Claire's Stores, Inc.
Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended July 30, 2005
OR
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission file number 001-08899
Claire’s Stores, Inc.
(Exact name of registrant as specified in its charter)
     
Florida   59-0940416
     
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No.)
     
3 S.W. 129th Avenue, Pembroke Pines, Florida   33027
     
(Address of principal executive offices)   (Zip Code)
Registrant’s telephone number, including area code: (954) 433-3900
     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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes þ No o
     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
     The number of shares of the registrant’s Common Stock and Class A Common Stock outstanding as of August 26, 2005 was 94,150,801 and 5,116,184, respectively.
 
 

 


Table of Contents

CLAIRE’S STORES, INC. AND SUBSIDIARIES
INDEX
         
    PAGE NO.  
       
 
       
Item 1. Financial Statements
       
 
       
    3  
 
       
    4  
 
       
    5  
 
       
    6  
 
       
    8  
 
       
    15  
 
       
    16  
 
       
       
 
       
    16  
 
       
    17  
 
       
    18  
 
       
    19  
 Section 302 Certification of Co-CEO
 Section 302 Certification of Co-CEO
 Section 302 Certification of CFO
 Section 906 Certification of Co-CEO
 Section 906 Certification of Co-CEO
 Section 906 Certification of CFO

2


Table of Contents

PART I. FINANCIAL INFORMATION
CLAIRE’S STORES, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
                 
    July 30, 2005     Jan. 29, 2005  
    (In thousands, except share and per share amounts)  
ASSETS
               
Current assets:
               
Cash and cash equivalents
  $ 328,185     $ 191,006  
Short-term investments
          134,613  
Inventories
    120,018       110,072  
Prepaid expenses and other current assets
    68,599       57,635  
 
           
Total current assets
    516,802       493,326  
 
           
Property and equipment:
               
Land and building
    18,151       18,151  
Furniture, fixtures and equipment
    243,461       238,022  
Leasehold improvements
    220,413       211,721  
 
           
 
    482,025       467,894  
Less accumulated depreciation and amortization
    (272,731 )     (263,368 )
 
           
 
    209,294       204,526  
 
           
 
               
Intangible assets, net
    51,562       52,474  
Other assets
    14,236       14,736  
Goodwill
    198,889       201,067  
 
           
 
    264,687       268,277  
 
           
 
Total assets
  $ 990,783     $ 966,129  
 
           
 
               
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current liabilities:
               
Trade accounts payable
  $ 60,150     $ 41,994  
Income taxes payable
    9,594       30,600  
Accrued expenses
    82,177       94,344  
 
           
Total current liabilities
    151,921       166,938  
 
           
Long-term liabilities:
               
Deferred tax liability
    22,969       24,293  
Deferred rent expense
    20,404       19,211  
 
           
 
    43,373       43,504  
 
           
 
               
Commitments and contingencies
           
 
               
Stockholders’ equity:
               
Preferred stock par value $1.00 per share; authorized 1,000,000 shares, issued and outstanding 0 shares
           
Class A common stock par value $0.05 per share; authorized 40,000,000 shares, issued and outstanding 5,120,803 shares and 5,125,432 shares, respectively
    256       256  
Common stock par value $0.05 per share; authorized 300,000,000 shares, issued and outstanding 94,136,182 shares and 93,858,213 shares, respectively
    4,707       4,693  
Additional paid-in capital
    53,696       50,477  
Accumulated other comprehensive income, net of tax
    18,772       28,041  
Retained earnings
    718,058       672,220  
 
           
 
    795,489       755,687  
 
           
Total liabilities and stockholders’ equity
  $ 990,783     $ 966,129  
 
           
See accompanying notes to unaudited condensed consolidated financial statements.

3


Table of Contents

CLAIRE’S STORES, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS
OF OPERATIONS AND COMPREHENSIVE INCOME
                                 
    Three Months Ended     Six Months Ended  
    July 30,     July 31,     July 30,     July 31,  
    2005     2004     2005     2004  
            (In thousands, except per share amounts)  
Net sales
  $ 325,042     $ 305,223     $ 627,750     $ 586,814  
Cost of sales, occupancy and buying expenses
    151,848       141,920       290,543       267,444  
 
                       
Gross profit
    173,194       163,303       337,207       319,370  
 
                       
Other expenses (income)
                               
Selling, general and administrative
    111,574       103,413       222,091       207,688  
Depreciation and amortization
    11,776       10,944       24,124       21,603  
Interest and other income
    (3,083 )     (1,267 )     (5,044 )     (2,477 )
 
                       
 
    120,267       113,090       241,171       226,814  
 
                       
Income before income taxes
    52,927       50,213       96,036       92,556  
Income taxes
    17,469       17,468       30,876       32,119  
 
                       
Net income
    35,458       32,745       65,160       60,437  
 
                       
Foreign currency translation adjustments
    (7,615 )     2,114       (9,269 )     (2,949 )
 
                       
Comprehensive income
  $ 27,843     $ 34,859     $ 55,891     $ 57,488  
 
                       
 
                               
Net income per share:
                               
Basic
  $ 0.36     $ 0.33     $ 0.66     $ 0.61  
 
                       
Diluted
  $ 0.36     $ 0.33     $ 0.66     $ 0.61  
 
                       
See accompanying notes to unaudited condensed consolidated financial statements.

4


Table of Contents

CLAIRE’S STORES, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                 
    Six Months Ended  
    July 30, 2005     July 31, 2004  
    (In thousands)  
Cash flows from operating activities:
               
Net income
  $ 65,160     $ 60,437  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization
    24,124       21,603  
Amortization of intangible assets
    502       565  
Loss on retirement of property and equipment
    1,582       2,075  
Gain on sale of intangible assets
          (170 )
Stock compensation expense
    1,605        
Increase in —
               
Inventories
    (11,839 )     (22,329 )
Prepaid expenses and other assets
    (14,087 )     (10,779 )
Increase (decrease) in —
               
Trade accounts payable
    19,878       11,267  
Income taxes payable
    (21,257 )     (22,424 )
Accrued expenses
    (10,266 )     336  
Deferred income taxes
    (25 )     3,804  
Deferred rent expense
    1,421       (178 )
 
           
Net cash provided by operating activities
    56,798       44,207  
 
           
 
               
Cash flows from investing activities:
               
Acquisition of property and equipment
    (34,433 )     (34,587 )
Acquisition of intangible assets
    (3,492 )     (3,719 )
Purchase of short-term investments
    (82,334 )      
Sale of short-term investments
    216,947        
 
           
Net cash provided by (used in) investing activities
    96,688       (38,306 )
 
           
 
               
Cash flows from financing activities:
               
Proceeds from stock options exercised
    1,628       23  
Dividends paid
    (19,321 )     (12,521 )
 
           
 
               
Net cash used in financing activities
    (17,693 )     (12,498 )
 
           
 
               
Effect of foreign currency exchange rate changes on cash and cash equivalents
    1,386       (263 )
 
           
 
               
Net increase (decrease) in cash and cash equivalents
    137,179       (6,860 )
 
               
Cash and cash equivalents at beginning of period
    191,006       224,630  
 
           
 
               
Cash and cash equivalents at end of period
  $ 328,185     $ 217,770  
 
           
See accompanying notes to unaudited condensed consolidated financial statements.

5


Table of Contents

CLAIRE’S STORES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1.   Basis of Presentation and Significant Accounting Policies
 
    The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q, and do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. These statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Annual Report on Form 10-K for the year ended January 29, 2005 filed with the Securities and Exchange Commission, including Note 1 to the consolidated financial statements included therein which discusses principles of consolidation and a summary of significant accounting policies. These 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, contingencies and litigation. Actual results could differ from these estimates. Due to the seasonal nature of the Company’s business, the results of operations for interim periods of the year are not necessarily indicative of the results of operations on an annualized basis. Certain prior period amounts have been reclassified to conform to the current period presentation.
 
2.   Earnings Per Share
 
    The information required to compute basic and diluted earnings per share is as follows (in thousands, except per share data):
                                 
    Three Months Ended     Six Months Ended  
    July 30,     July 31,     July 30,     July 31,  
    2005     2004     2005     2004  
Numerator:
                               
Net income
  $ 35,458     $ 32,745     $ 65,160     $ 60,437  
 
                               
Denominator:
                               
Weighted average number of shares outstanding
                               
Basic
    99,056       98,917       99,025       98,917  
Effect of dilutive stock options
    363       359       363       342  
Effect of dilutive restricted stock awards
    22             13        
 
                       
Diluted
    99,441       99,276       99,401       99,259  
 
                       
 
                               
Net income per share:
                               
Basic
  $ 0.36     $ 0.33     $ 0.66     $ 0.61  
Diluted
  $ 0.36     $ 0.33     $ 0.66     $ 0.61  
    Options to purchase 17,582 shares of common stock for the three months ended July 31, 2004 were not included in the computation of diluted earnings per share because their effect would be anti-dilutive. All outstanding options and restricted stock awards for the three months ended July 30, 2005 were included in the computation of diluted earnings per share.
 
    Options to purchase 8,791 shares of common stock for the six months ended July 31, 2004 were not included in the computation of diluted earnings per share because their effect would be anti-dilutive. All outstanding options and restricted stock awards for the six months ended July 30, 2005 were included in the computation of diluted earnings per share.

6


Table of Contents

3.   Stock-Based Compensation
 
    Statement of Financial Accounting Standards (“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 unaudited condensed 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 per share data).
                                 
    Three Months Ended     Six Months Ended  
    July 30,     July 31,     July 30,     July 31,  
    2005     2004     2005     2004  
Net income, as reported
  $ 35,458     $ 32,745     $ 65,160     $ 60,437  
Stock-based employee compensation expense determined under the fair value based methods, net of income tax
    (846 )     (507 )     (1,736 )     (1,027 )
Stock-based employee compensation expense included in reported net income, net of income tax
    627             1,043        
 
                       
Net income — pro forma
  $ 35,239     $ 32,238     $ 64,467     $ 59,410  
 
                       
Basic net income per share — as reported
  $ 0.36     $ 0.33     $ 0.66     $ 0.61  
Basic net income per share — pro forma
  $ 0.36     $ 0.33     $ 0.65     $ 0.60  
Diluted net income per share — as reported
  $ 0.36     $ 0.33     $ 0.66     $ 0.61  
Diluted net income per share — pro forma
  $ 0.35     $ 0.32     $ 0.65     $ 0.60  
4.   New Accounting Pronouncements
 
    In December 2004, the Financial Accounting Standards Board (“FASB”) issued 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. On April 15, 2005, the Securities and Exchange Commission announced an amendment to the compliance dates for SFAS 123R that delays the effective date to annual periods beginning after June 15, 2005. The Company will be required to recognize the expense attributable to stock options granted or vested subsequent to the Company’s fiscal year ending January 28, 2006. The Company is evaluating the requirements of SFAS 123R and has not yet determined the method of adoption or the effect of adopting SFAS 123R.
 
    In March 2005, the FASB issued FASB Interpretation (“FIN”) 47, “Accounting for Conditional Asset Retirement Obligations,” which is an interpretation of SFAS 143, “Accounting for Asset Retirement Obligations.” This interpretation clarifies terminology within SFAS 143 and requires an entity to recognize a liability for the fair value of a conditional asset retirement obligation when incurred if the liability’s fair value can be reasonably estimated. This interpretation is effective for fiscal years ending after December 15, 2005. The Company does not expect the adoption of this interpretation to have a material impact on our financial condition or results of operations.
 
5.   Segment Information
 
    The Company is organized based on the geographic markets in which it operates. Under this structure, the Company currently has two reportable segments: North America and International. The Company accounts for the results of operations of Claire’s Nippon under the equity method and includes the results within “Interest and other income” in the Company’s Condensed Consolidated Statements of Operations and Comprehensive Income within the Company’s North American division. Net sales and Income before income taxes for the periods presented were as follows (dollars in thousands):

7


Table of Contents

                                                                 
    Net Sales     Income Before Income Taxes  
    Three Months Ended     Six Months Ended     Three Months Ended     Six Months Ended  
    July 30,     July 31,     July 30,     July 31,     July 30,     July 31,     July 30,     July 31,  
    2005     2004     2005     2004     2005     2004     2005     2004  
North America
  $ 222,929     $ 214,260     $ 439,269     $ 422,460     $ 36,586     $ 35,501     $ 77,883     $ 77,494  
International
    102,113       90,963       188,481       164,354       16,341       14,712       18,153       15,062  
 
                                               
 
                                                               
Total
  $ 325,042     $ 305,223     $ 627,750     $ 586,814     $ 52,927     $ 50,213     $ 96,036     $ 92,556  
 
                                               
6.   Income Taxes
 
    The Company’s effective income tax rate during the three and six months ended July 30, 2005 was 33.0% and 32.2%, respectively, as compared to 34.8% and 34.7% during the comparable periods of Fiscal 2005. The Company’s lower effective income tax rate for the three and six month periods ended July 30, 2005 was the result of a change in the mix of earnings between U.S. and foreign operations and tax planning.
 
    On October 22, 2004, the American Jobs Creation Act (the “AJCA”) was signed into law. The AJCA includes a special one-time deduction of 85% of certain foreign earnings that are repatriated, as defined in the AJCA. The Company may elect to apply this provision to qualifying earnings repatriations in Fiscal 2006. The Company continues to evaluate the provisions of the law to determine whether it will repatriate foreign earnings and the impact, if any, this provision will have on its consolidated financial statements. Earnings under consideration for repatriation range from $0 to $45 million and the related income tax effects from such repatriation cannot be reasonably estimated at this time.
 
7.   Statements of Cash Flows
 
    Payments of income taxes were $50.6 million and $49.9 million for the six months ended July 30, 2005 and July 31, 2004, respectively.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Management’s Discussion and Analysis of Financial Condition and Results of Operations 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 the following sections: Overview, Critical Accounting Policies and Estimates, Results of Operations and Analysis of Consolidated Financial Condition. It is useful to read Management’s Discussion and Analysis in conjunction with the Unaudited Condensed Consolidated Financial Statements and related notes thereto contained elsewhere in this document.
Annually, our fiscal years end on the Saturday closest to January 31. As a result, both our current and prior fiscal years consist of four 13-week quarters. We refer to the prior fiscal year ended January 29, 2005 as Fiscal 2005, and the current fiscal year ending January 28, 2006 as Fiscal 2006. All references to earnings per share relate to diluted earnings per share from Net income.
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.

8


Table of Contents

Overview
We are a leading global 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 July 30, 2005 we operated a total of 2,851 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, Ireland and Spain. 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 operated 166 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. These results are included within “Interest and other income” in our Condensed Consolidated Statements of Operations and Comprehensive Income within our North American division. In addition, we licensed 70 stores in the Middle East under a licensing and merchandising agreement with Al Shaya Co. Ltd. and 6 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 Condensed Consolidated Statements of Operations and Comprehensive Income.
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 priced at approximately $4. Our stores share a similar format and our different store concepts and trade-names allow us to have multiple store locations within 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:
    maximizing the effectiveness of our retail product pricing through promotional activity
 
    minimizing our product costs through economies of scale as the world’s leading mall-based retailer of value-priced accessories and jewelry
 
    reinvesting operating cash flows into opening new stores, remodeling existing stores and infrastructure in order to create future revenues and build brand name loyalty
While our financial results have grown steadily and record sales performance was achieved during the first half of Fiscal 2006, the retail environment remains very competitive. Management’s plan for future growth is dependent on:
    successfully identifying merchandise appealing to our customers and managing our inventory levels
 
    displaying our merchandise at convenient, accessible locations staffed with personnel that provide courteous and professional customer service
 
    sourcing our merchandise to achieve a positive value/price relationship
 
    increasing sales at existing store locations
 
    expanding our sales, especially in our International division, through additional store locations

9


Table of Contents

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
Our Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America. Preparation of these statements requires management to make judgments and estimates. Some accounting policies have a significant impact on amounts reported in these financial statements. A summary of significant accounting policies and a description of accounting policies that are considered critical may be found in our Fiscal 2005 Annual Report on Form 10-K, filed on April 13, 2005, in the Notes to the Consolidated Financial Statements, Note 1, and the Critical Accounting Policies and Estimates section therein.
Results of Operations
Consolidated Operations
A summary of our consolidated results of operations is as follows (dollars in thousands, except per share data):
                                 
    Three Months Ended     Six Months Ended  
    July 30,   July 31,   July 30,   July 31,
    2005   2004   2005   2004
Net sales
  $ 325,042     $ 305,223     $ 627,750     $ 586,814  
Comparable store sales
    5.0 %     10.0 %     5.0 %     11.0 %
Gross profit percentage
    53.3 %     53.5 %     53.7 %     54.4 %
Selling, general and administrative expenses as a percentage of Net sales
    34.3 %     33.9 %     35.4 %     35.4 %
Net income
  $ 35,458     $ 32,745     $ 65,160     $ 60,437  
Net income per diluted share
  $ 0.36     $ 0.33     $ 0.66     $ 0.61  
Number of stores at the end of the period (1)
    2,851       2,833       2,851       2,833  
 
(1)   Number of stores excludes Claire’s Nippon and stores operated under licensing agreements
Net sales for the three months ended July 30, 2005 increased by $19.8 million, or 6.5% from the three months ended July 31, 2004. This increase was primarily attributable to comparable store sales increases of approximately 5.0%, or approximately $14.0 million, and new store revenue, net of store closures of approximately $3.6 million. Net sales for the six months ended July 30, 2005 increased by $40.9 million, or 7.0% over the comparable period ended July 31, 2004. This increase was primarily due to comparable store increases of approximately 5.0%, or approximately $27.3 million, new store revenue, net of store closures of approximately $6.2 million, and $3.8 million resulting from the weaker US dollar when translating our foreign operations at higher exchange rates.
The positive comparable sales experienced in our North American division has continued, although not at the high percentages experienced in Fiscal 2005, and were across various merchandise categories, most notably in the jewelry related areas. We believe we experienced this trend through successfully meeting our customers’ demands for current fashion trends in jewelry and superior customer service in our stores. The positive comparable sales within our International division continue and are stimulated by specific initiatives we continue to employ, including sharing best practices employed in our North American division for merchandise selection, store operations and attentive customer service.
During the first and second quarter of Fiscal 2006, the positive comparable sales were primarily driven by an increase in the average retail price per transaction, which was the result of an increase in the average unit retail price greater than the decrease of the number of units sold per transaction.

10


Table of Contents

The following table compares our percentage of sales of each product category for each of the periods presented:
                                 
    Three Months Ended   Six Months Ended
    July 30,   July 31,   July 30,   July 31,
    2005   2004   2005   2004
Jewelry
    60.0 %     59.0 %     59.0 %     59.0 %
Accessories
    40.0 %     41.0 %     41.0 %     41.0 %
 
                               
 
    100.0 %     100.0 %     100.0 %     100.0 %
 
                               
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 decreased by 20 basis points during the three months ended July 30, 2005 as compared to the three months ended July 31, 2004, and 70 basis points during the six months ended July 30, 2005 as compared to the six months ended July 31, 2004. The decrease during the three months was primarily attributable to higher freight costs. The decrease during the six months was due to increased promotional activity and higher freight costs.
Selling, general and administrative expenses increased $8.2 million for the three months ended July 30, 2005 as compared to the three months ended July 31, 2004, and $14.4 million for the six months ended July 30, 2005 as compared to the six months ended July 31, 2004. The increase was primarily attributable to general inflation increases in payroll hours used to operate our stores, increases in professional fees associated with litigation matters, Sarbanes-Oxley compliance, and a $1.9 million accrual in the second quarter for estimated future healthcare costs associated with the 2003 retirement package of our Chairman Emeritus. As a percentage of Net sales, Selling, general and administrative expenses increased by 40 basis points for the three months ended July 30, 2005, and these expenses did not change as a percentage of net sales for the six months ended July 30, 2005. The increase in the three month period ended July 30, 2005 is primarily a result of the estimated future healthcare costs recorded for the Chairman Emeritus.
Our effective income tax rates during the three months and six months of Fiscal 2006 were 33.0% and 32.2%, respectively, as compared to 34.8% and 34.7% during the comparable periods of Fiscal 2005. Our lower effective income tax rates for the three and six month periods ended July 30, 2005 were the result of a change in the mix of earnings between U.S. and foreign operations and tax planning. We currently expect our effective income tax rate for the remainder of Fiscal 2006 to be approximately 33.5%. Our effective income tax rate in future periods will depend on several variables, including the mix of earnings between U.S. and foreign operations and our overall level of earnings. This is primarily due to the fact that the combined effective income tax rate for our foreign operations is generally lower than our effective income tax rate for U.S. operations. Our effective income tax rate could also be affected by the resolution of tax contingencies for amounts different from our current estimates.
On October 22, 2004, the American Jobs Creation Act (the “AJCA”) was signed into law. The AJCA includes a special one-time deduction of 85% of certain foreign earnings that are repatriated, as defined in the AJCA. We may elect to apply this provision to qualifying earnings repatriations in Fiscal 2006. We continue to evaluate the provisions of the law to determine whether we will repatriate foreign earnings and the impact, if any, this provision will have on our consolidated financial statements. Earnings under consideration for repatriation range from $0 to $45 million and the related income tax effects from such repatriation cannot be reasonably estimated at this time.
Net income increased by approximately $2.7 million during the three months ended July 30, 2005 as compared to the three months ended July 31, 2004 and $4.7 million during the six months ended July 30, 2005 as compared to the six months ended July 31, 2004. These increases are primarily due to the increase in store

11


Table of Contents

sales which resulted in increased Gross margin dollars, an increase in interest and other income, and from the lower effective tax rates.
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):
                                 
    Three Months Ended     Six Months Ended  
    July 30,   July 31,   July 30,   July 31,
    2005   2004   2005   2004
Net sales
  $ 222,929     $ 214,260     $ 439,269     $ 422,460  
Comparable store sales
    3.0 %     13.0 %     3.0 %     15.0 %
Gross profit percentage
    52.5 %     52.5 %     54.1 %     55.3 %
Number of stores at the end of the period (1)
    2,115       2,121       2,115       2,121  
 
(1)   Number of stores excludes Claire’s Nippon and stores operated under licensing agreements
Net sales in North America during the three months ended July 30, 2005 increased by $8.7 million, or 4.0%, over the comparable period ended July 31, 2004. Net sales for the six months ended July 30, 2005 increased by $16.8 million, or 4.0%, over the comparable period ended July 31, 2004. The increases in Net sales for the three and six month periods were primarily attributable to comparable store sales increases of approximately 3.0%.
The positive comparable sales experienced in North America were primarily attributable to an increase in the average retail price per transaction, which was the result of an increase in the average unit retail price greater than the decrease of the average number of units sold per transaction. The positive comparable sales experienced in North America were across various merchandise categories, most notably in the jewelry related areas. We believe we experienced this trend through successfully meeting our customers’ demands 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 the second quarter of Fiscal 2006.
Gross profit percentages remained the same for the three months ended July 30, 2005 and decreased 120 basis points during the six months ended July 30, 2005 as compared to the same periods in the prior year. The decrease during the six months was primarily attributable to increased promotional activity and higher freight costs.
The following table compares our percentage of sales of each product category for each of the periods presented:
                                 
    Three Months Ended   Six Months Ended
    July 30,   July 31,   July 30,   July 31,
    2005   2004   2005   2004
Jewelry
    67.0 %     66.0 %     67.0 %     66.0 %
Accessories
    33.0 %     34.0 %     33.0 %     34.0 %
 
                               
 
    100.0 %     100.0 %     100.0 %     100.0 %
 
                               

12


Table of Contents

International
Key statistics and results of operations for our International division are as follows (dollars in thousands):
                                 
    Three Months Ended     Six Months Ended  
    July 30,   July 31,   July 30,   July 31,
    2005   2004   2005   2004
Net sales
  $ 102,113     $ 90,963     $ 188,481     $ 164,354  
Comparable store sales
    9.0 %     4.0 %     9.0 %     0.0 %
Gross profit percentage
    55.1 %     55.8 %     52.8 %     52.1 %
Number of stores at the end of the period (1)
    736       712       736       712  
 
(1)   Number of stores excludes Claire’s Nippon and stores operated under licensing agreements
Our objective is to increase sales in the International division primarily through store growth and comparable store sales increases. We also continue to explore expansion into countries in which we do not currently operate.
Net sales in our International division during the three months ended July 30, 2005 increased by $11.2 million, or 12.3%, from the three months ended July 31, 2004. Net sales for the six months ended July 30, 2005 increased by $24.1 million, or 14.7% over the comparable period ended July 31, 2004. The increase in Net sales for the three months ended July 30, 2005 was primarily attributable to comparable store sales increases of approximately 9.0%, or approximately $7.9 million during the period and by new store revenue net of store closures of approximately $3.6 million during the period. The increase in net sales for the six months ended July 30, 2005 was primarily attributable to comparable store sales increases of 9.0% or approximately $14.4 million during the period, by new store revenue net of store closures of approximately $6.2 million during the period, and the effects of the weaker US dollar when translating our foreign operations at higher exchange rates of approximately $3.8 million.
Due to the strategic initiatives employed within our International division, the comparable store sales have continued to improve. These initiatives included sharing best practices from our North America operations for merchandise selection, store operations and attentive customer service. In addition, we are investing in operational systems infrastructure in order to facilitate the greater level of complexity and precision now required of the business.
The Gross profit percentage declined by 70 basis points for the three months ended July 30, 2005. However, the Gross profit percentage improved by 70 basis points for the six months ended July 30, 2005. The decline in Gross profit percentage for the three months ended July 30, 2005, is a result of higher cost of goods sold, primarily due to increased promotional activity and higher freight costs than the comparable period ended July 31, 2004. These higher costs were partially offset by the shift to a higher percentage of jewelry sales, which had a positive impact on merchandise margins. The increase in Gross profit percentage for the six months ended July 30, 2005, is a result of higher comparable store sales which has provided us leverage on our fixed occupancy costs, partially offset by higher freight costs.
The following table compares our percentage of sales of each product category for each of the periods presented:
                                 
    Three Months Ended   Six Months Ended
    July 30,   July 31,   July 30,   July 31,
    2005   2004   2005   2004
Jewelry
    45.0 %     42.0 %     44.0 %     40.0 %
Accessories
    55.0 %     58.0 %     56.0 %     60.0 %
 
                               
 
    100.0 %     100.0 %     100.0 %     100.0 %
 
                               

13


Table of Contents

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):
                 
    Six Months Ended  
    July 30,     July 31,  
    2005     2004  
Operating activities
  $ 56,798     $ 44,207  
Investing activities
  $ 96,688     $ (38,306 )
Financing activities
  $ (17,693 )   $ (12,498 )
We have consistently satisfied operating liquidity needs and planned capital expenditure programs through our normal conversion of sales to cash. At July 30, 2005, we had approximately $328.2 million in Cash and cash equivalents, an increase of $2.6 million in Cash and cash equivalents and Short-term investments from January 29, 2005. We ended the second quarter of Fiscal 2006 with no borrowed debt outstanding. The net increase in Cash and cash equivalents during the period was primarily due to cash generated from operations and the sale 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 inventory, net of Trade accounts payable, operational costs, the payment of current taxes and capital expenditures.
Our working capital at July 30, 2005 was $364.9 million compared to $326.4 million at January 29, 2005.
Cash provided by operating activities during the first six months of Fiscal 2006 was $56.8 million compared to $44.2 million for the same period in Fiscal 2005, or a $12.6 million increase. The change was primarily due to an increase in net income of $4.7 million, a decrease in inventory purchases of $10.5 million over the comparable period in the prior year, and an increase in Trade accounts payable of $8.6 million offset by a decrease of $10.6 million in Accrued expenses.
Cash provided by investment activities during the first six months of Fiscal 2006 was $96.7 million compared to $38.3 million used for the same period in Fiscal 2005, or a $135.0 million increase. The cash provided was primarily due to the purchase and sale of Short-term investments, netting $134.6 million.
Capital expenditures of $34.4 million 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 $3.5 million in Intangible assets within our International division representing acquired lease rights on new store locations. We expect to fund approximately $79.0 million of capital expenditures and approximately $14.0 million of purchased lease rights in Fiscal 2006 in an effort to continue to expand and remodel our store base.
Cash used by financing activities during the first six months of Fiscal 2006 was $17.7 million compared to $12.5 million for the same period in Fiscal 2005, or a $5.2 million increase. This was primarily due to an increase of dividends paid by $6.8 million offset by an increase in cash provided by stock option exercises by $1.6 million over the comparable period last year.
We paid dividends of $19.3 million during the six months ended July 30, 2005. We expect to pay at least $38.7 million in dividends in Fiscal 2006.

14


Table of Contents

Liquidity and Capital Resources
Our credit facility is a revolving line of credit of up to $60.0 million, is secured by inventory in the United States and expires on March 31, 2009. The borrowings under this facility are limited based on certain calculations of availability, based primarily on the amount of inventory and cash on hand in the United States. At July 30, 2005, the entire amount of $60.0 million would have been available for borrowing by us, subject to reduction for $3.4 million of outstanding letters of credit. The credit facility is cancelable by us without penalty and borrowings would bear interest at a margin of 75 basis points over the London Interbank Borrowing Rate (LIBOR) at July 30, 2005. The credit facility also contains other restrictive covenants which limit, among other things, our ability to make dividend distributions if we are in default or if our excess liquidity is less than $20.0 million during certain periods. Excess liquidity is specifically defined in our debt agreement as the sum of our available credit lines and certain cash and cash equivalent amounts.
Our non-US subsidiaries have credit facilities totaling approximately $776,000 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 July 30, 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.
Cautionary Note Regarding Forward-Looking Statements and Risk Factors
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, business strategy, planned capital expenditures and new store openings for Fiscal 2006, are forward-looking statements. 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. Some of these risks, uncertainties and other factors are as follows: changes in consumer preferences and consumer spending; competition; general economic conditions, such as inflation and increased energy costs; general political and social conditions, such as war, political unrest and terrorism; natural disasters or severe weather events; currency fluctuations and exchange rate adjustments; changes in laws, including employment laws relating to overtime pay, tax laws and import laws; uncertainties generally associated with the specialty retailing business; and disruptions in our supply of inventory. In addition, we typically earn a disproportionate share of our operating income in the fourth quarter due to seasonal buying patterns, which are difficult to forecast with certainty. Additional discussion of these and other risks and uncertainties is contained elsewhere in this Item 2, in Item 3, “Quantitative and Qualitative Disclosures About Market Risk” and in our Form 10-K for Fiscal 2005 under “Cautionary Note Regarding Forward-Looking Statements and Risk Factors.”
Item 3. 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 from time to time, the use of 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

15


Table of Contents

value of net investments in foreign subsidiaries. We 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 July 30, 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. During the three and six months ended July 30, 2005, included in Comprehensive income and Stockholders’ equity is $7.6 million and $9.3 million, respectively, reflecting the unrealized loss on foreign currency translation. Based on our average net currency positions in Fiscal 2006, the potential gain or loss due to a 10% adverse change on foreign currency exchange rates could be significant to our operations.
Certain of our subsidiaries make significant US dollar purchases from Asian suppliers particularly in China. In July 2005, China revalued its currency 2.1%, changing the fixed exchange rate from 8.28 to 8.11 Chinese Yuan to the US dollar. If China adjusts the exchange rate further or allows the value to float, we may 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 months that comprise 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 during the first six months of Fiscal 2006, a 10% increase in the average effective interest rate in the remainder of Fiscal 2006 would not have a material impact on our annual interest income.
Item 4. Controls and Procedures
We carried out an evaluation, under the supervision and with the participation of our management, including our Co-Chief Executive Officers and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report. Based upon that evaluation, our Co-Chief Executive Officers and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this Quarterly Report to ensure that information required to be disclosed in this Quarterly Report is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission’s rules and forms.
There have been no changes in our internal control over financial reporting during the quarter ended July 30, 2005, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. 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.

16


Table of Contents

Item 4. Submission of Matters to a Vote of Security Holders
     (a) Our 2005 annual meeting of shareholders was held on June 28, 2005 in New York City. At the annual meeting, our shareholders voted on the following matters:
          1. The election of seven directors, each to serve for a one-year term;
          2. Approval of our 2005 Incentive Compensation Plan; and
          3. A shareholder proposal regarding our business operations in Northern Ireland.
     Proxies for the annual meeting were solicited pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended, and there was no solicitation in opposition to our solicitation.
     At the annual meeting, each holder of record of our common stock, par value $0.05 per share, and our Class A common stock, par value $0.05 per share, at the close of business on May 2, 2005 was entitled to vote, in person or by proxy, one vote for each share of our common stock and ten votes for each share of our Class A common stock, as the case may be, held by the stockholder. As of the record date, 94,049,140 shares of our common stock were outstanding and 5,122,245 shares of our Class A common stock were outstanding.
     The holders of 89,346,854 shares of our common stock (representing 89,346,854 votes) and 5,010,077 shares of our Class A common stock (representing 50,100,770 votes) were either present in person or represented by proxy, and constituted a quorum for the transaction of business at the annual meeting.
     (b) All of our nominees for directors were elected to serve a one-year term by more than the required plurality of affirmative votes of the holders of our common stock (one vote per share) and our Class A common stock (ten votes per share), voting together as a single class:
                                 
    COMMON             CLASS A        
    STOCK     VOTES     STOCK     VOTES  
DIRECTOR NOMINEE   VOTES FOR     WITHHELD     VOTES FOR     WITHHELD  
Marla L. Schaefer
    87,818,609       1,528,245       50,085,430       15,340  
E. Bonnie Schaefer
    87,863,233       1,483,621       50,085,430       15,340  
Ira D. Kaplan
    85,280,734       4,066,120       50,087,070       13,700  
Bruce G. Miller
    85,493,388       3,853,466       50,087,070       13,700  
Steven H. Tishman
    87,894,197       1,452,667       50,087,070       13,700  
Ann Spector Lieff
    88,440,242       906,612       50,085,430       15,340  
Martha Clark Goss
    88,284,400       1,062,454       50,087,070       13,700  
     (c) (i) Our shareholders approved the Company’s 2005 Incentive Compensation Plan by an affirmative vote of a majority of votes cast, either in person or by proxy, of the outstanding shares of our common stock (one vote per share) and Class A common stock (ten votes per share), voting together as a single class:
                                 
            VOTED           BROKER
SHARES   VOTED FOR   AGAINST   ABSTAIN   NON-VOTE
Common stock
    64,923,538       14,020,096       206,113       10,197,107  
Class A stock
    48,514,770       421,010       92,850       1,072,140  
     (c) (ii) The shareholder proposal regarding our business operations in Northern Ireland (referred to as the “MacBride Principles”) was not approved by the required affirmative vote of a majority of the votes cast, either in person or by proxy, by the holders of the outstanding shares of our common stock (one vote per share) and Class A common stock (ten votes per share), voting together as a single class:

17


Table of Contents

                                 
            VOTED           BROKER
SHARES   VOTED FOR   AGAINST   ABSTAIN   NON-VOTE
Common stock
    14,750,557       60,117,771       4,281,419       10,197,107  
Class A stock
    289,840       48,711,910       21,880       1,072,140  
Item 6. Exhibits
  31.1   Certification of Co-Chief Executive Officer pursuant to Rule 13a-14(a) and 15d-14(a).
 
  31.2   Certification of Co-Chief Executive Officer pursuant to Rule 13a-14(a) and 15d-14(a).
 
  31.3   Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and 15d-14(a).
 
  32.1   Certification of Co-Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
  32.2   Certification of Co-Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
  32.3   Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Items 2, 3 and 5 are not applicable and have been omitted.

18


Table of Contents

SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
         
 
      CLAIRE’S STORES, INC.
(Registrant)
 
       
September 7, 2005
      /s/ Marla L. Schaefer
 
       
 
      Marla L. Schaefer
 
      Co-Chairman of the Board of Directors
 
      (principal co-executive officer and director)
 
       
September 7, 2005
      /s/ E. Bonnie Schaefer
 
       
 
      E. Bonnie Schaefer
 
      Co-Chairman of the Board of Directors
 
      (principal co-executive officer and director)
 
       
September 7, 2005
      /s/ Ira D. Kaplan
 
       
 
      Ira D. Kaplan, Senior Vice President,
 
      Chief Financial Officer and Director
 
      (principal financial and accounting officer and director)

19


Table of Contents

INDEX TO EXHIBITS
     
EXHIBIT NO.   DESCRIPTION
 
   
31.1
  Certification of Co-Chief Executive Officer pursuant to Rule 13a-14(a) and 15d-14(a).
 
   
31.2
  Certification of Co-Chief Executive Officer pursuant to Rule 13a-14(a) and 15d-14(a).
 
   
31.3
  Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and 15d-14(a).
 
   
32.1
  Certification of Co-Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
   
32.2
  Certification of Co-Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
   
32.3
  Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

20