.10 and $.05 each quarter for common stock and Class A common stock, respectively. We expect to continue paying dividends. However, there is no assurance that we will be able to continue to do so because the declaration and payment of dividends are subject to various factors, including contingencies such as our earnings, liquidity and financial condition and other factors our Board of Directors consider relevant as well as certain limitations on our ability to make dividend distributions under our credit facility. See “Management’s Discussion and Analysis of Financial Condition and Results of Operation - Liquidity and Capital Resources.”

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The following table provides information as of January 29, 2005 with respect to compensation plans (including individual compensation arrangements) under which our Common stock and Class A common stock are authorized for issuance.

Item 6. Selected Financial Data

The balance sheet and income statement data set forth below is derived from our consolidated financial statements and should be read in conjunction with our consolidated financial statements included in this Annual Report, and in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operation.” The consolidated Balance Sheet data as of February 1, 2003, February 2, 2002, and February 3, 2001 and the consolidated Statements of Operations data for each of the fiscal years ended February 2, 2002 and February 3, 2001 are derived from our consolidated financial statements, which are not included herein. These amounts include certain reclassifications of prior year amounts in order to conform to current year presentation.

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation

Management’s Discussion and Analysis is designed to provide the reader of the financial statements with a narrative on our results of operations, financial position and liquidity, risk management activities, significant accounting policies and critical estimates, and the future impact of accounting standards that have been issued but are not yet effective. Management’s Discussion and Analysis is presented in five sections: Overview, Critical Accounting Policies and Estimates, Results of Consolidated Operations, Segment Operations and Analysis of Consolidated Financial Condition. It is useful to read Management’s Discussion and Analysis in conjunction with the consolidated financial statements and related notes thereto contained elsewhere in this document.

Our fiscal years end on the Saturday closest to January 31. As a result, our Fiscal 2005, Fiscal 2004 and Fiscal 2003 results consisted of 52 weeks. All references to earnings per share relate to diluted earnings per share from continuing operations.

We include a store in the calculation of comparable store sales once it has been in operation sixty weeks after its initial opening. If a store is closed during a fiscal period, the store’s sales will be included in the computation of comparable store sales for that fiscal month, quarter and year to date period only for the days in which it was operating as compared to those same days in the comparable period. Relocated, remodeled and expanded square footage stores are classified the same as the original store and are not considered new stores upon relocation, remodeling or completion of their expansion.

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Overview

We are a leading specialty retailer of value-priced fashion accessories and jewelry for pre-teens and teenagers as well as young adults. We are organized based on our geographic markets, which include our North American operations and our International operations. As of January 29, 2005, we operated a total of 2,836 stores in all 50 states of the United States, Puerto Rico, Canada, the Virgin Islands, the United Kingdom, Switzerland, Austria, Germany (the latter three collectively referred to as “S.A.G.”), France and Ireland. The stores are operated mainly under the trade names “Claire’s Boutiques”, “Claire’s Accessories”, “Icing by Claire’s”, “Afterthoughts” and “The Icing”. We are in the process of transitioning our “Afterthoughts” stores to “Icing by Claire’s” stores to capitalize on the Claire’s brand name. We also operate 148 stores in Japan through a 50:50 joint venture with AEON Co. Ltd. (“Claire’s Nippon”). We account for the results of operations of Claire’s Nippon under the equity method and include these results within “Interest and other income” in our Statement of Operations within our North American division. In addition, we license 57 stores in the Middle East under a licensing and merchandising agreement with Al Shaya Co. Ltd. and 4 stores in South Africa under similar agreements with the House of Busby Limited. We account for the goods we sell under the merchandising agreements within “Gross profit” in our North American division and the license fees we charge within “Interest and other income” within our International division in our Statement of Operations.

We have two store concepts: Claire’s Accessories, which caters to fashion-conscious girls and teens in the 7 to 17 age range, and Icing by Claire’s, which caters to fashion-conscious teens and young women in the 17 to 27 age range. Our merchandise typically ranges in price between $2 and $20, with the average product sold at approximately $4. Our stores share a similar format and our different store concepts and trade-names allow us to have multiple store locations in a single mall. Although we face competition from a number of small specialty store chains and others selling fashion accessories, we believe that our stores comprise one of the largest chains of specialty retail stores in the world devoted to the sale of value-priced fashion accessories for pre-teen, teenage and young adult females.

Fundamentally, our business model is to offer the customer a compelling price/value relationship and a wide array of products to choose from. We seek to deliver a high level of profitability and cash flow by:

While our financial results have grown steadily and record sales performance was achieved during Fiscal 2005, the retail environment remains very competitive. Management’s plan for future growth is dependent on:

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Our ability to achieve these objectives will be dependent on various factors, including those outlined in “Cautionary Note Regarding Forward-Looking Statements and Risk Factors.”

Critical Accounting Policies and Estimates

The preparation of financial statements requires us to estimate the effect of various matters that are inherently uncertain as of the date of the financial statements. Each of these required estimates varies in regard to the level of judgment involved and its potential impact on our reported financial results. Estimates are deemed critical when a different estimate could have reasonably been used or where changes in the estimate are reasonably likely to occur from period to period, and would materially impact our financial condition, changes in financial condition, or results of operations. Our significant accounting policies are discussed in Note 1 of the Notes to consolidated financial statements; critical estimates inherent in these accounting policies are discussed in the following paragraphs.

Inventory Valuation

Our inventories in North America and S.A.G. are valued at the lower of cost or market, with cost determined using the retail method. Inherent in the retail inventory calculation are certain significant management judgments and estimates including, among others, merchandise markups, markdowns and shrinkage, which impact the ending inventory valuation at cost as well as resulting gross margins. The methodologies used to value merchandise inventories include the development of the cost to retail ratios, the groupings of homogeneous classes of merchandise, development of shrinkage reserves and the accounting for retail price changes. The inventories in our United Kingdom, Irish and French stores are accounted for under the lower of cost or market method, with cost determined using the average cost method. Inventory valuation is impacted by the estimation of slow moving goods, shrinkage and markdowns.

Valuation of Long-Lived Assets

We evaluate the carrying value of long-lived assets whenever events or changes in circumstances indicate that a potential impairment has occurred. A potential impairment has occurred if the projected future undiscounted cash flows at the district level are less than the carrying value of the assets. The estimate of cash flows includes management’s assumptions of cash inflows and outflows directly resulting from the use of the asset in operations. When a potential impairment has occurred, an impairment charge is recorded if the carrying value of the long-lived asset exceeds its fair value. Fair value is measured based on a projected discounted cash flow model using a discount rate we feel is commensurate with the risk inherent in our business. Our impairment analyses contain estimates due to the inherently judgmental nature of forecasting long-term estimated cash flows and determining the ultimate useful lives of assets. Actual results may differ, which could materially impact our impairment assessment.

During Fiscal 2003, we recorded impairment charges of $2.7 million relating to fixed assets in our International segment due to those assets not being recoverable by estimated discounted cash flows. We recorded no impairment charges during Fiscal 2004 and Fiscal 2005.

Goodwill Impairment

We continually evaluate whether events and changes in circumstances warrant recognition of an impairment loss of goodwill. The conditions that would trigger an impairment assessment of goodwill include a significant, sustained negative trend in our operating results or cash flows, a decrease in demand for our products, a change in the competitive environment and other industry and economic factors. We measure impairment of goodwill utilizing the discounted cash flow method for each of our reporting units. The estimated discounted cash flows are then compared to our goodwill amounts. If the balance of the goodwill exceeds the estimated discounted cash flows, the excess of the balance is written off. Future cash flows may not meet projected amounts, which could result in impairment. We performed these analyses during Fiscal 2004 and 2005 and no impairment was required.

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Intangible Asset Impairment

We continually evaluate whether events and changes in circumstances warrant revised estimates of the useful lives or recognition of an impairment loss for intangible assets. Future adverse changes in market and legal conditions, or poor operating results of underlying assets could result in losses or an inability to recover the carrying value of the intangible asset, thereby possibly requiring an impairment charge in the future. The Company has concluded that certain intangible assets, comprised primarily of lease rights, qualify as indefinite-life intangible assets. Fair market value of the lease rights was determined through the use of third-party valuation. In addition, we make investments through our International subsidiaries in intangible assets upon the opening and acquisition of many of our store locations in Europe. These other intangible assets, which are subject to amortization, are amortized over the useful lives of the respective leases, not to exceed 25 years. We evaluate the market value of these assets periodically and record the impairment charge when we believe the carrying amount of the asset is not recoverable. We recorded impairment charges of approximately $1.0 million in Fiscal 2003 because the market value of certain lease rights included in our International segment were determined to be less than their carrying values. We recorded no impairment during Fiscal 2004 and Fiscal 2005.

Income Taxes

We are subject to income taxes in many jurisdictions, including the US, individual states and localities and abroad. We must first determine which revenues and expenses are included for each taxing jurisdiction. This process also involves the estimation of our actual current tax exposure, together with the assessment of temporary differences resulting from differing treatment of income or expense items for tax and accounting purposes. We establish deferred tax assets and liabilities as a result of these temporary differences. If we adjust our estimates in the future such that we would not expect to realize all or part of our net deferred tax assets, we may need to establish, or adjust a valuation allowance against our deferred tax assets, which could also materially affect our effective tax rate. We establish tax reserves in our consolidated financial statements based on our estimation of current tax exposures. If we prevail in tax matters for which reserves have been established or we are required to settle matters in excess of established reserves, our effective tax rate for a particular period could be materially affected.

Income tax expense also reflects our best estimate and assumptions regarding, among other things, the level of future taxable income, interpretation of tax laws of multiple jurisdictions, and tax planning. Future changes in tax laws, changes in projected levels of taxable income and tax planning could affect the effective tax rate and tax balances recorded by us. During the year, we base our tax rate on an estimate of our expected annual effective tax rate. These estimates are updated quarterly.

On an on-going basis, we evaluate our estimates. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances at the time, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Although management believes that the estimates discussed above are reasonable and the related calculations conform to generally accepted accounting principles, actual results could differ from these estimates, and such differences could be material.

Management has discussed the development and selection of these critical accounting policies with the Audit Committee of the Board of Directors and the Audit Committee has reviewed our disclosures relating to them.

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Results of Consolidated Operations

Overall, our operating results for Fiscal 2005 were a record in terms of sales and profitability. A summary of our consolidated results of operations is as follows (dollars in thousands, except per share data):

During the fourth quarter of Fiscal 2005, we recorded an after-tax charge of approximately $3.1 million, or $.03 per diluted share, relative to a settlement of litigation in connection with our disposition of our apparel segment in Fiscal 2003. This amount has been accounted for as loss from discontinued operation within our Consolidated Statement of Operations and Comprehensive Income.

Net sales in Fiscal 2005 increased by $146.6 million, or 13%, from Fiscal 2004, which in turn was $131.3 million, or 13% higher than Fiscal 2003. The increase in net sales was primarily attributable to comparable store sales increases of 8.0% and 7.0%, or approximately $92.2 million and $66.6 million during Fiscal 2005 and Fiscal 2004, respectively, the effects of the weak US Dollar when translating our foreign operations at higher exchange rates of approximately $34.4 million and $29.8 million, respectively, and new stores opened in our International division which produced higher average store sales than the stores we closed in our North American division.

The positive comparable sales experienced in our North American division during Fiscal 2005 and Fiscal 2004 were across most merchandise categories, most notably in the jewelry related areas and were primarily driven by an increase in the average number of transactions per store. We believe we experienced this trend through successfully meeting our customers’ demand for current fashion trends in jewelry and superior customer service in our stores. We have actively employed strategic initiatives in our International division to address the negative comparable store sales trend noted in the second half of Fiscal 2004. These initiatives included sharing best practices employed in our North American division for merchandise selection, store operations and attentive customer service. We believe our efforts contributed to our International division’s success in Fiscal 2005, providing comparable store sales of 4%.

The following table compares our sales of each product category for the last three fiscal years:

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In calculating gross profit and gross profit percentages, we exclude the costs related to our distribution center. These costs are included instead in Selling, general and administrative expenses. Other retail companies may include these costs in cost of sales, so our gross profit percentages may not be comparable to those retailers.

Gross profit percentages increased by 40 basis points and 230 basis points during Fiscal 2005 and Fiscal 2004, respectively. The primary source of this improvement during Fiscal 2005 was the ability of our International division to source a significant portion of goods at a lower cost due to those goods being purchased from our vendors in US Dollars. The lower cost was available due to the weakness in the US Dollar as compared to the British Pound and the Euro and approximated $4.4 million. Most of the goods sourced for sale in our International division are purchased in US Dollars. In addition, comparable sales increased at a rate faster than the increase in our occupancy related costs, creating positive leverage on those costs; however, these costs were partially offset by higher markdowns recorded at the end of Fiscal 2005 in connection with the Christmas selling season not meeting expectations. Fiscal 2005 also includes $1.5 million of rent expense recorded to account for the cumulative impact of not recording rent expense during the construction period prior to lease commencement. The increased gross profit percentages during Fiscal 2004 were primarily the result of improved merchandise margins relating to the shift in business from accessories to jewelry, as jewelry carries a higher initial markup and profit margin than that of accessories.

Selling, general and administrative expenses increased $36.7 million and $39.1 million in Fiscal 2005 and Fiscal 2004, respectively. These increases are primarily attributable to the increases in compensation paid to store personnel due to average wage increases and additional hours worked in our North American stores and the effects of the weak US Dollar when translating our foreign operations at higher exchange rates. Additional hours worked in the North American stores were necessary to achieve the positive comparable store sales experienced during these periods. In addition, during Fiscal 2005 and Fiscal 2004, increased store, field and corporate bonuses were earned in North America due to the positive comparable store sales and profit results during the period. We also recorded a charge of $8.7 million in the fourth quarter of Fiscal 2004 related to the retirement compensation package of our founder and former Chairman of the Board. As a percentage of Net sales, however, Selling, general and administrative expenses improved by 110 basis points and 70 basis points during Fiscal 2005 and Fiscal 2004, respectively. This improvement was primarily due to comparable store increases greater than the overall increases in the underlying expenses.

Our effective income tax rate for Fiscal 2005 and Fiscal 2004 was 34.0%. During Fiscal 2005, we recorded net benefits to the provision for income taxes totaling approximately $.4 million attributable to concluded state tax examinations that were settled more favorably than anticipated. Included in income taxes for Fiscal 2004 was a tax benefit of approximately $2.8 million related to concluded United States and foreign tax examinations that were settled more favorably than anticipated. Excluding the $2.8 million benefit recorded for Fiscal 2004, our effective income tax rate for Fiscal 2005 has decreased from the previous year due to a greater proportion of earnings from our International operations. This is primarily due to the fact that our combined effective income tax rate for International operations is generally lower than our effective income tax rate for domestic operations. Our effective income tax rate in future periods will depend on several variables, including the mix of earnings between domestic and International operations and our overall level of earnings. Our effective income tax rate could also be affected by the resolution of tax contingencies for amounts different from our current estimates.

Income from continuing operations increased by approximately $31.2 million and $37.1 million during each of Fiscal 2005 and Fiscal 2004, respectively. These increases were made possible primarily by the increase in comparable store sales and improved merchandise margins achieved during the period, as well as the leverage attained on our fixed costs.

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Seasonality and Quarterly Results

Our business is seasonal by nature, with the Christmas, Easter and back-to-school periods historically accounting for the largest percentage of annual net sales. In Fiscal 2005, the Christmas, Easter and back-to-school periods together accounted for approximately 30% of our annual net sales. See Note 10 of our consolidated financial statements for our quarterly results of operations.

Impact of Inflation

Inflation impacts several of our operating costs including, but not limited to cost of goods and supplies, occupancy costs and labor expenses. We seek to mitigate these effects by passing along inflationary increases in costs through increased sales prices of our products or by increasing sales volumes.

Matters Affecting Comparability

Included within Interest and other income during Fiscal 2005 and Fiscal 2004 is approximately $1.7 million and $1.2 million, respectively, of income recognized on our investment in Claire’s Nippon. We recorded no income during Fiscal 2003 as our portion of losses incurred by Claire’s Nippon were in excess of our investment and advances. Under the equity method of accounting, those losses would not be reflected in our financial statements once our investment and advances were reduced to zero. Store counts for the three years included in the tables above and below exclude Claire’s Nippon stores.

We believe that an understanding of our reported results and our ongoing financial performance is not complete without considering this impact and other transactions, as described within Management’s Discussion and Analysis of Financial Condition and Results of Operation.

Segment Operations

We are organized into two business segments – North America and International. Following is a discussion of results of operations by business segment.

North America

Key statistics and results of operations for our North American division are as follows (dollars in thousands):

It is our objective to increase sales in North America primarily through generating comparable store sales increases and also by increasing our quantity of our selling square footage.

Net sales in North America during Fiscal 2005 increased by $85.7 million, or 10.5%, from Fiscal 2004, which in turn was $79.5 million, or 10.7% higher than Fiscal 2003. The increase in Net sales was primarily attributable to comparable store sales increases of 10.0% and 10.0% or approximately $80.4 and $72.4 million during Fiscal 2005 and Fiscal 2004, respectively, and were primarily driven by an increase in the number of transactions per store.

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The positive comparable sales experienced in North America were across most merchandise categories, most notably in the jewelry related areas. We believe we experienced this trend through successfully meeting our customers’ demand for current fashion trends in jewelry and superior customer service in our stores. In addition, best practices in merchandise buying, planning and allocation from Claire’s have been shared with the Icing by Claire’s and Afterthoughts stores, which we believe have contributed significantly to the comparable store sales increases experienced during Fiscal 2005.

The following table compares our sales of each product category for the last three fiscal years:

The higher concentration of sales in jewelry as compared to accessories experienced during Fiscal 2005 and 2004 has had the result of improved gross profit margins due to the higher initial markup realized on jewelry.

International Division

Key statistics and results of operations for our International division are as follows (dollars in thousands):

It is our objective to increase sales in the International division primarily through store growth and also through comparable store sales increases. We also continue to explore adding operations in countries in which we do not currently operate.

Net sales in our International division during Fiscal 2005 increased by $60.8 million, or 19.5%, from Fiscal 2004, which in turn was $51.8 million, or 19.9% higher than Fiscal 2003. The increase in Net sales during Fiscal 2005 was primarily attributable to the net addition of 17 stores, the effects of the weak US Dollar when translating our foreign operations at higher exchange rates of approximately $34.4 million and by comparable store sales increases of 4.0%, or approximately $11.8 million during the period. The comparable store sales increase in Fiscal 2005 was primarily driven by an average increase in the number of units sold in each transaction.

The increase in Net sales during Fiscal 2004 was primarily attributable to the net addition of 47 stores, the effects of the weak US Dollar when translating our foreign operations at higher exchange rates of approximately $29.8 million, offset by comparable store sales decreases of 2.0%, or approximately $5.9 million during the period. We believe that the deterioration of comparable store sales during Fiscal 2004 was caused both by the difficult economic environments in several European countries for which we have store locations and also the deviation from best practices learned and practiced in our North American operations.

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The following table compares our sales of each product category for the last three fiscal years:

Gross profit percentages improved by 270 basis points in Fiscal 2005 and by 240 basis points in Fiscal 2004. The primary source of this improvement during both fiscal years was the ability of our International division to source a significant portion of goods at a lower cost due to those goods being purchased from our vendors in US Dollars, or approximately $4.4 million and $2.2 million, respectively. The lower cost was available due to the weakness in the US Dollar as compared to the British Pound and the Euro. Most of the goods sourced for sale in our International division are purchased in US Dollars.

Analysis of Consolidated Financial Condition

A summary of cash flows from operating, investing and financing activities is outlined in the table below (dollars in thousands):

We have consistently satisfied operating liquidity needs and planned capital expenditure programs through our normal conversion of sales to cash. Over the three years ended in Fiscal 2005, we generated over $570.9 million of cash flows from operating activities from continuing operations. We ended the year with approximately $191.0 million in cash and cash equivalents and $134.6 million in short-term investments, an overall increase of $101.0 million from the prior year. We ended the year with no debt outstanding. The decrease in cash and cash equivalents was due to cash generated from operations and purchases, net of sales, of short-term investments, offset by capital expenditures and the payment of dividends.

Our major source of cash from operations is store sales, nearly all of which are generated on a cash or credit card basis. Our primary outflow of cash from operations is the purchase of short-term investments and inventory (net of customary credit arrangements with vendors), operational costs and the payment of current taxes.

Working capital at the end of Fiscal 2005 was $326.4 million compared to $216.7 million at the end of Fiscal 2004. Changes in working capital reflect higher inventory levels and prepaid expenses, offset by higher accounts payable, which is due to the timing of inventory payments and increased accrued expenses, which reflects the increased bonuses earned by store, field and corporate employees that were not yet paid at the end of the year.

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Our $63.6 million of capital expenditures in Fiscal 2005 were made primarily to remodel existing stores and to open new stores. We generally experience a noticeable increase in sales in locations where a store has been recently remodeled. We also invested approximately $7.5 million during Fiscal 2005 in intangible assets within our International division which generally represents acquired lease rights on new store locations in certain countries. We expect to fund between $75.0 million and $85.0 million of capital expenditures and $10.0 million to $15.0 million of purchased lease rights in Fiscal 2006 in an effort to continue to remodel and expand our store base. In addition, purchases, net of sales of short-term investments, amounted to $134.6 million during Fiscal 2005.

We also paid dividends of $28.9 million during Fiscal 2005, an increase of approximately $15.6 million from the prior year. Dividends were increased again at the end of Fiscal 2005, and as of March 15, 2005, we expect to pay at least $38.6 million in dividends in Fiscal 2006.

Liquidity and Capital Resources

We entered into a new credit facility in March 2004. This credit facility is a revolving line of credit of up to $60.0 million, is secured by inventory in the United States and is due to expire March 31, 2009. The borrowings under this facility are limited based on certain calculations of availability, based primarily on the amount of inventory on hand in the United States. At January 29, 2005, the entire amount of $60.0 million would have been available for borrowing by us, subject to reduction for $2.6 million of outstanding letters of credit. The credit facility is cancelable by us without penalty and bears interest at an initial margin of 75 basis points over the London Interbank Borrowing Rate (LIBOR). The margin is then adjusted periodically based on certain liquidity measurements. The credit facility also contains other restrictive covenants which limit, among other things, our ability to make dividend distributions. This credit facility replaced our prior credit facility, which included a $40.0 million revolving line of credit and a $175.0 million five year term loan.

Our non-US subsidiaries have available credit facilities totaling approximately $843,000 with banks. The facilities are used for working capital requirements, letters of credit and various guarantees. These credit facilities have been arranged in accordance with customary lending practices in their respective countries of operation. At January 29, 2005, there were no borrowings under these credit facilities.

Management believes that our present ability to borrow is greater than our established credit lines. However, if market conditions change and sales were to dramatically decline or we could not control operating costs or other expenses, our cash flows and liquidity could be reduced, and we could experience an increase in borrowing costs, or even a reduction in or elimination of our access to debt and/or equity markets.

Contractual Obligations and Off Balance Sheet Arrangements

We finance certain leasehold improvements and equipment used in our stores through transactions accounted for as non-cancelable operating leases. As a result, the rental expense for these leasehold improvements and equipment is recorded during the term of the lease contract in our consolidated financial statements, generally over four to seven years. In the event that any of the real property leases where leasehold improvements or equipment are located that are subject to these non-cancelable operating leases are terminated by us or our landlord prior to the scheduled expiration date of the real property lease, we will be required to accrue all future rent payments under these operating leases.

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As of January 29, 2005, our future financial commitments under our arrangements were as follows:

In Fiscal 2003, we disposed of our apparel segment, which was comprised of “Mr. Rags” stores, or Lux Corp. As of January 29, 2005, we remained guarantor on certain real estate leases for Mr. Rags store locations with future rental payments of approximately $4.2 million.

Recent Accounting Pronouncements

In January 2003, the Financial Accounting Standards Board, (“FASB”) issued Interpretation No. 46 “Consolidation of Variable Interest Entities”. The interpretation requires certain variable interest entities, as defined, to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46, as amended, is effective for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after December 15, 2003. In December 2003, the FASB issued a revision to FIN 46 (“FIN 46R”) to clarify some of the provisions of the interpretation and defer the implementation date for certain entities to periods ending after March 14, 2004. The adoption of FIN 46R did not have an impact on our consolidated financial position, results of operations or cash flows.

In December 2004, the FASB issued Statement of Financial Accounting Standards (“SFAS”) 123R, “Share-Based Payment,” a revision of SFAS 123. The standard requires companies to expense the grant-date fair value of stock options and other equity-based compensation issued to employees and is effective for interim or annual periods beginning after June 15, 2005. In accordance with the revised statement, we will be required to recognize the expense attributable to stock options granted or vested subsequent to July 30, 2005. We are evaluating the requirements of SFAS 123R. We have not yet determined the method of adoption or the effect of adopting SFAS 123R, and we have not determined whether the adoption will result in amounts that are similar to the current pro forma disclosures under SFAS 123 in Note 1 of the Notes to consolidated financial statements.

Cautionary Note Regarding Forward-Looking Statements and Risk Factors

The Private Securities Litigation Reform Act of 1995, or the Act, provides a safe harbor for “forward-looking statements” made by or on our behalf. We and our representatives may from time to time make written or verbal forward-looking statements, including statements contained in this and other filings with the Securities and Exchange Commission and in our press releases and reports to shareholders. All statements which address operating performance, events or developments that we expect or anticipate will occur in the future, including statements relating to our future financial performance, planned capital expenditures and new store openings for Fiscal 2006, are forward-looking statements within the meaning

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of the Act and as defined in Section 21E of the Securities Exchange Act of 1934, as amended. The forward-looking statements are and will be based on management’s then current views and assumptions regarding future events and operating performance and we assume no obligation to update any forward-looking statement. Forward-looking statements involve known or unknown risks, uncertainties and other factors, including changes in estimates and judgments discussed under “Critical Accounting Policies and Estimates” which may cause our actual results, performance or achievements, or industry results to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements.

We believe that the following factors, among others, that are specific to our business, could cause or contribute to our actual results, performance or achievements differing from the future results, performance or achievements expressed or implied in our forward-looking statements:

We believe that the following factors, among others, that are general to our business, could cause or contribute to our actual results, performance or achievements differing from the future results, performance or achievements expressed or implied in our forward-looking statements:

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Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Foreign Currency

We are exposed to market risk from foreign currency exchange rate fluctuations on the US Dollar value of foreign currency denominated transactions and our investment in foreign subsidiaries. We manage this exposure to market risk through our regular operating and financing activities, and foreign currency options. Exposure to market risk for changes in foreign exchange rates relates primarily to foreign operations’ buying, selling and financing in currencies other than local currencies and to the carrying value of net investments in foreign subsidiaries. We may manage our exposure to foreign exchange rate risk related to our foreign operations’ buying, selling and financing in currencies other than local currencies by using foreign currency options from time to time to hedge foreign currency transactional exposure. At January 29, 2005, we had not entered into foreign currency options. We do not generally hedge the translation exposure related to our net investment in foreign subsidiaries, since we generally have no near term intent to repatriate funds from such subsidiaries. During Fiscal 2005, included in comprehensive income and stockholders’ equity is $7.9 million reflecting foreign currency translation. Based on our average net currency positions in Fiscal 2005, the potential gain or loss due to a 10% adverse change on foreign currency exchange rates could be significant to our operations.

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Certain of our subsidiaries make significant US Dollar purchases from Asian suppliers, particularly in China. There continues to be speculation that China may elect to adjust the exchange rate of the Chinese Yuan against the US Dollar. Currently, the Chinese Yuan has a fixed exchange rate against the US Dollar. If China adjusts the exchange rate or allows the value to float, based on the current weak US Dollar, we could experience increases in our cost of merchandise imported from China.

The results of operations of foreign subsidiaries, when translated into US Dollars, reflect the average rates of exchange for the periods presented. As a result, similar results in local currency can vary significantly upon translation into US Dollars if exchange rates fluctuate significantly from one period to the next.

Interest Rates

Our exposure to market risk for changes in interest rates is limited to our cash, cash equivalents and debt. Based on our average invested cash balances and outstanding debt during Fiscal 2005, a 10% increase in the average effective interest rate in Fiscal 2005 would not have materially impacted our annual interest income or expense.

Item 8. Financial Statements and Supplementary Data

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Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders
Claire’s Stores, Inc.:

We have audited the accompanying consolidated balance sheets of Claire’s Stores, Inc. and subsidiaries as of January 29, 2005 and January 31, 2004, and the related consolidated statements of operations and comprehensive income, changes in stockholders’ equity, and cash flows for the fiscal years ended January 29, 2005, January 31, 2004, and February 1, 2003. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Claire’s Stores, Inc. and subsidiaries as of January 29, 2005 and January 31, 2004 and the results of their operations and their cash flows for the fiscal years ended January 29, 2005, January 31, 2004, and February 1, 2003 in conformity with U.S. generally accepted accounting principles.

As discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for goodwill and intangible assets in the fiscal year ended February 1, 2003.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Claire’s Stores, Inc.’s internal control over financial reporting as of January 29, 2005, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated April 12, 2005 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.

/S/KPMG LLP
Tampa, Florida
April 12, 2005

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Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders
Claire’s Stores, Inc.:

We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting, that Claire’s Stores, Inc. maintained effective internal control over financial reporting as of January 29, 2005, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Claire’s Stores, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

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In our opinion, management’s assessment that Claire’s Stores, Inc. maintained effective internal control over financial reporting as of January 29, 2005, is fairly stated, in all material respects, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, Claire’s Stores, Inc. maintained, in all material respects, effective internal control over financial reporting as of January 29, 2005, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Claire’s Stores, Inc. and subsidiaries as of January 29, 2005 and January 31, 2004, and the related consolidated statements of operations and comprehensive income, changes in stockholders’ equity, and cash flows for the fiscal years ended January 29, 2005, January 31, 2004, and February 1, 2003, and our report dated April 12, 2005 expressed an unqualified opinion on those consolidated financial statements.

/S/KPMG LLP
Tampa, Florida
April 12, 2005

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CLAIRE’S STORES, INC. AND SUBSIDIARIES

See accompanying notes to consolidated financial statements.

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CLAIRE’S STORES, INC. AND SUBSIDIARIES

See accompanying notes to consolidated financial statements.

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CLAIRE’S STORES, INC. AND SUBSIDIARIES

See accompanying notes to consolidated financial statements.

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CLAIRE’S STORES, INC. AND SUBSIDIARIES

See accompanying notes to consolidated financial statements.

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CLAIRE’S STORES, INC. AND SUBSIDIARIES

1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations — Claire’s Stores, Inc., a Florida corporation, and subsidiaries (collectively the “Company”), is a leading retailer of value-priced fashion accessories targeted towards pre-teens, teenagers and young adults. The Company operates stores throughout the United States, Puerto Rico, Canada, the Virgin Islands, the United Kingdom, Switzerland, Austria, Germany, (the latter three collectively referred to as “S.A.G.”), France, Ireland and Japan.

Principles of Consolidation — The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. The Company’s 50% ownership interest in its Japanese joint venture (Claire’s Nippon) is accounted for under the equity method. All material intercompany balances and transactions have been eliminated in consolidation. All references in the Company’s financial statements to number of shares, per share amounts, stock option data and market prices of the Company’s Common stock have been restated to give effect to the 2-for-1 stock split of the Company’s Common stock and Class A common stock in the form of a 100% stock dividend in December 2003.

Reclassifications — The consolidated financial statements include certain reclassifications of prior period amounts in order to conform to current year presentation.

Use of Estimates — These consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America, which require management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The most significant estimates include valuation of inventories, valuation of goodwill and intangible assets, provisions for income taxes and contingencies and litigation. Actual results could differ from these estimates.

Fiscal Year — The Company’s fiscal year ends on the Saturday closest to January 31. Fiscal year 2005 consisted of 52 weeks and ended on January 29, 2005, Fiscal year 2004 consisted of 52 weeks and ended on January 31, 2004 and Fiscal year 2003 consisted of 52 weeks and ended on February 1, 2003.

Cash and Cash Equivalents — The Company considers all highly liquid debt instruments purchased with an original maturity of 90 days or less to be cash equivalents.

Short-term Investments — All short-term investments are classified as available-for-sale and are carried at par plus accrued interest, which approximates fair value. There were no unrealized gains or losses at January 29, 2005. At January 29, 2005, these investments consist of auction rate securities with original maturities over 90 days. The cost of securities sold is based on the specific identification method.

The Company views its portfolio of auction rate securities with maturity beyond 90 days to be available for use in current operations and has accordingly classified such marketable investments as short-term investments, even though the stated maturity dates may be one year or more beyond the current balance sheet date.

Inventories — Merchandise inventories are stated at the lower of cost or market. Cost is determined by the first-in, first-out basis using the retail method in North America and S.A.G., while the UK, Ireland and France use average cost. Approximately 18% and 16% of the Company’s inventory was maintained using the average cost method in Fiscal 2005 and 2004, respectively.

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Prepaid Expenses and Other Current Assets — Prepaid expenses and other current assets include the following components as of the period indicated (dollars in thousands):

Property and Equipment — Property and equipment are recorded at cost. Depreciation is computed on the straight-line method over the estimated useful lives of the building and the furniture, fixtures and equipment, which range from three to twenty-five years. Amortization of leasehold improvements is computed on the straight-line method based upon the shorter of the estimated useful lives of the assets or the terms of the respective leases. Maintenance and repair costs are charged to earnings while expenditures for major improvements are capitalized. Upon the disposition of property, plant and equipment, the accumulated depreciation is deducted from the original cost and any gain or loss is reflected in current earnings.

The Company reviews its long-lived assets for impairment under the provisions of Financial Accounting Standards Board, (“FASB”) Statement No. 144, whenever events or changes in circumstances indicate that the net book value of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the net book value of an asset to the future net undiscounted cash flows expected to be generated by the asset. An impairment loss would be recorded for the excess of the net book value over the fair value of the asset impaired. The fair value is estimated based on expected discounted future cash flows. Assets to be disposed of are reported at the lower of the carrying amount or fair value less cost to sell and are no longer depreciated. The Company recorded no impairment charges during the year ended January 31, 2004 or January 29, 2005. The Company recorded approximately $2.7 million during the year ended February 1, 2003 related to fixed assets in the International segment due to those assets not being recoverable by discounted cash flows. The impairment charge is included within the financial statement caption “Selling, general and administrative” expenses within the Company’s Consolidated Statements of Operations and Comprehensive Income.

Goodwill — Effective February 3, 2002, the Company adopted Statement of Financial Accounting Standards 142 (“SFAS 142”), “Goodwill and Other Intangible Assets.” In accordance with SFAS 142, the Company ceased amortizing its goodwill effective February 3, 2002. The Company had $201.1 million and $199.8 million of unamortized goodwill at January 29, 2005 and January 31, 2004, respectively. The Company had $18.2 million and $18.1 million of accumulative goodwill amortization at January 29, 2005 and January 31, 2004, respectively.

SFAS 142 required the Company upon its adoption to reassess the value of, and useful lives assigned to, intangible assets including goodwill to determine whether the value is impaired. The first step of this impairment test required the Company, within the first six months of Fiscal 2003, to determine the fair value of its reporting units, as defined by SFAS 142, and compare it to the carrying value of the net assets allocated to the reporting units. If this fair value exceeded the carrying value, no further analysis was required. If the fair value of the reporting unit was less than the carrying value of the net assets, the Company was required to perform step two of the impairment test, which required the Company to allocate the implied fair value of the reporting unit to all underlying assets and liabilities, including both recognized and unrecognized tangible and intangible assets, based on their fair value. The Company performed a transitional goodwill impairment test as required and determined that no goodwill impairment existed at February 3, 2002.

SFAS 142 also requires the Company to perform a goodwill and intangible assets impairment test on an annual basis. Any impairment charges resulting from the application of this test in the future would be immediately recorded as a charge to earnings in the Company’s statement of operations. The Company

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performed these impairment tests as of the first day of the fourth quarter of Fiscal 2004 and Fiscal 2005 and determined that no impairment exists.

Other Assets — Other assets primarily include deposits and the non-current portion of prepaid lease payments on leasehold improvements and equipment financed under non-cancelable operating leases. The prepaid lease payments are amortized on a straight line basis over the respective lease terms, typically ranging from four to seven years. Also included is the Company’s investment in its unconsolidated subsidiary in the amount of $3.2 million and $1.2 million at January 29, 2005 and January 31, 2004, respectively.

Intangible Assets — The Company has concluded that certain intangible assets, comprised primarily of lease rights, qualify as indefinite-life intangible assets under SFAS 142. Fair market value of the lease rights was determined through the use of third-party valuations. In addition, the Company makes investments through its International subsidiaries in intangible assets upon the opening and acquisition of many of our store locations in Europe. These other intangible assets which are subject to amortization are amortized over the useful lives of the respective leases, not to exceed 25 years. The Company evaluates the market value of its intangible assets periodically and records an impairment charge when the Company believes the carrying amount of the asset is not recoverable. The Company recorded impairment charges of approximately $1.0 million in Fiscal 2003, included within selling, general and administrative expenses, because the market value of certain lease rights included in its International segment were determined to be less than their carrying values. No impairment charges related to these assets were recorded during Fiscal 2005 and Fiscal 2004. The following table summarizes certain information regarding intangible assets at the respective periods, (dollars in thousands):

Amortization expense on these intangible assets is expected to be approximately $1.0 million for each of the next five years. The weighted average amortization period of amortized intangible assets as of January 29, 2005 approximates 14 years.

Accrued Expenses — Accrued expenses include the following components as of the period indicated (dollars in thousands):

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Revenue Recognition — The Company recognizes sales as the customer takes possession of the merchandise. The estimated liability for sales returns is based on the historical return levels, which is included in accrued expenses.

Cost of Sales — Included within the Company’s Consolidated Statement of Operations line item “Cost of sales, occupancy and buying expenses” is the cost of merchandise sold to our customers, inbound and outbound freight charges, purchasing costs and inspection costs. Also included in this line item are the occupancy costs of the Company’s stores and the Company’s internal costs of facilitating the merchandise procurement process, both of which are treated as period costs. All merchandise purchased by the Company is shipped to one of its three distribution centers. As a result, the Company has no internal transfer costs. The cost of the Company’s distribution center is included within the financial statement line item “Selling, general and administrative” expenses, and not in “Cost of sales, occupancy and buying expenses”. These distribution center costs were approximately $10.7 million, $9.2 million and $9.0 million in Fiscal 2005, Fiscal 2004 and Fiscal 2003, respectively.

Leasing — The Company recognizes rent expense for operating leases with periods of free rent (including construction periods), step rent provisions and escalation clauses on a straight line basis over the applicable lease term. The Company considers lease renewals in the useful life of its leasehold improvements when such renewals are reasonably assured. The Company takes these provisions into account when calculating minimum aggregate rental commitments under non-cancelable operating leases set forth below. From time to time, the Company may receive capital improvement funding from its lessors. These amounts are recorded as deferred liabilities and amortized over the remaining lease term as a reduction of rent expense.

Basic and Diluted Shares — Basic net income per share is based on the weighted average number of shares of Class A Common Stock and Common Stock outstanding during the period. Diluted net income per share includes the dilutive effect of stock options plus the number of shares included in basic net income per share. Options to purchase 326,604 and 328,346 shares of common stock, at $16.93 per share and prices ranging from $10.78 to $15.13 per share, respectively, were outstanding for the years ended January 31, 2004 and February 1, 2003, respectively, but were not included in the computation of diluted earnings per share because the options’ exercise prices were greater than the average market price of the common shares for the respective fiscal year. All options outstanding at January 29, 2005 were included in the calculation of diluted shares.

Income Taxes — The Company accounts for income taxes under the provisions of SFAS 109 which generally requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement carrying amounts and tax bases of assets and liabilities, using enacted tax rates in effect for the year in which the differences are expected to reverse. Under SFAS 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

Foreign Currency Translation — The financial statements of the Company’s foreign operations are translated into US Dollars. Assets and liabilities are translated at current exchange rates while income and expense accounts are translated at the average rates in effect during the year. Equity accounts are translated at historical exchange rates. Resulting translation adjustments are accumulated as a component of other comprehensive income. Foreign currency gains and losses resulting from transactions denominated in foreign currencies, including intercompany transactions, except for intercompany loans of a long-term investment nature, are included in results of operations.

Fair Value of Financial Instruments — The Company’s financial instruments consist primarily of current assets and current liabilities. Current assets and liabilities approximate fair market value.

Derivative Instruments and Hedging Activities — The Company accounts for derivatives and hedging activities in accordance with SFAS 133, Accounting for Derivative Instruments and Certain Hedging

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Activities, as amended, which requires that all derivative instruments be recorded on the balance sheet at their respective fair values.

The Company is exposed to market risk from foreign exchange rates. The Company continues to evaluate these risks and continues to take measures to mitigate these risks, including, among other measures, entering into derivative financial instruments to hedge risk exposures to currency rates. The Company enters into foreign currency options to minimize and manage the currency related to its import merchandise purchase program. The counter-party to these contracts is a highly rated financial institution. These foreign currency options are designated as cash flow hedges, as defined by SFAS 133, and are effective as hedges. Accordingly, changes in the effective portion of the fair value of these foreign currency options are included in other comprehensive income. Once the hedged transactions are completed, or when merchandise is sold, the unrealized gains and losses on the foreign currency options are reclassified from accumulated other comprehensive income and recognized in earnings. The unrealized losses related to the import merchandise purchase program contracts, which were recorded in other comprehensive income, were not material for each period presented.

Stock Options — SFAS 123, “Accounting for Stock Based Compensation,” as amended by SFAS 148, “Accounting for Stock Based Compensation-Transition and Disclosure”, allows entities to choose between a fair value based method of accounting for employee stock options or similar equity instruments and the intrinsic value based method of accounting prescribed by Accounting Principles Board Opinion 25 (“APB 25”), “Accounting for Stock Issued to Employees.” Entities electing to account for employee stock options or similar equity instruments under APB 25 must make pro forma disclosures of net income and earnings per share as if the fair value method of accounting had been applied. The Company has elected to apply the provisions of APB 25 in the preparation of its consolidated financial statements and provide pro forma disclosure of net income and earnings per share as required under SFAS 123 and SFAS 148 (dollars in thousands, except share data).