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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

(Mark One)

For the transition period from ______________ to ____________________

Commission file number 1-8899

CLAIRE’S STORES, INC.

(954) 433-3900

(Former name, former address and former fiscal year, if changed since last report)

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 an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes   x   No   o

The number of shares of the registrant’s Common Stock and Class A Common Stock outstanding as of November 30, 2002 was 46,084,369 and 2,803,648, respectively, excluding treasury shares.

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CLAIRE’S STORES, INC. AND SUBSIDIARIES
INDEX

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PART I. FINANCIAL INFORMATION

See accompanying notes to unaudited condensed consolidated financial statements.

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CLAIRE’S STORES, INC. AND SUBSIDIARIES

See accompanying notes to unaudited condensed consolidated financial statements.

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CLAIRE’S STORES, INC. AND SUBSIDIARIES

See accompanying notes to unaudited condensed consolidated financial statements.

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CLAIRE’S STORES, INC. AND SUBSIDIARIES

1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared by the Company without audit, in accordance with the instructions to Form 10-Q, and therefore do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation have been included. These statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Annual Report on Form 10-K for the year ended February 2, 2002 filed with the Securities and Exchange Commission, including Note 1 to the consolidated financial statements included therein which discusses consolidation and financial statement presentation. The preparation of financial statements in conformity with generally accepted accounting principles requires the Company to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets, liabilities, revenues, expenses and disclosure of gain and loss contingencies at the date of the financial statements. Actual results could differ from those estimates and assumptions. Due to the seasonal nature of the Company’s business, the results of operations for the first nine months of the year are not indicative of the results of operations on an annualized basis. Certain prior period amounts have been reclassified to conform to the current period presentation. See Note 4.

2. Earnings Per Share

Basic net income per share is computed based on the weighted average number of shares of Class A Common Stock and Common Stock outstanding during the period presented, while diluted net income per share includes the dilutive effect of stock options. Options to purchase 60,905 shares and 1,147,337 shares of common stock, at prices ranging from $25.00 to $30.25 per share and $17.75 to $30.25 per share, respectively, were outstanding for the quarters ended November 2, 2002 and November 3, 2001, respectively, but were not included in the computation of diluted earnings per share because the options’ exercise prices were greater than the average market price of the common shares for the respective fiscal quarter. Options to purchase 231,130 shares and 1,166,826 shares of common stock, at prices ranging from $21.25 to $30.25 per share and $17.31 to $30.25 per share, respectively, were outstanding for the nine months ended November 2, 2002 and November 3, 2001, respectively, but were not included in the computation of diluted earnings per share because the options’ exercise prices were greater than the average market price of the common shares for the respective nine month period.

3. New Accounting Pronouncements

Effective February 3, 2002, the Company adopted Statement of Financial Accounting Standards No. 142 (“SFAS 142”), “Goodwill and Other Intangible Assets.” In accordance with SFAS 142, the Company ceased amortizing its goodwill effective February 3, 2002. The Company recorded $2.2 million and $6.6 million of amortization during the third quarter and nine months ended November 3, 2001 respectively, and would have recorded $2.2 million and $6.6 million of amortization during the third quarter and nine months ended November 2, 2002, respectively. Net income for the three and nine months ended November 3, 2001 would have been $3.8 million and $8.5 million or $0.08 and $0.17 per diluted share, respectively, without goodwill amortization expense during those periods. The Company had $196.1 and $193.1 million of unamortized goodwill at November 2, 2002 and February 2, 2002, respectively.

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SFAS 142 required the Company upon its adoption to reassess the value of, and useful lives assigned to, intangible assets including goodwill to determine whether the value of one or more intangible assets is impaired. The first step of this impairment test required the Company, within the first six months of Fiscal 2003, to determine the fair value of the reporting unit, as defined by SFAS 142, and compare it to the carrying value of the net assets allocated to the reporting unit. If this fair value exceeded the carrying value, no further analysis was required. If the fair value of the reporting unit was less than the carrying value of the net assets, the Company was required to perform step two of the impairment test, which required the Company to allocate the implied fair value of the reporting unit to all underlying assets and liabilities, including both recognized and unrecognized tangible and intangible assets, based on their fair value. The Company performed a transitional goodwill impairment test as required and has determined that no goodwill impairment existed at February 3, 2002. The Company has also evaluated the lives of all of its intangible assets. As a result of this evaluation, the Company has determined that none of its intangible assets, other than goodwill, have indefinite lives and that the existing useful lives are appropriate.

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

In August 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”. This statement retains the requirements of SFAS No. 121 to (a) recognize an impairment loss only if the carrying amount of a long lived asset is not recoverable from its discounted cash flows and (b) measure an impairment loss as the difference between the carrying amount and fair value of the asset. This statement requires that a long-lived asset to be abandoned, exchanged for a similar productive asset, or distributed to owners in a spin-off be considered held and used until it is disposed of. This statement requires that the depreciable life of a long-lived asset to be abandoned be revised and that an impairment loss be recognized at the date a long-lived asset is exchanged for a similar productive asset or distributed to owners in a spin-off if the carrying amount of the asset exceeds its fair value. The accounting model for long-lived assets to be disposed of by sale is used for all long-lived assets, whether previously held and used or newly acquired. That accounting model measures a long-lived asset classified as held for sale at the lower of its carrying amount or fair value less cost to sell and requires depreciation (amortization) to cease. Discontinued operations are no longer measured on a net realizable value basis, and future operating losses are no longer recognized before they occur. This statement retains the basic provisions of Accounting Principles Board Opinion 30 for the presentation of discontinued operations in the income statement but broadens that presentation to include a component of an entity (rather than a segment of a business). A component of an entity comprises operations and cash flows that can be clearly distinguished, operationally and for financial reporting purposes, from the rest of the entity. A component of an entity that is classified as held for sale or that has been disposed of is presented as a discontinued operation if the operations and cash flows of the component will be (or have been) eliminated from the ongoing operations of the entity and the entity will not have any significant continuing involvement in the operations of the component. The Company adopted SFAS 144 on February 3, 2002. Management has determined that the adoption of SFAS 144 did not have a material effect on the Company’s financial statements.

In June 2002, the FASB issued Statement No. 146 (“Costs Associated with Exit or Disposal Activities”). This Statement requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred compared to prior literature, which recognized a liability when the entity committed to an exit plan. Management believes that this Statement will not have a material impact on the Company’s financial statements;

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however, the Statement will result in a change in accounting policy associated with the recognition of liabilities in connection with future restructuring charges.

4. Discontinued Operation

In January 2002, the Company’s Board of Directors authorized the disposition of the Mr. Rags stores, which represented the Company’s apparel segment. In connection with the plan to dispose of Mr. Rags, the Company recorded a loss on disposal of Lux Corp., net of tax of $12.9 million in the consolidated financial statements as of February 2, 2002. Included in the loss on disposal was an estimate of proceeds from the sale of closing date inventory of $4.4 million, net of tax and an estimate of operating losses of Mr. Rags during the six month phase out period of $2.5 million, net of tax. On May 17, 2002, the Company sold the stock of Lux Corporation, d/b/a Mr. Rags for (i) an initial payment of $5 million, (ii) deferred payments to be paid aggregating $10 million payable as 1% of net sales during the first year and 2% of net sales thereafter, and (iii) an amount to be paid equal to approximately 48% of the gross sales of the inventory of Mr. Rags as of the closing date. Through the date of disposition, the operations of Mr. Rags were accounted for as a discontinued operation in the Company’s unaudited condensed consolidated financial statements. The deferred payments aggregating $10 million were not included in the Company’s estimate of loss on disposition as the timing and amount could not be reasonably estimated due to the uncertainty of the financial condition of the acquired business. In order to conform to the separate presentation of the net assets and operating results of Mr. Rags as a discontinued operation, certain prior period amounts have been reclassified to conform to current period presentation.

During the nine months ended November 2, 2002, the Company recorded approximately $2 million, net of tax, gain on disposal of Mr. Rags. This gain represents proceeds in excess of the Company’s original estimates for the sale of the closing date inventory of Mr. Rags of $3.0 million, net of tax, $ .5 million net of tax, of operating losses of Mr. Rags during the phase out period below the Company’s original estimates, and $1.3 million net of tax, which represents an accrual for a portion of guaranteed lease payments on operating leases for which the Company remains liable if the new owner of Mr. Rags were to default on the lease payments.

The Company remains as a guarantor on 12 operating leases for store locations and $5.0 million in gross future lease payments on operating leases for equipment and leasehold improvements of Lux Corp. As of November 2, 2002, the new owners of Mr. Rags have met all obligations relating to their guaranteed leases, however, certain other payments due the Company have been delayed due to cash flow deficiencies. Based on management’s review of the financial performance of Mr. Rags and its impact on the new owners’ ability to fulfill the commitments under the leases, $2.0 million was accrued as a liability at November 2, 2002. The Company has also entered into a service agreement with the new owner of Mr. Rags under which the Company will perform certain administrative services for the benefit of Mr. Rags, for an initial period of one year with no decision making authority. The agreement can be cancelled by either party upon written notice in accordance with the terms of the service agreement. As of November 2, 2002, the Company has received approximately $736,000 for these services and has included them within interest and other within its statement of operations.

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5. Segment Information

The Company is primarily organized based on the geographic markets in which it operates. Under this organizational structure, the Company currently has two reportable segments: North America and International. Net sales from continuing operations for the periods presented were as follows:

accrued as a liability. We have also entered into a service agreement with the new owner of Mr. Rags under which we will perform certain administrative services for the benefit of Mr. Rags, for an initial period of one year with no decision making authority. The agreement can be cancelled by either party upon written notice in accordance with the terms of the service agreement. As of November 2, 2002, we have received approximately $736,000 for these services and have included them within interest and other within its statement of operations.

Quarterly Information and Seasonality

The specialty retail industry is seasonal in nature and a disproportionately higher level of our revenues and earnings are generated in the fall and holiday selling seasons. Our working capital requirements and inventories increase substantially in the third quarter in anticipation of the holiday selling season.

Liquidity and Capital Resources

In connection with the acquisition of Afterthoughts in December of 1999, we entered into a credit facility pursuant to which we financed $200 million of the purchase price for Afterthoughts. The credit facility includes a $40 million revolving line of credit which matures on December 1, 2004, and a $175 million five year term loan, the first installment of which was paid on December 31, 2000, with future installments, thereafter, payable on a quarterly basis through December 1, 2004. The credit facility is prepayable without penalty and bears interest at a margin of 125 basis points over the London Interbank Borrowing Rate. The margin is adjusted periodically based on our performance as it relates to certain financial covenants. On November 2, 2002, approximately $25 million was outstanding on this line of credit, while $105 million was outstanding under the term loan. Also, on November 2, 2002, the borrowings under this credit facility were in compliance with all debt covenants. We cannot re-borrow amounts repaid under the term loan. As a result, we have no future availability under the term loan. We can re-borrow amounts repaid under the revolving line of credit, subject to the terms of the credit facility. As of November 2, 2002, we had $15 million of availability under the revolving line of credit.

We are required to maintain financial ratios under our credit facility. Required financial ratios include fixed charge coverage ratio, consolidated leverage ratio and current ratio. The credit facility also contains other restrictive covenants which limit, among other things, our ability to make dividend distributions and repurchase shares of our Common stock. If these financial ratios and other restrictive covenants are not maintained, our bank will have the option to require immediate repayment of all amounts outstanding under the credit facility. The most likely result would require us to either renegotiate certain terms of the credit agreement, obtain a waiver from the bank, or obtain a new credit agreement with another bank, which may contain different terms.

Our cash flow from operations, together with our cash balances, provides adequate liquidity to meet our operational needs and debt obligations. Cash and cash equivalents totaled $130.1 million at November 2, 2002.

Net cash provided by operating activities from continuing operations was $62.9 million for the nine months ended November 2, 2002 compared to $47.6 million for the nine months ended November 3, 2001. The primary increase of net cash provided by operating activities from continuing operations as compared to the prior period was an increase in net income, offset by an increase in the use of funds for inventory accumulation in advance of the holiday shopping season.

Inventory at November 2, 2002 increased 36% compared to the inventory balance at the end of our February 2, 2002 fiscal year. This increase is primarily a result of the seasonally adjusted levels of inventory that we carry to meet expected future sales demand. Inventory at November 2, 2002 increased 2.7% as compared to inventory at November 3, 2001.

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Net cash used in investing activities of $35 million for the nine months ended November 2, 2002 was primarily as a result of capital expenditures of $36.6 million offset by the sale of short-term investments

Net cash provided by financing activities was $4 million for the nine months ended November 2, 2002 as compared to $2.7 million provided by financing activities for the nine months ended November 3, 2001. The cash used in financing activities during the first nine months of Fiscal 2003 was to fund dividends on our Class A and Common stock.

For the nine months ended November 2, 2002, we opened 162 stores and closed 110 stores ending the quarter with 2,927 stores.

We believe that our significant cash balances, consistent ability to generate cash flow from operations and available funds under our credit facility will be sufficient to fund our operations, debt and currently anticipated capital expenditure plans for Fiscal 2003.

During the nine months ended November 2, 2002, the U.S. dollar weakened against the major currencies included in our consolidated financial statements. As a result, the cumulative foreign currency translation adjustment increased shareholders’ equity by $14.9 million for the nine months ended November 2, 2002.

In December 2002, after consultation with an expert in the executive compensation field, we entered into a three-year employment agreement with our Chairman, with successive one-year renewal terms. The agreement provides that our Chairman will be paid an annual base salary of $1.0 million, the base salary for our Chairman prior to entering into the agreement, and a one-time $3.0 million transition bonus, of which $1.5 million was paid upon signing of the employment agreement, and $1.5 million will be paid upon achievement of certain milestones as set forth in the agreement. The agreement also provides that, in consideration of certain restrictive covenants agreed to by our Chairman and other exclusive rights granted to us by our Chairman for the benefit of the Company and, as long as the milestones referenced above have been met, our Chairman will also be paid a $1.3 million annual bonus during the remaining term of the agreement, payable in quarterly installments, commencing November 1, 2003.

Forward-Looking Statements

The Private Securities Litigation Reform Act of 1995, or the Act, provides a safe harbor for “forward-looking statements” made by or on our behalf. We and our representatives may from time to time make written or verbal forward-looking statements, including statements contained in this and other filings with the Securities and Exchange Commission and in our press releases and reports to shareholders. All statements which address operating performance, events or developments that we expect or anticipate will occur in the future, including statements relating to new store openings, customer demand and future operating results, are forward-looking statements within the meaning of the Act and as defined in Section 21E of the Securities Exchange Act of 1934, as amended. These statements may also be identified by their use of forward-looking terminology, such as “believes,” “expects,” “may,” “should,” “would,” “will,” “intends,” “plans,” “estimates,” and “anticipates.” 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 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. Factors that could cause or contribute to such differences include but are not limited to: fluctuations in sales and same-store sales results, fashion trends, dependence on foreign suppliers, competition from other retailers, relationships with mall developers and operators, general economic conditions, success of joint ventures and relationships with and reliance upon third parties, and uncertainties generally associated with

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specialty retailing. Additional information concerning these risks and uncertainties is contained in our filings with the Securities and Exchange Commission, including our Annual Report on Form 10-K for the year ended February 2, 2002.

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, but currently do not use foreign currency purchased put options or foreign exchange forward contracts. During the first nine months of Fiscal 2003, included in comprehensive income and stockholders’ equity is $14.9 million reflecting the unrealized gain on foreign currency translation. Based on our average net currency positions at November 2, 2002, the potential gain or loss due to a 10% adverse change on foreign currency exchange rates could be significant to our Statement of Operations.

Interest Rates

Our exposure to market risk for changes in interest rates is limited to our cash, cash equivalents and debt. Based on our average invested cash balances and outstanding debt during the first nine months of Fiscal 2003, a 10% increase in the average effective interest rate during the remainder of Fiscal 2003 would not have materially impacted our annual net interest expense.

Item 4. Controls and Procedures

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PART II. OTHER INFORMATION

Item 6. Exhibits and Reports on Form 8-K

     (a)  Exhibits

     (b)  Reports on Form 8-K

Items 1 through 5 are not applicable and have been omitted.

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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

CERTIFICATION

I, Marla Schaefer, acting co-Chief Executive Officer of Claire’s Stores, Inc. (the “Company”), certify that:

     1.     I have reviewed this quarterly report on Form 10-Q of the Company;

     2.     Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

     3.     Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the Company as of, and for, the periods presented in this quarterly report.

     4.     The Company’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the Company and we have:

     5.     The Company’s other certifying officers and I have disclosed, based on our most recent evaluation, to the Company’s auditors and the audit committee of the Company’s board of directors (or persons performing the equivalent function):

     6.     The Company’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

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CERTIFICATION

I, E. Bonnie Schaefer, acting co-Chief Executive Officer of Claire’s Stores, Inc. (the “Company”), certify that:

     1.     I have reviewed this quarterly report on Form 10-Q of the Company;

     2.     Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

     3.     Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the Company as of, and for, the periods presented in this quarterly report.

     4.     The Company’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the Company and we have:

     5.     The Company’s other certifying officers and I have disclosed, based on our most recent evaluation, to the Company’s auditors and the audit committee of the Company’s board of directors (or persons performing the equivalent function):

     6.     The Company’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

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CERTIFICATION

I, Ira D. Kaplan, Chief Financial Officer of Claire’s Stores, Inc. (the “Company”), certify that:

     1.     I have reviewed this quarterly report on Form 10-Q of the Company;

     2.     Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

     3.     Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the Company as of, and for, the periods presented in this quarterly report.

     4.     The Company’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the Company and we have:

     5.     The Company’s other certifying officers and I have disclosed, based on our most recent evaluation, to the Company’s auditors and the audit committee of the Company’s board of directors (or persons performing the equivalent function):

     6.     The Company’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

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