10-Q
Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended November 1, 2008
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 No. 333-148108
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 x      No o
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer o   Accelerated filer o   Non-accelerated filer x   Smaller reporting company o
      (Do not check if a smaller reporting company)  
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o      No x
As of December 1, 2008, 100 shares of the Registrant’s common stock, $0.001 par value, were outstanding.
 
 

 


 

CLAIRE’S STORES, INC. AND SUBSIDIARIES
INDEX
                 
            PAGE NO.  
PART I.          
       
 
       
               
       
 
       
            3  
       
 
       
            4  
       
 
       
            5  
       
 
       
            6  
       
 
       
            18  
       
 
       
            29  
       
 
       
            29  
       
 
       
PART II.          
       
 
       
            30  
       
 
       
            30  
       
 
       
            30  
       
 
       
SIGNATURE PAGE        
       
 
       
       
Ex-31.1 Section 302 Certification of CEO
    33  
       
Ex-31.2 Section 302 Certification of CFO
    34  
       
Ex-32.1 Section 906 Certification of CEO
    35  
       
Ex-32.2 Section 906 Certification of CFO
    36  

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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
CLAIRE’S STORES, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
                 
    November 1, 2008     February 2, 2008  
    (In thousands, except share and per share amounts)  
ASSETS
               
Current assets:
               
Cash and cash equivalents
  $ 193,897     $ 85,974  
Inventories
    148,578       117,679  
Prepaid expenses
    37,283       37,315  
Other current assets
    47,323       37,658  
 
           
Total current assets
    427,081       278,626  
 
           
Property and equipment:
               
Land and building
    22,288       22,288  
Furniture, fixtures and equipment
    142,372       130,130  
Leasehold improvements
    217,084       211,163  
 
           
 
    381,744       363,581  
Less accumulated depreciation and amortization
    (101,813 )     (53,972 )
 
           
 
    279,931       309,609  
 
           
 
               
Intangible assets, net of accumulated amortization of $16,256 and $4,762, respectively
    790,000       777,130  
Deferred financing costs, net of accumulated amortization of $15,010 and $7,079, respectively
    62,580       70,511  
Other assets
    69,227       71,754  
Goodwill
    1,841,346       1,840,867  
 
           
 
    2,763,153       2,760,262  
 
           
 
               
Total assets
  $ 3,470,165     $ 3,348,497  
 
           
 
               
LIABILITIES AND STOCKHOLDER’S EQUITY
               
Current liabilities:
               
Trade accounts payable
  $ 82,559     $ 56,089  
Current portion of long-term debt
    14,500       14,500  
Income taxes payable
    5,948       12,191  
Accrued interest payable
    38,403       19,536  
Accrued expenses and other liabilities
    105,202       117,076  
 
           
Total current liabilities
    246,612       219,392  
 
           
 
               
Long-term debt
    2,367,505       2,363,250  
Revolving credit facility
    194,000        
Deferred tax liability
    93,276       139,506  
Deferred rent expense
    16,789       10,572  
Unfavorable lease obligations and other liabilities
    45,367       10,577  
 
           
 
    2,716,937       2,523,905  
 
           
 
               
Commitments and contingencies
           
 
               
Stockholder’s equity:
               
Common stock par value $0.001 per share; authorized 1,000 shares, issued and outstanding 100 shares
           
Additional paid-in capital
    607,354       601,201  
Accumulated other comprehensive income (loss), net of tax
    (27,324 )     3,358  
Retained earnings (deficit)
    (73,414 )     641  
 
           
 
    506,616       605,200  
 
           
Total liabilities and stockholder’s equity
  $ 3,470,165     $ 3,348,497  
 
           
See accompanying notes to unaudited condensed consolidated financial statements.

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CLAIRE’S STORES, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND
COMPREHENSIVE LOSS

(in thousands)
                                           
    Successor Entity       Predecessor Entity  
    Three Months     Three Months     Nine Months     May 29, 2007       February 4, 2007  
    Ended     Ended     Ended     Through       Through  
    Nov. 1, 2008     Nov. 3, 2007     Nov. 1, 2008     Nov. 3, 2007       May 28, 2007  
Net sales
  $ 332,971     $ 357,366     $ 1,019,947     $ 638,556       $ 424,899  
Cost of sales, occupancy and buying expenses
    170,979       176,215       523,228       314,490         206,438  
 
                               
Gross profit
    161,992       181,151       496,719       324,066         218,461  
 
                               
Other expenses (income):
                                         
Selling, general and administrative
    129,121       127,772       392,877       220,513         154,482  
Depreciation and amortization
    20,024       26,428       64,686       39,598         19,652  
Transaction-related costs
    (569 )     1,200       5,695       3,261         72,672  
Other income
    (2,612 )     (1,310 )     (3,721 )     (1,706 )       (1,476 )
 
                               
 
    145,964       154,090       459,537       261,666         245,330  
 
                               
Operating income (loss)
    16,028       27,061       37,182       62,400         (26,869 )
Interest expense (income), net
    50,462       56,322       147,858       92,250         (4,876 )
 
                               
Loss before income taxes
    (34,434 )     (29,261 )     (110,676 )     (29,850 )       (21,993 )
Income taxes
    (12,880 )     (15,449 )     (36,621 )     (15,231 )       21,779  
 
                               
Net loss
  $ (21,554 )   $ (13,812 )   $ (74,055 )   $ (14,619 )     $ (43,772 )
 
                               
 
                                         
 
                                         
Net loss
  $ (21,554 )   $ (13,812 )   $ (74,055 )   $ (14,619 )     $ (43,772 )
Foreign currency translation and interest rate swap adjustments, net of tax
    (42,827 )     9,242       (30,682 )     12,987         8,440  
 
                               
Comprehensive loss
  $ (64,381 )   $ (4,570 )   $ (104,737 )   $ (1,632 )     $ (35,332 )
 
                               
See accompanying notes to unaudited condensed consolidated financial statements.

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CLAIRE’S STORES, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)
                           
    Successor Entity       Predecessor Entity  
    Nine Months     May 29, 2007       February 4, 2007  
    Ended     Through       Through  
    Nov. 1, 2008     Nov. 3, 2007       May 28, 2007  
Cash flows from operating activities:
                         
Net loss
  $ (74,055 )   $ (14,619 )     $ (43,772 )
 
                         
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
                         
Depreciation and amortization
    64,686       39,598         19,652  
Amortization of lease rights and other assets
    1,593       789         622  
Amortization of debt issuance costs
    7,931       4,421          
Payment in kind interest expense
    15,130                
Net accretion of favorable (unfavorable) lease obligations
    (1,114 )              
Impairment of intangible assets
                  73  
(Gain) loss on sale/retirement of property and equipment and other assets, net
    (215 )     399         1,201  
Gain on sale of intangible assets
    (1,446 )              
Excess tax benefit from stock-based compensation
                  (2,885 )
Stock compensation expense
    6,153       2,832         8,946  
(Increase) decrease in:
                         
Inventories
    (37,704 )     (20,695 )       (10,932 )
Prepaid expenses
    (4,989 )     (9,676 )       6,389  
Other assets
    (3,600 )     (25,256 )       (2,941 )
Increase (decrease) in:
                         
Trade accounts payable
    31,874       (6,138 )       31,202  
Income taxes payable
    (14,551 )     619         (11,732 )
Accrued expenses and other liabilities
    2,863       (61,502 )       39,727  
Accrued interest payable
    18,867       49,321          
Deferred income taxes
    (38,204 )     (21,397 )       6,723  
Deferred rent expense
    7,337       3,851         373  
 
                   
Net cash provided by (used in) operating activities
    (19,444 )     (57,453 )       42,646  
 
                   
Cash flows from investing activities:
                         
Acquisition of property and equipment, net
    (45,267 )     (42,667 )       (27,988 )
Acquisition of predecessor entity
          (3,045,247 )        
Acquisition of intangible assets/lease rights
    (1,273 )     (1,670 )       (81 )
 
                   
Net cash used in investing activities
    (46,540 )     (3,089,584 )       (28,069 )
 
                   
Cash flows from financing activities:
                         
Credit facility proceeds
    194,000       1,450,000          
Credit facility payments
    (10,875 )     (3,625 )        
Note offerings proceeds
          935,000          
Capital contribution
          595,675          
Stock option proceeds
                  177  
Excess tax benefit from stock compensation
                  2,885  
Option conversion payment
          (7,924 )        
Financing fees paid
          (77,561 )        
Dividends paid
          (7,252 )       (9,065 )
 
                   
Net cash provided by (used in) financing activities
    183,125       2,884,313         (6,003 )
 
                   
Effect of foreign currency exchange rate changes on cash and cash equivalents
    (9,218 )     (9,714 )       1,025  
 
                   
Net increase (decrease) in cash and cash equivalents
    107,923       (272,438 )       9,599  
Cash and cash equivalents at beginning of period
    85,974       350,476         340,877  
 
                   
Cash and cash equivalents at end of period
  $ 193,897     $ 78,038       $ 350,476  
 
                   
 
                         
 
                         
Supplemental disclosure of cash flow information:
                         
Income taxes paid
  $ 15,251     $ 6,340       $ 22,820  
Interest paid
    107,186       40,268         86  
See accompanying notes to unaudited condensed consolidated financial statements.

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CLAIRE’S STORES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
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 U.S. 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 statement of the results for the interim periods presented 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 February 2, 2008 filed with the Securities and Exchange Commission, including Note 2 to the consolidated financial statements included therein which discusses principles of consolidation and summary of significant accounting policies. These statements have been prepared in accordance with U.S. generally accepted accounting principles, 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, long-lived and intangible assets, provisions for income taxes, stock-based compensation, and contingencies and litigation. Actual results could differ from these estimates. Due to the seasonal nature of the retail industry and 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.
2. Acquisition of Claire’s Stores, Inc.
On March 20, 2007, our former Board of Directors approved a merger agreement (the “Merger”) to sell the Company to Apollo Management VI, L.P. and certain affiliated co-investment partnerships. On May 24, 2007, our shareholders approved the Merger at a special meeting of shareholders. On May 29, 2007, the Merger occurred and Claire’s Stores, Inc. became a wholly-owned subsidiary of Claire’s Inc., f/k/a Bauble Holdings Corp.
The purchase of the Company and the related fees and expenses were financed through the issuance of senior notes, borrowings under a credit facility, an equity investment, and cash on hand at the Company. The aforementioned transactions, including the Merger and payment of costs related to these transactions, are collectively referred to as the “Transactions.”
The acquisition of Claire’s Stores, Inc. was accounted for as a business combination using the purchase method of accounting, whereby the purchase price was allocated to the assets and liabilities based on the estimated fair market values at the date of acquisition. The final evaluation and allocation of the purchase price was completed during the three month period ended August 2, 2008.
In connection with the consummation of the Transactions, the Company is sometimes referred to as the “Successor Entity” for periods on or after May 29, 2007, and the “Predecessor Entity” for periods prior to May 29, 2007. The consolidated financial statements presented for the period from February 4, 2007 through May 28, 2007 are shown under the Predecessor Entity caption. The consolidated financial statements for the Successor Entity for the three and nine months ended November 1, 2008 and the period from May 29, 2007 through November 3, 2007 show the operations of the Successor Entity. The consolidated financial statements for the periods after May 28, 2007 are presented on a different basis than for the periods prior to May 29, 2007 as a result of the application of purchase accounting.

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A reconciliation of the purchase price adjustments recorded in connection with the Transactions is presented below (in thousands):
                         
    Predecessor Entity     Successor Entity  
    May 28,     Transaction     May 29,  
    2007     Adjustments     2007  
ASSETS
                       
Current assets:
                       
Cash and cash equivalents
  $ 350,476     $ (186,053 )   $ 164,423  
Inventories
    133,156             133,156  
Prepaid expenses
    29,792             29,792  
Other current assets
    36,378             36,378  
 
                 
Total current assets
    549,802       (186,053 )     363,749  
 
                 
Property and equipment:
                       
Land and buildings
    17,272       5,016       22,288  
Furniture, fixtures and equipment
    289,974       (194,125 )     95,849  
Leasehold improvements
    305,469       (120,083 )     185,386  
 
                 
 
    612,715       (309,192 )     303,523  
Less accumulated depreciation and amortization
    (336,240 )     336,240        
 
                 
 
    276,475       27,048       303,523  
 
                 
Intangible assets, net
    55,629       753,424       809,053  
Deferred financing costs
          77,411       77,411  
Other assets
    35,589       27,570       63,159  
Goodwill
    201,552       1,638,181       1,839,733  
 
                 
 
    292,770       2,496,586       2,789,356  
 
                 
Total assets
  $ 1,119,047     $ 2,337,581     $ 3,456,628  
 
                 
 
                       
LIABILITIES AND STOCKHOLDERS’ EQUITY
                       
Current liabilities:
                       
Trade accounts payable
  $ 87,854     $ (753 )   $ 87,101  
Current portion of long-term debt
          10,875       10,875  
Income taxes payable
    11,355       3,611       14,966  
Accrued expenses and other liabilities
    170,444       531       170,975  
 
                 
Total current liabilities
    269,653       14,264       283,917  
 
                 
Long-term debt
          2,374,125       2,374,125  
Deferred tax liability
    21,534       131,279       152,813  
Deferred rent expense
    26,808       (26,808 )      
Unfavorable lease obligations and other liabilities
    8,981       41,117       50,098  
 
                 
 
    57,323       2,519,713       2,577,036  
 
                 
Stockholders’ equity
    792,071       (196,396 )     595,675  
 
                 
Total liabilities and stockholders’ equity
  $ 1,119,047     $ 2,337,581     $ 3,456,628  
 
                 

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The unaudited pro forma results of operations provided below for the nine months ended November 3, 2007 are presented below as though the Transactions had occurred at the beginning of the period presented, after giving effect to purchase accounting adjustments relating to depreciation and amortization of the revalued assets, interest expense associated with the credit facility and the notes and other acquisition-related adjustments in connection with the Transactions. The pro forma results of operations are not necessarily indicative of the combined results that would have occurred had the Transactions been consummated at the beginning of the period presented, nor are they necessarily indicative of future operating results (in thousands):
         
    Nine Months  
    Ended  
    November 3, 2007  
Net sales
  $ 1,063,455  
Depreciation and amortization
    68,441  
Transaction-related costs
    3,261  
Operating income
    98,902  
Interest expense, net
    162,551  
Loss before income taxes
    (63,649 )
Net loss
    (32,536 )
3. Significant Accounting Policies
Recent Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 157, “Fair Value Measurements”. The Statement establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosure about fair value measurements. This Statement does not require any new fair value measurement and applies to financial statements issued for fiscal years beginning after November 15, 2007 with early application encouraged. Certain provisions of the Statement were effective for the Company on February 3, 2008, while the effective date of other provisions relating to nonfinancial assets and nonfinancial liabilities will be effective in the fiscal year beginning February 1, 2009. The adoption of this Statement on February 3, 2008 required additional financial statement disclosure and did not have an impact on the Company’s financial position, results of operations or cash flows. The adoption on February 1, 2009 of the Statement’s provisions relating to nonfinancial assets and nonfinancial liabilities is not expected to have a material impact on the Company’s financial position, results of operations or cash flows.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115”. SFAS No. 159 permits entities to choose to measure certain financial assets and liabilities at fair value. Unrealized gains and losses, arising subsequent to adoption, are reported in earnings. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company adopted SFAS No. 159 effective February 3, 2008, and elected not to measure any of our eligible financial assets or liabilities at fair value upon adoption.
During December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations”. SFAS No. 141R will modify how business acquisitions are accounted for both on the acquisition date and in subsequent periods. The Company will be required to apply the provisions of the new Statement to acquisitions that close in the fiscal year beginning February 1, 2009. The adoption of this statement will affect the accounting for future acquisitions entered into by the Company. This statement will require the Company to account for adjustments to acquired tax liabilities and unrecognized tax benefits as elements of income tax expense instead of increases or decreases to goodwill.

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In December 2007, the Securities and Exchange Commission issued Staff Accounting Bulletin (“SAB”) No. 110, which allows the continued use of the simplified method discussed in SAB No. 107 in developing an estimate of the expected term of certain share options. SAB No. 107 did not provide for the use of the simplified method after December 31, 2007. The adoption of SAB No. 110 did not have a material impact on the Company’s financial position, results of operations or cash flows.
During April 2008, the FASB issued FASB Staff Position (“FSP”) FAS 142-3, “Determination of the Useful Life of Intangible Assets”. This FSP, which applies to intangible assets accounted for pursuant to SFAS No. 142, provides guidance for the development of renewal or extension assumptions used to determine the useful life of an intangible asset. The Company must adopt the FSP for its fiscal year beginning February 1, 2009. The adoption of this FSP is not expected to have a material impact on the Company’s financial position, results of operations or cash flows.
During June 2008, the Emerging Issues Task Force issued EITF 08-3, “Accounting by Lessees for Nonrefundable Maintenance Deposits”. Issue 08-3 requires lessees to account for nonrefundable maintenance deposits as deposits if it is probable that maintenance activities will occur and the deposit is realizable. Amounts on deposit that are not probable of being used to fund future maintenance activities should be charged to expense. Issue 08-3 is effective for fiscal years beginning after December 15, 2008. The adoption of Issue 08-3 is not expected to have a material impact on the Company’s financial position, results of operations or cash flows.
4. 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 Europe. The Company accounts, within its North American division, for the goods it sells to third parties under franchising agreements within “Net sales” and “Cost of sales, occupancy and buying expenses” in the Company’s Unaudited Condensed Consolidated Statements of Operations and Comprehensive Loss. The franchise fees the Company charges, within its European division, under the franchising agreements are reported in “Other income” in the Company’s Unaudited Condensed Consolidated Statements of Operations and Comprehensive Loss.
Information about the Company’s operations by segment is as follows (in thousands):
                                         
    Successor Entity     Predecessor Entity  
    Three Months     Three Months     Nine Months     May 29, 2007     February 4, 2007  
    Ended     Ended     Ended     Through     Through  
    Nov. 1, 2008     Nov. 3, 2007     Nov. 1, 2008     Nov. 3, 2007     May 28, 2007  
Net sales:
                                       
North America
  $ 211,873     $ 232,011     $ 643,893     $ 413,924     $ 292,483  
Europe
    121,098       125,355       376,054       224,632       132,416  
 
                             
Total net sales
    332,971       357,366       1,019,947       638,556       424,899  
 
                             
 
                                       
Depreciation and amortization:
                                       
North America
    13,356       20,057       42,758       29,173       12,823  
Europe
    6,668       6,371       21,928       10,425       6,829  
 
                             
Total depreciation and amortization
    20,024       26,428       64,686       39,598       19,652  
 
                             
 
                                       
Operating income (loss) for reportable segments
                                       
North America
    11,642       16,422       30,871       42,671       46,569  
Europe
    3,817       11,839       12,006       22,990       (766 )
 
                             
Operating income (loss) for reportable segments
    15,459       28,261       42,877       65,661       45,803  
Transaction-related costs
    (569 )     1,200       5,695       3,261       72,672  
 
                             
Total consolidated operating income (loss)
    16,028       27,061       37,182       62,400       (26,869 )
Interest expense (income), net
    50,462       56,322       147,858       92,250       (4,876 )
 
                             
Total consolidated loss before income taxes
  $ (34,434 )   $ (29,261 )   $ (110,676 )   $ (29,850 )   $ (21,993 )
 
                             

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Excluded from operating income (loss) for the North American segment are transaction-related costs of approximately $(0.6) million, $1.0 million, $3.7 million, $2.1 million and $71.8 million for the three months ended November 1, 2008, the three months ended November 3, 2007, the nine months ended November 1, 2008, the period from May 29, 2007 through November 3, 2007, and the period from February 4, 2007 through May 28, 2007, respectively.
Excluded from operating income (loss) for the European segment are transaction-related costs of approximately $0.0 million, $0.2 million, $2.0 million, $1.2 million and $0.9 million for the three months ended November 1, 2008, the three months ended November 3, 2007, the nine months ended November 1, 2008, the period from May 29, 2007 through November 3, 2007, and the period from February 4, 2007 through May 28, 2007, respectively.
5. Long-Term Debt and Revolving Credit Facility
On May 14, 2008, the Company elected to pay interest in kind on its 9.625%/10.375% Senior Toggle Notes due 2015. The election is for the interest period from June 1, 2008 through November 30, 2008. Payment in kind interest accrued during the three and nine months ended November 1, 2008 of approximately $9.1 and $15.1 million, respectively, is included in long-term debt in the Unaudited Condensed Consolidated Balance Sheets. On December 1, 2008, the Company increased the principal amount outstanding on the Senior Toggle Notes by $18.2 million in satisfaction of interest paid in kind for the interest period from June 1, 2008 through November 30, 2008. It is the Company’s current intention to pay interest in kind on the Senior Toggle Notes for all interest periods through June 1, 2011.
The Company drew down the remaining $194.0 million available under its Revolving Credit Facility (the “Revolver”) during the three months ended November 1, 2008. The Company may pay all or portions of the Revolver at its discretion until the expiration of the facility on May 29, 2013. The interest rate on the Revolver on November 1, 2008 was 5.25%.
6. Stock Options and Stock-Based Compensation
The following is a summary of activity in the Company’s stock option plan for the nine months ended November 1, 2008:
                                 
                    Weighted        
            Weighted     Average        
            Average     Remaining     Aggregate  
    Number of     Exercise     Contractual     Intrinsic  
    Shares     Price     Life (Years)     Value  
Outstanding at beginning of period
    6,142,622     $ 10.00       6.4        
Options granted
    1,717,550     $ 10.00              
Options exercised
                       
Options forfeited
    (1,465,240 )   $ 10.00              
Options expired
                       
 
                             
Outstanding at end of period
    6,394,932     $ 10.00       5.7        
 
                             
 
                               
Exercisable at end of period
    1,337,128     $ 10.00       5.7        
The weighted average grant date fair value of options granted during the nine months ended November 1, 2008 was $4.21.
During the three and nine months ended November 1, 2008, the Company recorded approximately $2.2 million and $6.1 million of additional paid-in capital relating to stock-based compensation, respectively.

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7. Income Taxes
The effective income tax benefit rate was 37.4% and 33.1% for the three and nine months ended November 1, 2008, respectively. These effective income tax benefit rates differed from the statutory federal tax rate of 35% due to the overall geographic mix of losses in jurisdictions with higher tax rates and income in jurisdictions with lower tax rates, offset by the accrual of U.S. tax expense on current foreign earnings and other factors.
The effective income tax rate was 52.8%, 51.0% and (99.0%) for the three months ended November 3, 2007, the period from May 29, 2007 through November 3, 2007 and the period from February 4, 2007 through May 28, 2007, respectively. These effective income tax rates differed from the statutory federal tax rate of 35% due to the overall geographic mix of losses in jurisdictions with higher tax rates and income in jurisdictions with lower tax rates, the tax expense associated with non-deductible transaction costs, the repatriation of foreign earnings to fund, in part, the acquisition of the Company and other factors.
8. Fair Value of Financial Instruments
At November 1, 2008, the fair value and carrying value of the Company’s debt was approximately $1,039 million and approximately $2,576 million, respectively. At November 1, 2008, the fair value and carrying value of the Company’s interest rate swaps approximated $18.1 million.
The following table summarizes the Company’s assets (liabilities) measured at fair value on a recurring basis (in thousands):
                         
    Fair Value Measurements at November 1, 2008 Using  
    Quoted Prices in              
    Active Markets for     Significant     Significant  
    Identical Assets     Other Observable     Unobservable  
    (Liabilities)     Inputs     Inputs  
    (Level 1)     (Level 2)     (Level 3)  
Interest rate swaps
  $     $ 18,069     $  
 
                 
The fair value of the Company’s interest rate swaps represents the estimated amounts the Company would pay to terminate those contracts at the reporting date based upon pricing or valuation models applied to current market information. The interest rate swaps are valued using the market standard methodology of netting the discounted future fixed cash payments and the discounted expected variable cash receipts. The variable cash receipts are based on an expectation of future interest rates derived from observed market interest rate curves.
9. Commitments and Contingencies
The Company is, from time to time, involved in litigation incidental to the conduct of its business, including personal injury litigation, litigation regarding merchandise sold, including product and safety concerns regarding metal content in merchandise, litigation with respect to various employment matters, including litigation with present and former employees, wage and hour litigation, and litigation to protect trademark rights. The Company believes that current pending litigation will not have a material adverse effect on its consolidated financial position, earnings or cash flows.
10. Supplemental Financial Information
On May 29, 2007, Claire’s Stores, Inc. (the “Issuer”), issued $935.0 million in senior notes, senior toggle notes and senior subordinated notes. These notes are irrevocably and unconditionally guaranteed, jointly and severally, by all wholly-owned domestic current and future subsidiaries of Claire’s Stores, Inc. that guarantee the Company’s senior secured credit facility (the “Guarantors”). The Company’s other subsidiaries, principally its international subsidiaries including our European, Asian and Canadian subsidiaries, (the “Non-Guarantors”) are not guarantors of these notes.

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The following tables present the condensed consolidating financial information for the Issuer, the Guarantors and the Non-Guarantors, together with eliminations, as of and for the periods indicated. The consolidating financial information may not necessarily be indicative of the financial position, results of operations or cash flows had the Issuer, Guarantors and Non-Guarantors operated as independent entities.
Condensed Consolidating Balance Sheet
November 1, 2008
(in thousands)

 
                                         
                    Non-              
    Issuer     Guarantors     Guarantors     Eliminations     Consolidated  
ASSETS
                                       
Current assets:
                                       
Cash and cash equivalents
  $ 155,382     $ (2,237 )   $ 40,752     $     $ 193,897  
Inventories
          107,216       41,362             148,578  
Prepaid expenses
    957       15,343       20,983             37,283  
Other current assets
    8       33,733       13,582             47,323  
 
                             
Total current assets
    156,347       154,055       116,679             427,081  
 
                             
Property and equipment:
                                       
Land and building
          22,288                   22,288  
Furniture, fixtures and equipment
    2,061       101,089       39,222             142,372  
Leasehold improvements
    1,630       137,619       77,835             217,084  
 
                             
 
    3,691       260,996       117,057             381,744  
Less accumulated depreciation and amortization
    (1,100 )     (68,216 )     (32,497 )           (101,813 )
 
                             
 
    2,591       192,780       84,560             279,931  
 
                             
 
                                       
Intercompany receivables
    39,069             36,779       (75,848 )      
Investment in subsidiaries
    2,438,855       (3,820 )           (2,435,035 )      
Intangible assets, net
    421,313       19,580       349,107             790,000  
Deferred financing costs, net
    62,580                         62,580  
Other assets
    35,387       1,876       31,964             69,227  
Goodwill
          1,409,940       431,406             1,841,346  
 
                             
 
    2,997,204       1,427,576       849,256       (2,510,883 )     2,763,153  
 
                             
Total assets
  $ 3,156,142     $ 1,774,411     $ 1,050,495     $ (2,510,883 )   $ 3,470,165  
 
                             
 
                                       
LIABILITIES AND STOCKHOLDER’S EQUITY
                                       
Current liabilities:
                                       
Trade accounts payable
  $ 4,206     $ 30,395     $ 47,958     $     $ 82,559  
Current portion of long-term debt
    14,500                         14,500  
Income taxes payable
                5,948             5,948  
Accrued interest payable
    38,390             13             38,403  
Accrued expenses and other liabilities
    30,088       36,003       39,111             105,202  
 
                             
Total current liabilities
    87,184       66,398       93,030             246,612  
 
                             
Intercompany payables
          75,848             (75,848 )      
Long-term debt
    2,367,505                         2,367,505  
Revolving credit facility
    194,000                         194,000  
Deferred tax liability
          77,094       16,182             93,276  
Deferred rent expense
    837       10,971       4,981             16,789  
Unfavorable lease obligations and other liabilities
          40,679       4,688             45,367  
 
                             
 
    2,562,342       204,592       25,851       (75,848 )     2,716,937  
 
                             
 
                                       
Stockholder’s equity:
                                       
Common stock
          367       2       (369 )      
Additional paid in capital
    607,354       1,445,795       876,748       (2,322,543 )     607,354  
Accumulated other comprehensive loss, net of tax
    (27,324 )     (2,126 )     (17,283 )     19,409       (27,324 )
Retained earnings (deficit)
    (73,414 )     59,385       72,147       (131,532 )     (73,414 )
 
                             
 
    506,616       1,503,421       931,614       (2,435,035 )     506,616  
 
                             
Total liabilities and stockholder’s equity
  $ 3,156,142     $ 1,774,411     $ 1,050,495     $ (2,510,883 )   $ 3,470,165  
 
                             

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Condensed Consolidating Balance Sheet
February 2, 2008
(in thousands)

 
                                         
                    Non-              
    Issuer     Guarantors     Guarantors     Eliminations     Consolidated  
ASSETS
                                       
Current assets:
                                       
Cash and cash equivalents
  $ 25,835     $ 1,892     $ 58,247     $     $ 85,974  
Inventories
          84,952       32,727             117,679  
Prepaid expenses
    403       15,264       21,648             37,315  
Other current assets
    100       31,501       6,057             37,658  
 
                             
Total current assets
    26,338       133,609       118,679             278,626  
 
                             
Property and equipment:
                                       
Land and building
          22,288                   22,288  
Furniture, fixtures and equipment
    2,050       83,924       44,156             130,130  
Leasehold improvements
    1,628       127,522       82,013             211,163  
 
                             
 
    3,678       233,734       126,169             363,581  
Less accumulated depreciation and amortization
    (609 )     (34,615 )     (18,748 )           (53,972 )
 
                             
 
    3,069       199,119       107,421             309,609  
 
                             
Intercompany receivables
    20,198             13       (20,211 )      
Investment in subsidiaries
    2,452,074       5,764             (2,457,838 )      
Intangible assets, net
    423,000       300       353,830             777,130  
Deferred financing costs, net
    70,511                         70,511  
Other assets
    35,124       1,269       35,361             71,754  
Goodwill
          1,401,959       438,908             1,840,867  
 
                             
 
    3,000,907       1,409,292       828,112       (2,478,049 )     2,760,262  
 
                             
Total assets
  $ 3,030,314     $ 1,742,020     $ 1,054,212     $ (2,478,049 )   $ 3,348,497  
 
                             
 
                                       
LIABILITIES AND STOCKHOLDER’S EQUITY
                                       
Current liabilities:
                                       
Trade accounts payable
  $ 762     $ 22,140     $ 33,187     $     $ 56,089  
Current portion of long-term debt
    14,500                           14,500  
Income taxes payable
    (8,383 )     14,246       6,328             12,191  
Accrued interest payable
    19,534             2               19,536  
Accrued expenses and other liabilities
    34,194       39,737       43,145             117,076  
 
                             
Total current liabilities
    60,607       76,123       82,662             219,392  
 
                             
Intercompany payables
          20,211             (20,211 )      
Long-term debt
    2,363,250                           2,363,250  
Deferred tax liability
          120,742       18,764             139,506  
Deferred rent expense
    1,257       5,350       3,965             10,572  
Unfavorable lease obligations and other liabilities
          10,577                   10,577  
 
                             
 
    2,364,507       156,880       22,729       (20,211 )     2,523,905  
 
                             
 
                                       
Stockholder’s equity:
                                       
Common stock
          367       2       (369 )      
Additional paid in capital
    601,201       1,449,307       878,145       (2,327,452 )     601,201  
Accumulated other comprehensive income, net of tax
    3,358       2,959       17,513       (20,472 )     3,358  
Retained earnings
    641       56,384       53,161       (109,545 )     641  
 
                             
 
    605,200       1,509,017       948,821       (2,457,838 )     605,200  
 
                             
Total liabilities and stockholder’s equity
  $ 3,030,314     $ 1,742,020     $ 1,054,212     $ (2,478,049 )   $ 3,348,497  
 
                             

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Successor Entity
Condensed Consolidating Statement of Operations and Comprehensive Loss
For The Three Months Ended November 1, 2008
(in thousands)

 
                                         
                    Non-              
    Issuer     Guarantors     Guarantors     Eliminations     Consolidated  
Net sales
  $     $ 422,260     $ 136,281     $ (225,570 )   $ 332,971  
Cost of sales, occupancy and buying expenses
          330,020       66,529       (225,570 )     170,979  
 
                             
Gross profit
          92,240       69,752             161,992  
 
                             
Other expenses (income):
                                       
Selling, general and administrative
    8,108       66,553       54,460             129,121  
Depreciation and amortization
    733       11,735       7,556             20,024  
Transaction-related costs
    (569 )                       (569 )
Other (income) expense
    (7,608 )     6,857       (1,861 )           (2,612 )
 
                             
 
    664       85,145       60,155             145,964  
 
                             
 
                                       
Operating income (loss)
    (664 )     7,095       9,597             16,028  
Interest expense (income), net
    50,703       (46 )     (195 )           50,462  
 
                             
Income (loss) before income taxes
    (51,367 )     7,141       9,792             (34,434 )
Income tax expense (benefit)
    (26,135 )     11,347       1,908             (12,880 )
 
                             
Income (loss) from continuing operations
    (25,232 )     (4,206 )     7,884             (21,554 )
Equity in earnings of subsidiaries
    3,678       2,646             (6,324 )      
 
                             
Net income (loss)
    (21,554 )     (1,560 )     7,884       (6,324 )     (21,554 )
Foreign currency translation and interest rate swap adjustments
    (42,827 )     (5,124 )     (40,587 )     45,711       (42,827 )
 
                             
Comprehensive loss
  $ (64,381 )   $ (6,684 )   $ (32,703 )   $ 39,387     $ (64,381 )
 
                             
 
Successor Entity
Condensed Consolidating Statement of Operations and Comprehensive Income (Loss)
For The Three Months Ended November 3, 2007
(in thousands)

 
                                         
                    Non-              
    Issuer     Guarantors     Guarantors     Eliminations     Consolidated  
Net sales
  $     $ 468,643     $ 140,612     $ (251,889 )   $ 357,366  
Cost of sales, occupancy and buying expenses
          361,073       67,031       (251,889 )     176,215  
 
                             
Gross profit
          107,570       73,581             181,151  
 
                             
Other expenses (income):
                                       
Selling, general and administrative
    7,327       68,394       52,051             127,772  
Depreciation and amortization
    1,546       17,378       7,504             26,428  
Transaction-related costs
    1,000             200             1,200  
Other (income) expense
    (4,362 )     3,896       (844 )           (1,310 )
 
                             
 
    5,511       89,668       58,911             154,090  
 
                             
Operating income (loss)
    (5,511 )     17,902       14,670             27,061  
Interest expense (income), net
    56,838       (86 )     (430 )           56,322  
 
                             
Income (loss) before income taxes
    (62,349 )     17,988       15,100             (29,261 )
Income tax expense (benefit)
    (24,212 )     9,745       (982 )           (15,449 )
 
                             
Income (loss) from continuing operations
    (38,137 )     8,243       16,082             (13,812 )
Equity in earnings of subsidiaries
    24,325       863             (25,188 )      
 
                             
Net income (loss)
    (13,812 )     9,106       16,082       (25,188 )     (13,812 )
Foreign currency translation and interest rate swap adjustments
    9,242       3,567       14,242       (17,809 )     9,242  
 
                             
Comprehensive income (loss)
  $ (4,570 )   $ 12,673     $ 30,324     $ (42,997 )   $ (4,570 )
 
                             

14


Table of Contents

Successor Entity
Condensed Consolidating Statement of Operations and Comprehensive Income (Loss)
For The Nine Months Ended November 1, 2008
(in thousands)

 
                                         
                    Non-              
    Issuer     Guarantors     Guarantors     Eliminations     Consolidated  
Net sales
  $     $ 1,173,323     $ 420,993     $ (574,369 )   $ 1,019,947  
Cost of sales, occupancy and buying expenses
          889,345       208,252       (574,369 )     523,228  
 
                             
Gross profit
          283,978       212,741             496,719  
 
                             
Other expenses (income):
                                       
Selling, general and administrative
    24,969       200,364       167,544             392,877  
Depreciation and amortization
    2,244       37,648       24,794             64,686  
Transaction-related costs
    3,737             1,958             5,695  
Other (income) expense
    (16,765 )     15,189       (2,145 )           (3,721 )
 
                             
 
    14,185       253,201       192,151             459,537  
 
                             
Operating income (loss)
    (14,185 )     30,777       20,590             37,182  
Interest expense (income), net
    148,922       (300 )     (764 )           147,858  
 
                             
Income (loss) before income taxes
    (163,107 )     31,077       21,354             (110,676 )
Income tax expense (benefit)
    (64,201 )     29,150       (1,570 )           (36,621 )
 
                             
Income (loss) from continuing operations
    (98,906 )     1,927       22,924             (74,055 )
Equity in earnings of subsidiaries
    24,851       4,878             (29,729 )      
 
                             
Net income (loss)
    (74,055 )     6,805       22,924       (29,729 )     (74,055 )
Foreign currency translation and interest rate swap adjustments
    (30,682 )     (5,085 )     (34,147 )     39,232       (30,682 )
 
                             
Comprehensive income (loss)
  $ (104,737 )   $ 1,720     $ (11,223 )   $ 9,503     $ (104,737 )
 
                             
Successor Entity
Condensed Consolidating Statement of Operations and Comprehensive Income (Loss)
For The Period May 29, 2007 Through November 3, 2007
(in thousands)

 
                                         
                    Non-              
    Issuer     Guarantors     Guarantors     Eliminations     Consolidated  
Net sales
  $     $ 778,114     $ 252,946     $ (392,504 )   $ 638,556  
Cost of sales, occupancy and buying expenses
          586,521       120,473       (392,504 )     314,490  
 
                             
Gross profit
          191,593       132,473             324,066  
 
                             
Other expenses (income):
                                       
Selling, general and administrative
    11,816       117,741       90,956             220,513  
Depreciation and amortization
    2,598       24,818       12,182             39,598  
Transaction-related costs
    2,042             1,219             3,261  
Other (income) expense
    (5,164 )     5,039       (1,581 )           (1,706 )
 
                             
 
    11,292       147,598       102,776             261,666  
 
                             
Operating income (loss)
    (11,292 )     43,995       29,697             62,400  
Interest expense (income), net
    93,423       (588 )     (585 )           92,250  
 
                             
Income (loss) before income taxes
    (104,715 )     44,583       30,282             (29,850 )
Income tax expense (benefit)
    (39,688 )     22,467       1,990             (15,231 )
 
                             
Income (loss) from continuing operations
    (65,027 )     22,116       28,292             (14,619 )
Equity in earnings of subsidiaries
    50,408       3,106             (53,514 )      
 
                             
Net income (loss)
    (14,619 )     25,222       28,292       (53,514 )     (14,619 )
Foreign currency translation and interest rate swap adjustments
    12,987       3,840       19,399       (23,239 )     12,987  
 
                             
Comprehensive income (loss)
  $ (1,632 )   $ 29,062     $ 47,691     $ (76,753 )   $ (1,632 )
 
                             

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Table of Contents

Predecessor Entity
Condensed Consolidating Statement of Operations and Comprehensive Income (Loss)
For The Period February 4, 2007 Through May 28, 2007
(in thousands)

 
                                         
                    Non-              
    Issuer     Guarantors     Guarantors     Eliminations     Consolidated  
Net sales
  $     $ 540,394     $ 149,666     $ (265,161 )   $ 424,899  
Cost of sales, occupancy and buying expenses
          397,435       74,164       (265,161 )     206,438  
 
                             
Gross profit
          142,959       75,502             218,461  
 
                             
Other expenses (income):
                                       
Selling, general and administrative
    7,021       84,633       62,828             154,482  
Depreciation and amortization
    367       11,504       7,781             19,652  
Transaction-related costs
    72,672                         72,672  
Other (income) expense
    (8,054 )     5,926       652             (1,476 )
 
                             
 
    72,006       102,063       71,261             245,330  
 
                             
Operating income (loss)
    (72,006 )     40,896       4,241             (26,869 )
Interest expense (income), net
    (3,235 )     (376 )     (1,265 )           (4,876 )
 
                             
Income (loss) before income taxes
    (68,771 )     41,272       5,506             (21,993 )
Income tax expense (benefit)
    8,369       15,361       (1,951 )           21,779  
 
                             
Income (loss) from continuing operations
    (77,140 )     25,911       7,457             (43,772 )
Equity in earnings of subsidiaries
    33,368       2,775             (36,143 )      
 
                             
Net income (loss)
    (43,772 )     28,686       7,457       (36,143 )     (43,772 )
Foreign currency translation
    8,440       2,861       8,478       (11,339 )     8,440  
 
                             
Comprehensive income (loss)
  $ (35,332 )   $ 31,547     $ 15,935     $ (47,482 )   $ (35,332 )
 
                             
Successor Entity
Condensed Consolidating Statement of Cash Flows
For The Nine Months Ended November 1, 2008
(in thousands)

 
                                         
                    Non-              
    Issuer     Guarantors     Guarantors     Eliminations     Consolidated  
Cash flows from operating activities:
                                       
Net income (loss)
  $ (74,055 )   $ 6,805     $ 22,924     $ (29,729 )   $ (74,055 )
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
                                       
Equity in earnings of subsidiaries
    (24,851 )     (4,878 )           29,729        
Depreciation and amortization
    2,244       37,648       24,794             64,686  
Amortization of lease rights and other assets
          41       1,552             1,593  
Amortization of debt issuance costs
    7,931                         7,931  
Payment in kind interest expense
    15,130                         15,130  
Net accretion of favorable (unfavorable) lease obligations
          (1,520 )     406             (1,114 )
(Gain) loss on sale/retirement of property and equipment and other assets, net
          7       (222 )           (215 )
Gain on sale of intangible assets
                (1,446 )             (1,446 )
Stock compensation expense
    4,516             1,637             6,153  
(Increase) decrease in:
                                       
Inventories
          (22,265 )     (15,439 )           (37,704 )
Prepaid expenses
    (553 )     (79 )     (4,357 )           (4,989 )
Other assets
    (137 )     (3,232 )     (231 )           (3,600 )
Increase (decrease) in:
                                       
Trade accounts payable
    3,444       8,255       20,175             31,874  
Income taxes payable
    8,383       (17,468 )     (5,466 )           (14,551 )
Accrued expenses and other liabilities
    2,455       (3,056 )     3,464             2,863  
Accrued interest payable
    18,855             12             18,867  
Deferred income taxes
          (35,756 )     (2,448 )           (38,204 )
Deferred rent expense
    (122 )     5,621       1,838             7,337  
 
                             
Net cash provided by (used in) operating activities
    (36,760 )     (29,877 )     47,193             (19,444 )
 
                             
Cash flows from investing activities:
                                       
Acquisition of property and equipment, net
    (78 )     (31,307 )     (13,882 )           (45,267 )
Acquisition of intangible assets/lease rights
                (1,273 )           (1,273 )
 
                             
Net cash used in investing activities
    (78 )     (31,307 )     (15,155 )           (46,540 )
 
                             
Cash flows from financing activities:
                                       
Proceeds from credit facility
    194,000                         194,000  
Credit facility payments
    (10,875 )                       (10,875 )
Intercompany activity, net
    (16,740 )     57,413       (40,673 )            
 
                             
Net cash provided by (used in) financing activities
    166,385       57,413       (40,673 )           183,125  
 
                             
Effect of foreign currency exchange rate changes on cash and cash equivalents
          (358 )     (8,860 )           (9,218 )
 
                             
Net increase (decrease) in cash and cash equivalents
    129,547       (4,129 )     (17,495 )           107,923  
Cash and cash equivalents at beginning of period
    25,835       1,892       58,247             85,974  
 
                             
Cash and cash equivalents at end of period
  $ 155,382     $ (2,237 )   $ 40,752     $     $ 193,897  
 
                             

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Table of Contents

Successor Entity
Condensed Consolidating Statement of Cash Flows
For The Period May 29, 2007 through November 3, 2007
(in thousands)

 
                                         
                    Non-              
    Issuer     Guarantors     Guarantors     Eliminations     Consolidated  
Cash flows from operating activities:
                                       
Net income (loss)
  $ (14,619 )   $ 25,222     $ 28,292     $ (53,514 )   $ (14,619 )
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
                                       
Equity in earnings of subsidiaries
    (50,408 )     (3,106 )           53,514        
Depreciation and amortization
    2,598       24,818       12,182             39,598  
Amortization of lease rights and other assets
          24       765             789  
Amortization of debt issuance costs
    4,421                         4,421  
Loss on sale/retirement of property and equipment, net
          265       134             399  
Stock compensation expense
    2,832                         2,832  
(Increase) decrease in:
                                       
Inventories
          (16,058 )     (4,637 )           (20,695 )
Prepaid expenses
    328       (12,578 )     2,574             (9,676 )
Other assets
    10,681       (864 )     (35,073 )           (25,256 )
Increase (decrease) in:
                                       
Trade accounts payable
    (649 )     1,728       (7,217 )           (6,138 )
Income taxes payable
    (3,978 )     6,805       (2,208 )           619  
Accrued expenses and other liabilities
    (80,810 )     6,805       12,503             (61,502 )
Accrued interest payable
    49,308             13             49,321  
Deferred income taxes
          (21,086 )     (311 )           (21,397 )
Deferred rent expense
          3,157       694             3,851  
 
                             
Net cash provided by (used in) operating activities
    (80,296 )     15,132       7,711             (57,453 )
 
                             
Cash flows from investing activities:
                                       
Acquisition of property and equipment, net
    (142 )     (28,271 )     (14,254 )           (42,667 )
Acquisition of predecessor entity
    (2,877,176 )     (78,642 )     (89,429 )           (3,045,247 )
Acquisition of intangible assets/lease rights
          (58 )     (1,612 )           (1,670 )
 
                             
Net cash used in investing activities
    (2,877,318 )     (106,971 )     (105,295 )           (3,089,584 )
 
                             
Cash flows from financing activities:
                                       
Credit facility proceeds
    1,450,000                         1,450,000  
Credit facility payments
    (3,625 )                       (3,625 )
Note offerings proceeds
    935,000                         935,000  
Capital contribution
    595,675                         595,675  
Option conversion payment
    (7,924 )                       (7,924 )
Financing fees paid
    (77,561 )                       (77,561 )
Dividends paid
    (7,252 )                       (7,252 )
Intercompany activity, net
    (105,023 )     (37,451 )     142,474              
 
                             
Net cash provided by (used in) financing activities
    2,779,290       (37,451 )     142,474             2,884,313  
 
                             
Effect of foreign currency exchange rate changes on cash and cash equivalents
    (5,231 )     (153 )     (4,330 )           (9,714 )
 
                             
Net increase (decrease) in cash and cash equivalents
    (183,555 )     (129,443 )     40,560             (272,438 )
Cash and cash equivalents at beginning of period
    188,407       131,210       30,859             350,476  
 
                             
Cash and cash equivalents at end of period
  $ 4,852     $ 1,767     $ 71,419     $     $ 78,038  
 
                             

17


Table of Contents

Predecessor Entity
Condensed Consolidating Statement of Cash Flows
For The Period February 4, 2007 Through May 28, 2007
(in thousands)

 
                                         
                    Non-              
    Issuer     Guarantors     Guarantors     Eliminations     Consolidated  
Cash flows from operating activities:
                                       
Net income (loss)
  $ (43,772 )   $ 28,686     $ 7,457     $ (36,143 )   $ (43,772 )
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
                                       
Equity in earnings of subsidiaries
    (33,368 )     (2,775 )           36,143        
Depreciation and amortization
    367       11,504       7,781             19,652  
Amortization of lease rights and other assets
          39       583             622  
Impairment of intangible assets
                73             73  
Loss on retirement of property and equipment, net
          873       328             1,201  
Excess tax benefit from stock compensation
    (2,885 )                       (2,885 )
Stock compensation expense
    8,946                         8,946  
(Increase) decrease in:
                                       
Inventories
          (9,551 )     (1,381 )           (10,932 )
Prepaid expenses
    465       11,266       (5,342 )           6,389  
Other assets
    (941 )     1,164       (3,164 )           (2,941 )
Increase (decrease) in:
                                       
Trade accounts payable
    (90 )     7,490       23,802             31,202  
Income taxes payable
    3,754       (9,903 )     (5,583 )           (11,732 )
Accrued expenses and other liabilities
    54,909       (8,666 )     (6,516 )           39,727  
Deferred income taxes
          7,015       (292 )           6,723  
Deferred rent expense
          634       (261 )           373  
 
                             
Net cash provided by (used in) operating activities
    (12,615 )     37,776       17,485             42,646  
 
                             
Cash flows from investing activities:
                                       
Acquisition of property and equipment, net
    (171 )     (18,822 )     (8,995 )           (27,988 )
Acquisition of intangible assets/lease rights
          (20 )     (61 )           (81 )
 
                             
Net cash used in investing activities
    (171 )     (18,842 )     (9,056 )           (28,069 )
 
                             
Cash flows from financing activities:
                                       
Stock option proceeds
    177                         177  
Excess tax benefit from stock compensation
    2,885                         2,885  
Dividends paid
    (9,065 )                       (9,065 )
Intercompany activity, net
    13,118       96,485       (109,603 )            
 
                             
Net cash provided by (used in) financing activities
    7,115       96,485       (109,603 )           (6,003 )
 
                             
Effect of foreign currency exchange rate changes on cash and cash equivalents
    (20 )     (16 )     1,061             1,025  
 
                             
Net increase (decrease) in cash and cash equivalents
    (5,691 )     115,403       (100,113 )           9,599  
Cash and cash equivalents at beginning of period
    194,098       15,807       130,972             340,877  
 
                             
Cash and cash equivalents at end of period
  $ 188,407     $ 131,210     $ 30,859     $     $ 350,476  
 
                             
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, and significant accounting policies and critical estimates. Management’s Discussion and Analysis should be read in conjunction with the Unaudited Condensed Consolidated Financial Statements and related notes thereto contained elsewhere in this document.
Our fiscal year ends on the Saturday closest to January 31. In prior years, we referred to the fiscal year ended February 2, 2008 as “Fiscal 2008”. Effective with the three month period ended May 3, 2008, we now refer to the fiscal year ended February 2, 2008 as “Fiscal 2007”. The current fiscal year ending January 31, 2009 is referred to as “Fiscal 2008.” All such terms used herein have been revised for this change.

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We include a store in the calculation of same store sales once it has been in operation sixty weeks after its initial opening. A store which is temporarily closed, such as for remodeling, is removed from the same store sales computation if it is closed for nine consecutive weeks. The removal is effective prospectively upon the completion of the ninth consecutive week of closure. A store which is closed permanently, such as upon termination of the lease, is immediately removed from the same store sales computation.
Business Overview
We believe we are the world’s largest specialty retailer of value-priced, fashion-right costume jewelry and accessories focusing on girls and young women in the 7 to 27 age range. We are organized based on our geographic markets, which include our North American operations and our European operations. As of November 1, 2008, we operated a total of 3,074 stores, of which 2,144 were located in all 50 states of the United States, Puerto Rico, Canada, and the U.S. Virgin Islands (our North American operations) and 930 stores were located in Europe (our European operations). Our stores are operated mainly under the trade names “Claire’s” and “Icing.”
In addition, as of November 1, 2008, we had 188 stores in the Middle East, Turkey, Russia, South Africa, Poland and Guatemala that operated under franchising agreements. We account in our North America division for the goods we sell under the merchandising agreements with our franchisees within “Net sales” and “Cost of sales, occupancy and buying expenses.” The royalty fees are accounted for within our European division in “Other income” in our Unaudited Condensed Consolidated Statements of Operations and Comprehensive Loss.
As of November 1, 2008, we also operated 209 stores in Japan through our Claire’s Nippon 50:50 joint venture with AEON Co. Ltd. We account for the results of operations of Claire’s Nippon under the equity method. These results are included within our North America division in “Other income” in our Unaudited Condensed Consolidated Statements of Operations and Comprehensive Loss.
Our primary store concept in North America and exclusively in Europe is Claire’s. Our merchandise is designed and intended primarily for the young (ages 13-18), younger (ages 7-12) and youngest (ages 3-6) customers. Our second store concept in North America is Icing, which caters to college students and young women entering the work force between the ages of 19 and 27.
We believe that we are the leading jewelry and accessories destination for our target customers because of our value orientation at competitive prices, our broad selection of merchandise, a fun experience and exciting in-store environment, and excellent customer service.
The differentiation of our Claire’s and Icing concepts allows us to operate multiple store locations within a single mall. In North America, our stores are located primarily in shopping malls and average approximately 1,200 square feet. In Europe and Japan, our stores are located primarily on high streets, in shopping malls and in high traffic urban areas and average approximately 600 square feet.
We also have a substantial organization dedicated to developing and sourcing our products, including our Company-owned and operated Hong Kong sourcing, buying and logistics office, RSI. The majority of our products are manufactured to our specifications through a global network of suppliers and vendors.
Our mission is to be the global leader in our retail niche, offering value-priced, fashion-right costume jewelry and accessories targeted to the life-style and ever-growing disposable income of tweens, teens and young women.

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Consolidated Results of Operations
As a result of the sale of the Company in May 2007, the financial results for the nine month period ended November 3, 2007 have been separately presented in the Unaudited Condensed Consolidated Statements of Operations and Comprehensive Loss. The results have been split between the “Predecessor Entity”, covering the period from February 4, 2007 through May 28, 2007, and the “Successor Entity”, covering the period from May 29, 2007 (the date the sale was consummated) through November 3, 2007. The results for the three and nine month periods ended November 1, 2008 are presented under “Successor Entity”. For comparative purposes, the Company combined the Predecessor Entity and Successor Entity periods in its discussion below of the financial results for the nine month period ended November 3, 2007. This combination is not a generally accepted accounting principles presentation. However, the Company believes this combination is useful to provide the reader a more accurate comparison and is provided to enhance the reader’s understanding of the results of operations for the periods presented.
A summary of our consolidated results of operations is as follows (in thousands):
                 
    Three Months     Three Months  
    Ended     Ended  
    November 1, 2008     November 3, 2007  
Net sales
  $ 332,971     $ 357,366  
Increase (decrease) in same store sales
    (6.3 )%     (0.7 %)
Gross profit percentage
    48.7 %     50.7 %
Selling, general and administrative expenses as a percentage of net sales
    38.8 %     35.8 %
Depreciation and amortization as a percentage of net sales
    6.0 %     7.4 %
Transaction-related costs as a percentage of net sales
    (0.2 )%     0.3 %
Operating income
  $ 16,028     $ 27,061  
Net loss
  $ (21,554 )   $ (13,812 )
Number of stores at the end of the period (1)
    3,074       3,051  
 
(1)   Number of stores excludes stores operated under franchising agreements and joint venture stores.
                                 
    Successor             Successor     Predecessor  
    Entity     Combined     Entity     Entity  
    Nine Months     Nine Months     May 29, 2007     Feb. 4, 2007  
    Ended     Ended     Through     Through  
  Nov. 1, 2008     Nov. 3, 2007     Nov. 3, 2007     May 28, 2007  
Net sales
  $ 1,019,947     $ 1,063,455     $ 638,556     $ 424,899  
Increase (decrease) in same store sales
    (6.8 )%     (0.4 %)     (1.1 %)     0.5 %
Gross profit percentage
    48.7 %     51.0 %     50.7 %     51.4 %
Selling, general and administrative expenses as a percentage of net sales
    38.5 %     35.3 %     34.5 %     36.4 %
Depreciation and amortization as a percentage of net sales
    6.3 %     5.6 %     6.2 %     4.6 %
Transaction-related costs as a percentage of net sales
    0.6 %     7.1 %     0.5 %     17.1 %
Operating income (loss)
  $ 37,182     $ 35,531     $ 62,400     $ (26,869 )
Net loss
  $ (74,055 )   $ (58,391 )   $ (14,619 )   $ (43,772 )
Number of stores at the end of the period (1)
    3,074       3,051       3,051       3,003  
 
(1)   Number of stores excludes stores operated under franchising agreements and joint venture stores.
Net sales for the three months ended November 1, 2008 decreased by $24.4 million, or 6.8%, from the three months ended November 3, 2007. This net decrease was primarily attributable to same store sales declining 6.3%, or $21.4 million and a decrease of $7.7 million resulting from foreign currency translation of our foreign operations, partially offset by new store revenue, net of store closures, of $4.6 million.
Net sales for the nine months ended November 1, 2008 decreased by $43.5 million, or 4.1%, from the nine months ended November 3, 2007. This net decrease was attributable to same store sales declining 6.8% or $70.9 million, partially offset by new store revenue, net of store closures, of $13.6 million, a $0.8 million increase in franchise sales and a net increase of $13.0 million resulting from foreign currency translation of our foreign operations.

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During the three months ended November 1, 2008, the decrease in the average number of transactions per store of 11.2% was offset by an increase in average transaction value of 6.2%; the aggregate of which differs immaterially from the decrease in same store sales as the Company currently only collects this data on an average rather than same store basis.
During the nine months ended November 1, 2008, the decrease in the average number of transactions per store of 11.3% was offset by an increase in average transaction value of 5.6%, the aggregate of which differs immaterially from the decrease in same store sales as the Company currently only collects this data on an average rather than same store basis.
The following tables compare our sales of each product category for each of the periods presented:
                 
    Three Months     Three Months  
    Ended     Ended  
% of Total   November 1, 2008     November 3, 2007  
Jewelry
    51.2       54.4  
Accessories
    48.8       45.6  
 
           
 
    100.0       100.0  
 
           
                                 
    Successor             Successor     Predecessor  
    Entity     Combined     Entity     Entity  
    Nine Months     Nine Months     May 29, 2007     Feb. 4, 2007  
  Ended     Ended     Through     Through  
% of Total   Nov. 1, 2008     Nov. 3, 2007     Nov. 3, 2007     May 28, 2007  
Jewelry
    53.3       55.3       54.9       55.8  
Accessories
    46.7       44.7       45.1       44.2  
 
                       
 
    100.0       100.0       100.0       100.0  
 
                       
We exclude the costs related to our distribution centers in calculating gross profit and gross profit percentages. 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 percentage decreased by 200 basis points during the three months ended November 1, 2008 compared to the three months ended November 3, 2007. A 30 basis point increase in merchandise margin was offset by a 230 basis point increase in occupancy cost. The increase in occupancy costs is primarily attributable to the deleveraging effect of the decline in same store sales. Excluding $0.5 million of non-recurring expenses related to our Pan European Transformation project (“PET”), the decline in gross profit percentage would have been 190 basis points. The PET costs primarily include expenses related to consulting, severance, salaries and recruiting costs.
Gross profit percentage decreased by 230 basis points during the nine months ended November 1, 2008 compared to the nine months ended November 3, 2007. A 90 basis point increase in merchandise margin was offset by a 320 basis point increase in occupancy cost. The increase in occupancy costs is primarily attributable to the deleveraging effect of the decline in same store sales. However, excluding $3.1 million of non-recurring expenses related to our PET project, the decline in gross profit percentage would have been 200 basis points.
During the three months ended November 1, 2008, selling, general and administrative expenses increased $1.3 million or a 1.1% increase over the comparable prior year period. However, excluding $2.2 million of non-recurring PET costs and $2.8 million of expense relating to the Cost Savings Initiative, offset by a $2.3 million of benefit resulting from foreign currency translation, selling, general and administrative expense would have decreased $1.4 million or 1.1%.

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During the nine months ended November 1, 2008, selling, general and administrative expenses increased $17.9 million or a 4.8% increase over the comparable prior year period. However, excluding $5.7 million of PET costs, $4.5 million of costs related to the Cost Savings Initiative, $7.0 million of foreign currency translation effect, and an increase of $1.0 million of sponsor management fees, there would have been a decrease in selling, general and administrative expenses of $0.3 million or 0.1%.
Depreciation and amortization expense decreased $6.4 million to $20.0 million during the three months ended November 1, 2008 compared to the three months ended November 3, 2007. During the fourth quarter of Fiscal 2007, we finalized our purchase accounting adjustments related to property and equipment. The depreciation and amortization expense recognized in the three months ended November 1, 2008 were based on the final purchase accounting adjustments. The depreciation and amortization expense recognized in the three months ended November 3, 2007 were based on initial estimates of the purchase accounting adjustments.
Depreciation and amortization expense increased $5.4 million to $64.7 million during the nine months ended November 1, 2008 compared to the nine months ended November 3, 2007. This increase is primarily from additional amortization expense arising from purchase accounting fair value adjustments for store leasehold improvements and intangible assets, including franchise and non-compete agreements. The current year period includes nine months of amortization expense arising from purchase accounting adjustments, whereas the comparable prior year period includes purchase accounting related amortization expense for five months.
Other income for the three months ended November 1, 2008 totaled $2.6 million, an increase of $1.3 million from the prior year period, primarily due to the sale of certain intangible assets.
Other income for the nine months ended November 1, 2008 totaled $3.7 million, an increase of $0.5 million from the prior year period.
Interest income for the three months ended November 1, 2008 totaled $0.4 million, a decrease of $0.5 million from the prior year period.
Interest income for the nine months ended November 1, 2008 totaled $1.3 million, a decrease of $5.5 million from the prior year period. This decrease was due to lower average cash and cash equivalent balances primarily resulting from cash used to fund the acquisition of the Company and related expenses.
Interest expense for the three months ended November 1, 2008 totaled $50.9 million (of which approximately $2.6 million consisted of amortization of deferred debt issuance costs and approximately $9.1 million consisted of payment in kind interest) compared to $57.2 million for the three months ended November 3, 2007. This decrease is due primarily to lower interest rates on the variable portion of our debt.
Interest expense for the nine months ended November 1, 2008 totaled $149.2 million (of which approximately $7.9 million consisted of amortization of deferred debt issuance costs and approximately $15.1 million consisted of payment in kind interest) compared to $94.2 million for the nine months ended November 3, 2007. The current year period includes nine months of interest expense arising from the debt financing of the acquisition of the Company, whereas the comparable prior period includes interest expense related to the debt financing for five months.
Our effective income tax benefit rate was 37.4% and 33.1% for the three and nine months ended November 1, 2008, respectively. Our effective income tax rate for the three and nine months ended November 3, 2007 was 52.8% and (12.6%), respectively. The change primarily related to the overall geographic mix of results, the tax expense associated with non-deductible transaction costs, the repatriation of foreign earnings and other factors. Our effective income tax rate in future periods will depend on several variables, including the geographic mix of income and losses and the resolution of unrecognized tax benefits for amounts different from our current estimates.
In assessing the need for a valuation allowance, we consider all available evidence including past operating results, estimates of future taxable income and tax planning opportunities. In the event we change our determination as to the amount of deferred tax assets that can be realized, we will adjust our valuation allowance with a corresponding impact to income tax expense in the period in which such determination is made. Although realization is not assured, we believe it is more likely than not that our deferred tax assets, net of valuation allowance, at November 1, 2008 will be realized.

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Segment Operations
We are organized into two business segments — North America and Europe. The 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     Three Months  
    Ended     Ended  
    November 1, 2008     November 3, 2007  
Net sales
  $ 211,873     $ 232,011  
Increase (decrease) in same store sales
    (8.7 )%     (1.0 %)
Gross profit percentage
    48.1 %     50.6 %
Number of stores at the end of the period (1)
    2,144       2,151  
 
(1)   Number of stores excludes stores operated under franchising agreements and joint venture stores.
                                 
    Successor             Successor     Predecessor  
    Entity     Combined     Entity     Entity  
    Nine Months     Nine Months     May 29, 2007     Feb. 4, 2007  
    Ended     Ended     Through     Through  
  Nov. 1, 2008     Nov. 3, 2007     Nov. 3, 2007     May 28, 2007  
Net sales
  $ 643,893     $ 706,407     $ 413,924     $ 292,483  
Increase (decrease) in same store sales
    (9.7 )%     (0.1 %)     (1.2 %)     1.3 %
Gross profit percentage
    48.2 %     51.7 %     50.7 %     53.1 %
Number of stores at the end of the period (1)
    2,144       2,151       2,151       2,124  
 
(1)   Number of stores excludes stores operated under franchising agreements and joint venture stores.
Net sales in North America decreased by $20.1 million during the three months ended November 1, 2008, or 8.7%, from the three months ended November 3, 2007. The decrease in net sales was primarily attributable to same store sales decreases of $19.3 million or 8.7%, and a decrease of $1.3 million resulting from foreign currency translation of our Canadian operations.
Net sales in North America decreased by $62.5 million during the nine months ended November 1, 2008, or 8.8%, from the nine months ended November 3, 2007. The decrease in net sales was primarily attributable to same store sales decreases of $66.3 million or 9.7%, which was partially offset by an increase of $1.4 million resulting from foreign currency translation of our Canadian operations.
Gross profit percentage decreased by 250 basis points during the three months ended November 1, 2008 compared to the three months ended November 3, 2007. A 40 basis point increase in merchandise margin was offset by a 290 basis point increase in occupancy costs. The increase in occupancy costs is largely attributable to the deleveraging effect of the decline in same store sales. However, excluding $0.3 million of non-recurring expenses related to our Pan European Transformation project, the gross profit percentage would have decreased by 240 basis points.
Gross profit percentage decreased by 350 basis points during the nine months ended November 1, 2008 compared to the nine months ended November 3, 2007. A 30 basis point increase in merchandise margin was offset by a 380 basis point increase in occupancy costs. The increase in occupancy costs is largely attributable to the deleveraging effect of the decline in same store sales. However, excluding $1.1 million of non-recurring expenses related to our Pan European Transformation project, the gross profit percentage would have decreased by 330 basis points.

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The following tables compare our sales of each product category for each of the periods presented:
                 
    Three Months     Three Months  
    Ended     Ended  
% of Total   November 1, 2008     November 3, 2007  
Jewelry
    56.3       59.0  
Accessories
    43.7       41.0  
 
           
 
    100.0       100.0  
 
           
                                 
    Successor             Successor     Predecessor  
    Entity     Combined     Entity     Entity  
    Nine Months     Nine Months     May 29, 2007     Feb. 4, 2007  
  Ended     Ended     Through     Through  
% of Total   Nov. 1, 2008     Nov. 3, 2007     Nov. 3, 2007     May 28, 2007  
Jewelry
    58.7       59.3       59.2       59.4  
Accessories
    41.3       40.7       40.8       40.6  
 
                       
 
    100.0       100.0       100.0       100.0  
 
                       
Europe
Key statistics and results of operations for our European division are as follows (dollars in thousands):
                         
            Three Months     Three Months  
            Ended     Ended  
            November 1, 2008     November 3, 2007  
Net sales
          $ 121,098     $ 125,355  
Increase (decrease) in same store sales
            (1.8 )%     (0.1 %)
Gross profit percentage
            49.7 %     50.9 %
Number of stores at the end of the period (1)
            930       900  
 
(1)   Number of stores excludes stores operated under franchising agreements and joint venture stores.
                                 
    Successor             Successor     Predecessor  
    Entity     Combined     Entity     Entity  
    Nine Months     Nine Months     May 29, 2007     Feb. 4, 2007  
    Ended     Ended     Through     Through  
  Nov. 1, 2008     Nov. 3, 2007     Nov. 3, 2007     May 28, 2007  
Net sales
  $ 376,054     $ 357,048     $ 224,632     $ 132,416  
Increase (decrease) in same store sales
    (1.3 )%     (1.0 %)     (0.9 %)     (1.2 %)
Gross profit percentage
    49.6 %     49.7 %     50.8 %     47.8 %
Number of stores at the end of the period (1)
    930       900       900       879  
 
(1)   Number of stores excludes stores operated under franchising agreements and joint venture stores.
Net sales in our European division during the three months ended November 1, 2008 decreased by $4.3 million, or 3.4%, over the comparable prior year period. The decrease in net sales was primarily attributable to a decrease of $6.5 million resulting from foreign currency translation of our European operations and a same store sales decrease of $2.1 million, or 1.8%, partially offset by new store revenue, net of store closures of $4.3 million.
Net sales in our European division during the nine months ended November 1, 2008 increased by $19.0 million, or 5.3%, over the comparable prior year period. The increase in net sales was primarily attributable to an increase of $11.6 million resulting from the foreign currency translation of our European operations and new store revenue, net of store closures, of $12.0 million; offset by same store sales decrease of $4.6 million, or 1.3%.

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Gross profit percentage decreased by 120 basis points during the three months ended November 1, 2008 compared to the three months ended November 3, 2007. A 10 basis point decrease in merchandise margin combined with a 110 basis point increase in occupancy costs. The increase in occupancy costs is primarily attributable to the deleveraging effect of the decline in same store sales. However, excluding $0.2 million of non-recurring expenses related to our Pan European Transformation project, the gross profit percentage would have decreased by 100 basis points.
Gross profit percentage decreased by 10 basis points during the nine months ended November 1, 2008 compared to the nine months ended November 3, 2007. A 170 basis point increase in merchandise margin was offset by a 180 basis point increase in occupancy costs. The increase in occupancy costs is primarily attributable to the deleveraging effect of the decline in same store sales. However, excluding $2.0 million of non-recurring expenses related to our Pan European Transformation project, the gross profit percentage would have increased by 40 basis points.
The following tables compare our sales of each product category for each of the periods presented:
                 
    Three Months     Three Months  
    Ended     Ended  
% of Total   November 1, 2008     November 3, 2007  
Jewelry
    42.4       45.7  
Accessories
    57.6       54.3  
 
           
 
    100.0       100.0  
 
           
                                 
    Successor             Successor     Predecessor  
    Entity     Combined     Entity     Entity  
    Nine Months     Nine Months     May 29, 2007     Feb. 4, 2007  
    Ended     Ended     Through     Through  
  Nov. 1, 2008     Nov. 3, 2007     Nov. 3, 2007     May 28, 2007  
Jewelry
    44.1       47.4       47.1       47.9  
Accessories
    55.9       52.6       52.9       52.1  
 
                       
 
    100.0       100.0       100.0       100.0  
 
                       
Analysis of Consolidated Financial Condition
A summary of cash flows provided by (used in) operating, investing and financing activities is outlined in the table below (dollars in thousands):
                                 
    Successor             Successor     Predecessor  
    Entity     Combined     Entity     Entity  
    Nine Months     Nine Months     May 29, 2007     Feb. 4, 2007  
    Ended     Ended     Through     Through  
  Nov. 1, 2008     Nov. 3, 2007     Nov. 3, 2007     May 28, 2007  
Operating activities
  $ (19,444 )   $ (14,807 )   $ (57,453 )   $ 42,646  
Investing activities
    (46,540 )     (3,117,653 )     (3,089,584 )     (28,069 )
Financing activities
    183,125       2,878,310       2,884,313       (6,003 )
Although the Company did not need to do so, during the quarter ended November 1, 2008, the Company drew down the remaining $194 million available under its Revolving Credit Facility (“Revolver”). An affiliate of Lehman Brothers is a member of the facility syndicate, and so immediately after Lehman Brothers filed for bankruptcy, in order to preserve the availability of the commitment, the Company drew down the full available amount under the Revolver. The Company received the entire $194 million, including the Lehman Brothers affiliate’s portion. Upon the replacement of Lehman Brothers, or the assumption of its commitment by a creditworthy entity, the Company will assess whether to pay down all or a portion of this outstanding balance based on various factors, including the creditworthiness of other syndicate members and general economic conditions. The interest rate on the Revolver on November 1, 2008 was 5.25%.

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Our cash and cash equivalents increased approximately $107.9 million from $86.0 million at February 2, 2008 to $193.9 million at November 1, 2008. The increase in cash and cash equivalents was primarily the result of the draw of $194.0 million from our Revolving Credit Facility described above, offset by net cash used in operations of $19.4 million (which amount is after cash interest expense, cash income taxes and investment in working capital), cash used in investment activities of $46.5 million, credit facility payment of $10.9 million and the effect of foreign currency exchange rate changes of $9.2 million.
During the nine months ended November 1, 2008, cash used in operating activities approximated $19.4 million compared to $14.8 million during the nine months ended November 3, 2007. The increase in cash used in operating activities was primarily impacted by increased interest expense payments due to nine months of debt interest in the current year period as compared to five months of debt interest for the prior year period. This was partially offset by a decrease in transaction-related costs.
Cash used in investing activities during the nine months ended November 1, 2008 was $46.5 million, a decrease of $3.1 billion from the cash used in investing activities during the nine months ended November 3, 2007 of $3.1 billion. The cash used during the nine months ended November 3, 2007 included $3.0 billion to fund the acquisition of the Company and $70.7 million to fund capital expenditures. Capital expenditures of $45.3 million were made during the nine months ended November 1, 2008 of which $28.7 million related to store openings and remodeling projects. During the remainder of Fiscal 2008, we expect to fund a total of approximately $15.0 to $20.0 million of capital expenditures to remodel existing stores, open new stores and to improve technology systems.
Cash provided by financing activities during the nine months ended November 1, 2008 was $183.1 million, a decrease of $2.7 billion from the cash provided by financing activities for the comparable period in Fiscal 2007 of $2.9 billion. The cash provided by financing activities for the nine months ended November 3, 2007 principally related to cash proceeds from the Credit Facility and Notes used to fund the acquisition of the Company of $2.3 billion, net of debt issuance costs, and the associated capital contribution of $595.7 million. In addition, $7.9 million of cash was paid upon the sale of the Company to holders of the predecessor entity’s stock options. We paid dividends of $16.3 million during the nine months ended November 3, 2007. During the nine months ended November 1, 2008, we paid $10.9 million in principal payments related to our credit facility. The Company and its affiliates may, from time to time, purchase portions of its indebtedness.
On May 14, 2008, we elected to pay interest in kind on our 9.625%/10.375% Senior Toggle Notes due 2015 for the interest period beginning on June 1, 2008 and ending November 30, 2008. The interest expense associated with this payment in kind was $9.1 million and $15.1 million for the three and nine months ended November 1, 2008, respectively. The liability for interest paid in kind is included in long-term debt on the accompanying unaudited condensed consolidated balance sheet. On December 1, 2008, we increased the outstanding Senior Toggle Notes by $18.2 million in satisfaction of interest paid in kind for the interest period from June 1, 2008 through November 30, 2008.
We will pay interest in kind on our Senior Toggle Notes for the interest period beginning on December 1, 2008 and ending May 31, 2009. This election continues unless we take action to discontinue this option. It is our current intention to pay interest in kind on the Senior Toggle Notes for all interest periods through June 1, 2011.
As of November 1, 2008, we had cash and cash equivalents of $193.9 million. The Company anticipates that cash generated from operations will be sufficient to meet its future working capital requirements, new store expenditures, and debt service requirements as they become due. However, the Company’s ability to fund future operating expenses and capital expenditures and its ability to make scheduled payments of interest on, to pay principal on, or refinance indebtedness and to satisfy any other present or future debt obligations will depend on future operating performance. Our future operating performance and liquidity may also be adversely affected by general economic, financial, and other factors beyond the Company’s control, including those disclosed in “Risk Factors” in our Annual Report on Form 10-K for the year ended February 2, 2008.

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Intangible Asset and Goodwill Impairment Assessment
In accordance with our accounting policies, we will conduct our annual intangible asset and goodwill testing during the fourth quarter. As our fourth quarter is ordinarily a very significant quarter, generating 31% of our total sales and 52% of our operating income over the past two fiscal years, the business trends of the fourth quarter and the results of such testing may result in the recognition of an impairment in the value of a portion of these assets. If there is an impairment, the non-cash charge associated with the impairment could result in a substantial reduction in the carrying value of these assets. Any such impairment will be recognized during our fourth quarter.
Critical Accounting Policies and Estimates
Our Unaudited Condensed Consolidated Financial Statements have been prepared in accordance with U.S. generally accepted accounting principles. 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 2007 Annual Report on Form 10-K, filed on April 25, 2008, in the Notes to the Consolidated Financial Statements, Note 2, and the Critical Accounting Policies and Estimates section contained in the Management’s Discussion and Analysis of Financial Condition and Results of Operations therein.
Recent Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 157, “Fair Value Measurements”. The Statement establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosure about fair value measurements. This Statement does not require any new fair value measurement and applies to financial statements issued for fiscal years beginning after November 15, 2007 with early application encouraged. Certain provisions of the Statement were effective for the Company on February 3, 2008, while the effective date of other provisions relating to nonfinancial assets and nonfinancial liabilities will be effective in the fiscal year beginning February 1, 2009. The adoption of this Statement on February 3, 2008 required additional financial statement disclosure and did not have an impact on the Company’s financial position, results of operations or cash flows. The adoption on February 1, 2009 of the Statement’s provisions relating to nonfinancial assets and nonfinancial liabilities is not expected to have a material impact on the Company’s financial position, results of operations or cash flows.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115”. SFAS No. 159 permits entities to choose to measure certain financial assets and liabilities at fair value. Unrealized gains and losses, arising subsequent to adoption, are reported in earnings. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. We adopted SFAS No. 159 effective February 3, 2008, and elected not to measure any of our eligible financial assets or liabilities at fair value upon adoption.
During December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations”. SFAS No. 141R will modify how business acquisitions are accounted for both on the acquisition date and in subsequent periods. The Company will be required to apply the provisions of the new Statement to acquisitions that close in the fiscal year beginning February 1, 2009. The adoption of this statement will affect the accounting for future acquisitions entered into by the Company. This statement will require the Company to account for adjustments to acquired tax liabilities and unrecognized tax benefits as elements of income tax expense instead of increases or decreases to goodwill.
In December 2007, the Securities and Exchange Commission issued Staff Accounting Bulletin (“SAB”) No. 110, which allows the continued use of the simplified method discussed in SAB No. 107 in developing an estimate of the expected term of certain share options. SAB No. 107 did not provide for the use of the simplified method after December 31, 2007. The adoption of SAB No. 110 did not have a material impact on the Company’s financial position, results of operations or cash flows.

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During April 2008, the FASB issued FASB Staff Position (“FSP”) FAS 142-3, “Determination of the Useful Life of Intangible Assets”. This FSP, which applies to intangible assets accounted for pursuant to SFAS No. 142, provides guidance for the development of renewal or extension assumptions used to determine the useful life of an intangible asset. The Company must adopt the FSP for its fiscal year beginning February 1, 2009. The adoption of this FSP is not expected to have a material impact on the Company’s financial position, results of operations or cash flows.
During June 2008, the Emerging Issues Task Force issued EITF 08-3, “Accounting by Lessees for Nonrefundable Maintenance Deposits”. Issue 08-3 requires lessees to account for nonrefundable maintenance deposits as deposits if it is probable that maintenance activities will occur and the deposit is realizable. Amounts on deposit that are not probable of being used to fund future maintenance activities should be charged to expense. Issue 08-3 is effective for fiscal years beginning after December 15, 2008. The adoption of Issue 08-3 is not expected to have a material impact on the Company’s financial position, results of operations or cash flows.
Cautionary Note Regarding Forward-Looking Statements and Risk Factors
We and our representatives may from time to time make written or oral 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, ability to service our debt, and new store openings for Fiscal 2008, 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; uncertainties generally associated with the specialty retailing business; disruptions in our supply of inventory; inability to increase same store sales; inability to renew, replace or enter into new store leases on favorable terms; significant increases in our merchandise markdowns; inability to grow our store base in Europe; inability to design and implement new information systems; delays in anticipated store openings or renovations; changes in applicable laws, rules and regulations, including changes in federal, state or local regulations governing the sale of our products, particularly regulations relating to the metal content in jewelry, and employment laws relating to overtime pay, tax laws and import laws; product recalls; loss of key members of management; increases in the cost of labor; labor disputes; unwillingness of vendors and service providers to supply goods or services pursuant to historical customary credit arrangements; increases in the cost of borrowings; unavailability of additional debt or equity capital; and the impact of our substantial indebtedness on our operating income and our ability to grow. The Company undertakes no obligation to update or revise any forward-looking statements to reflect subsequent events or circumstances. 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 Annual Report on Form 10-K for the year ended February 2, 2008 under “Statement Regarding Forward-Looking Disclosures” and “Risk Factors.”

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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 U.S. 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 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 November 1, 2008, we maintained no foreign currency options. We do not generally hedge the translation exposure related to our net investment in foreign subsidiaries. Included in comprehensive loss is $16.3 million, net of tax, reflecting the unrealized loss on foreign currency translation as of November 1, 2008. Based on the extent of our foreign operations in Fiscal 2008, the potential gain or loss due to a 10% adverse change on foreign currency exchange rates could be significant to our consolidated operations. As of December 1, 2008, the strengthening of the U.S. dollar has resulted in a 8.6% and 1.2% adverse change in foreign currency rate of the Pound Sterling and Euro, respectively, as compared to November 1, 2008 foreign currency rates.
Certain of our subsidiaries make significant U.S. 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 U.S. Dollar. Since July 2005, the Chinese Yuan increased by 18.4% as compared to the U.S. Dollar, based on continued pressure from the international community. 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 U.S. 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 U.S. Dollars if exchange rates fluctuate significantly from one period to the next.
Interest Rates
Between July 20, 2007 and August 3, 2007, we entered into three interest rate swap agreements (the “Swaps”) to manage exposure to fluctuations in interest rates. The Swaps represent contracts to exchange floating rate for fixed interest payments periodically over the lives of the Swaps without exchange of the underlying notional amount. At November 1, 2008, the Swaps cover an aggregate notional amount of $435.0 million of the $1.43 billion outstanding principal balance of the senior secured term loan facility. The fixed rates of the three swap agreements range from 4.96% to 5.25% and each swap expires on June 30, 2010. The Swaps have been designated as cash flow hedges. At November 1, 2008, the estimated fair value of the Swaps was a liability of approximately $18.1 million and is recorded, net of tax, as a reduction in accumulated other comprehensive income (loss).
At November 1, 2008, we had fixed rate debt of $950.0 million and variable rate debt of $1.63 billion. Based on our variable rate debt balance (less $435.0 million of interest rate swaps) as of November 1, 2008, a 1% change in interest rates would increase or decrease our annual interest cost by approximately $12.0 million, net.
Item 4T. Controls and Procedures
Disclosure Controls and Procedures
We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934), as of the end of the period covered by this Quarterly Report. Based upon that evaluation, our Chief Executive Officer 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 the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including each of such officers as appropriate to allow timely decisions regarding required disclosure.

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Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting identified during the period covered by this Quarterly Report, 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 wage and hour litigation, litigation with present and former employees, and litigation regarding intellectual property 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.
Item 1A. Risk Factors
There have been no material changes in our risk factors disclosed in our Annual Report on Form 10-K for the year ended February 2, 2008.
Item 6. Exhibits
  31.1   Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a).
 
  31.2   Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a).
 
  32.1   Certification of 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 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, 4 and 5 of Part II are not applicable and have been omitted.

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SIGNATURES
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.
 
 
December 5, 2008  By:   /s/ Eugene S. Kahn    
    Eugene S. Kahn, Chief Executive Officer   
    (principal executive officer)   
 
         
     
December 5, 2008  By:   /s/ J. Per Brodin    
    J. Per Brodin, Senior Vice President and Chief  
    Financial Officer (principal financial and accounting officer)   

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

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