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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended February 1, 2003
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. 1-8899

Claire’s Stores, Inc.
(Exact name of registrant as specified in its charter)

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

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

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

     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 Exchange Act Rule 12b-2). Yes x No o

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

     As of the last business day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of the 42,555,628 shares of Class A Common Stock and Common Stock held by non-affiliates of the registrant was $713,232,325. All outstanding shares of Class A Common Stock and Common Stock, except for shares held by executive officers and members of the Board of Directors and their affiliates, are deemed to be held by non-affiliates.

     At March 31, 2003, there were outstanding 46,147,991 shares of registrant’s Common Stock, $.05 par value, and 2,691,396 shares of the registrant’s Class A Common Stock, $.05 par value.

DOCUMENTS INCORPORATED BY REFERENCE

     The Proxy Statement for the 2003 Annual Meeting of Stockholders, to be filed no later than 120 days after the end of the registrant’s fiscal year covered by this report, is incorporated by reference into Part III of this report.

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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, 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. 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 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, potential difficulties or delays in identifying, attracting and retaining qualified individuals to serve in senior management positions, uncertainties generally associated with specialty retailing, and the other factors referred to herein including, but not limited to, the items discussed in Part II, Item 7 under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Certain Risk Factors Relating to our Business.” Unless the context requires otherwise, all references to the “company”, “we”, “us” or “our” include Claire’s Stores, Inc. and its subsidiaries.

PART I.

Item 1. Business

General

We are a leading mall-based retailer of value-priced fashion accessories for pre-teens and teenagers as well as young adults through our wholly-owned subsidiaries, Claire’s Boutiques, Inc., which also operates through its Icing by Claire’s division, Claire’s Puerto Rico Corp., Claire’s Canada Corp., Claire’s Accessories UK Ltd., Bijoux One Trading GmbH, Claire’s Switzerland GmbH, Claire’s Germany GmbH (Bijoux, which are our stores located in Switzerland, Austria and Germany), Claire’s France and Claire’s Nippon Co. Ltd., which is our 50%-owned joint venture with Aeon Co, Ltd. (f/k/a Jusco Co., Ltd.). We are primarily organized based on our geographic markets, which include our North American operations and our International operations.

As of March 31, 2003 we operated a total of 2,925 stores in all 50 states of the United States, Canada, the Caribbean, the United Kingdom, Switzerland, Austria, Germany, France, Ireland and Japan. The stores are operated mainly under the trade names “Claire’s Boutiques”, “Claire’s Accessories”, “Afterthoughts”, “The Icing”, “Icing by Claire’s”, and “Bijoux One”. We are in the process of transitioning our “Afterthoughts” stores to “Icing by Claire’s” stores to capitalize on the Claire’s brand name.

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

Our executive offices are located at 3 S.W. 129 Avenue, Pembroke Pines, Florida 33027, our telephone number is (954) 433-3900 and our internet address is www.claires.com. Through our website, we make available free of charge, as soon as reasonably practicable after such information has been filed or furnished to the Securities and Exchange Commission, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports. The reference to

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our website does not constitute incorporation by reference of the information contained on our website, and the information contained on the website is not part of this Form 10-K.

Business Description

We specialize in selling value-priced fashion accessories designed to predominantly appeal to pre-teen and teenage females as well as young adults. We have two store concepts: Claire’s Accessories, which caters to fashion-conscious girls and teens in the 7 to 14 age range, and Icing by Claire’s, which caters to fashion-conscious teens and young women in the 15 to 26 age range. Our merchandise typically ranges in price between $2 and $20, with the average product priced at about $5. Our stores share a similar format and our different store concepts and tradenames allow us to have multiple store locations in a single mall. Although we face competition from a number of small specialty store chains and others selling fashion accessories, we believe that our stores comprise the largest and among the most successful chain of specialty retail stores in the world, devoted to the sale of value-priced pre-teen and teenage fashion accessories.

Our sales are divided into two principal product categories:

	•		Jewelry—Costume jewelry, earrings and ear piercing services; and
	•		Accessories—Other fashion accessories, hair ornaments, totebags and novelty items.

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

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

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Strategy

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

Actively Manage Merchandise Trends and Display of Merchandise. We devote considerable effort to identifying emerging fashion trends. Through constant product testing and rapid placement of successful test items in our stores, we are able to respond to emerging fashion trends. We also devote considerable effort to how our merchandise is displayed in our stores, which we believe commands our customers’ attention, supports our image and promotes a consistent shopping environment for our customers. Our distribution systems enhance our ability to make quick responses to new fashion trends. We typically deliver to our stores 3-5 times a week.

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

Store Growth Strategy. We opened our first store in Europe in 1996 and, as of February 1, 2003, operated 653 stores in Europe. We intend to continue our store growth through the opening of new stores in our international markets. Our European stores are typically smaller than our North American stores, which results in higher sales per square foot than our North American stores.

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

Stores

Our stores in North America are located primarily in enclosed shopping malls. Our stores in North America operating as “Claire’s Boutiques” and “Claire’s Accessories” average approximately 1,000 square feet while those stores operating as “The Icing”, “Icing by Claire’s” and “Afterthoughts” average approximately 1,200 square feet. Our stores in the United Kingdom, Switzerland, Austria, Germany, France, Ireland and Japan average approximately 600 square feet and are located primarily in enclosed shopping malls and central business districts. Each store uses our proprietary displays, which permit the presentation of a wide variety of items in a relatively small space.

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

Approximately 76% of sales are made in cash, with the balance made by credit cards. We permit, with restrictions on certain items, returns for exchange or refund.

Purchasing and Distribution

We purchase our merchandise from approximately 1,500 suppliers. We are not dependent on an individual supplier for merchandise purchased. Substantially all of the costume jewelry and fashion accessories that we sell are purchased from importers or imported directly. All merchandise is shipped from suppliers to our distribution facility in Hoffman Estates, Illinois, a suburb of Chicago, which services the North American stores, or the distribution facility in Birmingham, England, which services the stores in the United Kingdom, Ireland and France, or the distribution facilities in Zurich, Switzerland and Vienna, Austria, which service the stores in Switzerland, Austria and Germany. After inspection, merchandise is shipped via common carrier to the individual stores. Stores typically receive three to five shipments a week, which provide our stores with a steady flow of new merchandise.

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Store Management

Except as stated below, our Senior Vice President of Store Operations is responsible for managing our North American stores and reports to our Chief Operating Officer for North America, who in turn, reports to our Acting Co-Chief Executive Officers of Claire’s Stores, our parent company. We currently employ 214 District Managers in North America, each of whom oversees approximately 10 stores in his or her respective geographic area and reports to one of 20 Regional Managers. Each Regional Manager in North America reports to one of 6 Territorial Vice Presidents, who reports to the Senior Vice President of Store Operations. Each store is staffed by a Manager, an Assistant Manager and one or more part-time employees. A majority of the District Managers have been promoted from within the organization, while a majority of the Regional Managers were hired externally. All of the Territorial Vice Presidents in North America were promoted from within the organization. The reporting structure for our stores in the international group is similar to the reporting structure in North America. The Presidents of Claire’s UK, Claire’s France and Bijoux report to the Chief Operating Officer of Europe, who in turn reports to our Acting Co-Chief Executive Officers of Claire’s Stores, our parent company. In the international group, there are a total of 4 Regional Managers and 69 District Managers. The Chief Operating Officer of Europe position is vacant. We are actively recruiting to fill this position, as well as hire a Chief Operating Officer of Claire’s Stores, Inc., our parent company.

Store Openings, Closings and Future Growth

For the fiscal year ended February 1, 2003, which is referred to as Fiscal 2003, we expanded our operations by 40 stores, net, in the United Kingdom, resulting in a total of 454 stores, by 8 stores, net, in Bijoux, resulting in a total of 95 stores, and by 47 stores, net, in France, resulting in a total of 104 stores. In North America, we decreased our operations by 70 stores, net to 2,150 stores. We believe our store growth will occur in our international markets, where we plan on opening approximately 10 stores, net, in the United Kingdom, opening 50 stores, net, in France and opening 4 stores, net, in Bijoux during the fiscal year ending January 31, 2004, which is referred to as Fiscal 2004. We plan on closing approximately 15 stores, net, in North America in Fiscal 2004. In Fiscal 2003, we and our joint venture partner, Aeon Co., Ltd. (formerly known as Jusco Co., Ltd.), a Japanese company, increased our operations in Japan by 12 stores to 109 stores. There are 15 store openings planned in Japan in Fiscal 2004. Net stores refers to stores opened, net of closings, if any.

We closed 588 stores in the last three fiscal years, primarily due to certain locations not meeting our established profit benchmarks or the unwillingness of landlords to renew leases on terms acceptable to us, and the elimination of stores in connection with our acquisition of Afterthoughts. Most of these stores were closed at or near lease expiration. We have not experienced any substantial difficulty in renewing desired store leases and have no reason to expect any such difficulty in the future. For each of the last three fiscal years, no individual store accounted for more than one percent of total sales.

We plan to continue opening stores when suitable locations are found and satisfactory lease negotiations are concluded. Our initial investment in new stores opened during Fiscal 2003, which includes leasehold improvements and fixtures, averaged approximately $112,000 per store. In addition, certain store locations in our International operations require the purchase of intangible assets. In these cases, we invested approximately $235,000 per store in Fiscal 2003.

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

Trademarks and Service Marks

We are the owner in the United States of various marks, including “Claire’s,” “Claire’s Accessories,” “Afterthoughts” and “Icing by Claire’s.” We have also registered these marks outside of the United

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States. We believe our rights in our marks are important to our business and intend to maintain our marks and the related registrations.

Information Systems

Our information systems provide our management with data that helps them identify emerging trends and manage inventories. Our information systems in North America include purchase order management, open order reporting, receiving, distribution, merchandise allocation, basic stock replenishment, inter-store transfers, inventory, financial reporting and price management.

All of our stores in North America have a point-of-sale system. The system features bar-coded ticket scanning, automatic price look-up, dial-out check and credit authorization and automatic nightly transmittal of data between the store and our corporate offices.

We are in the process of upgrading and integrating our information systems in our international operations. We believe our management information systems are adequate to support our planned expansion at least through Fiscal 2005.

Competition

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

Seasonality

Sales of each category of merchandise vary from period to period depending on current fashion trends. We experience traditional retail patterns of peak sales during the Christmas, Easter and back-to-school periods. Sales, as a percentage of total sales in each of the four quarters of the fiscal year ended February 1, 2003 were 21%, 24%, 23% and 32% in the first, second, third and fourth quarters, respectively.

Employees

On March 31, 2003, we had approximately 16,325 employees, 56% of whom were part-time. Part-time employees typically work up to 20 hours per week. We do not have collective bargaining agreements with any labor unions and we consider employee relations to be good.

Item 2. Properties

Our stores are located in all 50 states of the United States, Puerto Rico, Canada, the United Kingdom, Switzerland, Austria, Germany, France, Ireland and Japan. We lease all of our 2,925 store locations, generally for terms of seven to ten years. Under the leases, we pay a fixed minimum rent and/or rentals based on gross sales in excess of specified amounts. We also pay certain other expenses (e.g., common area maintenance charges and real estate taxes) under the leases. The internal layout and fixtures of each store are designed by management and constructed under contracts with third parties.

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

We own central buying and store operations offices and North American distribution center located in Hoffman Estates, Illinois which is on approximately 24.8 acres. The property has buildings with

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approximately 520,000 total square feet of space, of which 404,000 square feet is devoted to receiving and distribution and 116,000 square feet is devoted to office space.

Our subsidiary, Claire’s Accessories UK Ltd., or UK, leases distribution and office space in Birmingham, England. The facility consists of 25,000 square feet of office space and 60,000 square feet of distribution space. The lease expires in December 2024 and UK has the right to assign or sublet this lease at any time during the term of the lease. UK also has a lease for 25,000 square feet of office and distribution space which it occupied prior to its current location. This lease expires in March 2012, although UK has the right to terminate in March 2007. UK utilizes this space to support its growing needs for distribution to Ireland and France, but also has the right to assign or sublet the old lease.

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

We lease from Rowland Schaefer & Associates (formerly Two Centrum Plaza Associates) approximately 33,000 square feet in Pembroke Pines, Florida, where we maintain our executive, accounting and finance offices. The lease provides for the payment of annual base rent of approximately $679,000, which is subject to annual cost-of-living increases, and a proportionate share of all taxes and operating expenses of the building. We exercised a five year renewal option under the lease, which now expires on July 31, 2005. See Note 10 entitled “Related Party Transactions” to our consolidated financial statements included in this report of Form 10-K.

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

Item 3. Legal Proceedings

We are, from time to time, involved in routine litigation incidental to the conduct of our business, including proceedings to protect our trademark rights, litigation instituted by persons injured upon premises under our control and litigation with present and former employees. Although litigation with present and former employees is routine and incidental to the conduct of our business, like any business employing significant numbers of employees, such litigation can result in large monetary awards when a civil jury is allowed to determine compensatory and/or punitive damages for actions claiming discrimination on the basis of age, gender, race, religion, disability of other legally protected characteristic or for termination of employment that is wrongful or in violation of implied contracts. We believe that currently pending litigation will not have a material adverse effect on our financial position, earnings or cash flows. We may also become involved with litigation for businesses that we have acquired or businesses that we have disposed of, and we may be required to pursue our indemnification rights, to the extent available, under agreements with third parties for liabilities, if any, that might be assessed against us for these claims. Potential claims may also be asserted against us by creditors of Lux Corp. as a result of its recent bankruptcy filing. These potential claims may include or relate to obligations under real estate leases guaranteed by us, obligations under equipment and leasehold improvement leases assigned by us to Lux Corp., and payments received by us under the stock purchase agreement. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Discontinued Operations.”

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

No matters were submitted to a vote of security holders during the fourth quarter of Fiscal 2003.

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PART II

Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters

We have two classes of common stock, par value $.05 per share, outstanding: common stock having one vote per share and Class A common stock having ten votes per share. The common stock is traded on the New York Stock Exchange, Inc. under the symbol CLE. The Class A common stock has only limited transferability and is not traded on any stock exchange or in any organized market. However, the Class A common stock is convertible on a share-for-share basis into common stock and may be sold, as common stock, in open market transactions. The following table sets forth, for each quarterly period within the last two fiscal years, the high and low closing prices of the common stock on the NYSE Composite Tape. At March 31, 2003, the number of record holders of shares of common stock and Class A common stock was 1,383 and 493, respectively.

We have paid regular quarterly dividends to our shareholders on the common stock since 1985 and on the Class A common stock since July 1994. Our Board of Directors, in its sole discretion, has determined the distribution rate based on our results of operations, economic conditions, tax considerations and other factors. In Fiscal 2002 and Fiscal 2003, we paid quarterly cash dividend distributions each year (four in the amount of $.04 per share of common stock each year and four in the amount of $.02 share of Class A common stock each year) totaling $.16 per share of common stock each year and $.08 per share of Class A common stock each year. We expect to continue paying dividends. However, there is no assurance that we will be able to continue to do so because the declaration and payment of dividends are subject to various factors, including contingencies such as our earnings and financial condition and other factors our Board of Directors consider relevant as well as certain limitations on our ability to make dividend distributions that could become effective if we fail to meet specified financial covenants under our credit facility. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources.”

The following table provides information as of February 1, 2003 with respect to compensation plans (including individual compensation arrangements) under which our common stock and Class A common stock are authorized for issuance.

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Item 6. Selected Financial Data

The balance sheet and income statement data set forth below is derived from our consolidated financial statements and should be read in conjunction with our consolidated financial statements included in Part II, Item 8 of this report on Form 10-K, and in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in this report. The consolidated Balance Sheet data as of February 3, 2001, January 29, 2000, and January 30, 1999 and the consolidated Statements of Operations and Comprehensive Income for each of the two fiscal years in the period ended January 29, 2000 and January 30, 1999 are derived from our consolidated financial statements, which are not included herein.

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(2)		We adopted a plan to discontinue the operations of our Just Nikki catalog segment in January 1999.
(3)		We adopted a plan to discontinue the operations of Mr. Rags (Lux Corp.) in January 2002. See Note 3 to the consolidated financial statements for additional information.

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

The following discussion should be read in conjunction with our consolidated financial statements and notes thereto included in Part II, Item 8 of this report on Form 10-K. The following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including changes in estimates and judgments used in preparing our financial statements set forth under “Critical Accounting Policies and Estimates” and the factors set forth under “Certain Risk Factors Relating to our Business” in this section.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to inventories, valuation of goodwill and intangible assets, income taxes, financing operations, contingencies and litigation. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Our significant accounting policies are discussed in Note 1 to our consolidated financial statements. Management believes that the following accounting policies include a higher degree of judgment and/or complexity and, thus, are considered to be critical accounting policies. Management has discussed the development and selection of these critical accounting policies with the Audit Committee of the Board of Directors and the Audit Committee has reviewed our disclosures relating to them.

Inventory Valuation

We mark down our inventory for estimated unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory markdowns may be required, which could reduce our margins and operating results. Management records these inventory markdowns periodically based on the various assumptions, including customer demand and preferences. Our success is largely dependent upon management’s ability to gauge the fashion tastes of our customers and provide merchandise that satisfies customer demand. Any failure to provide appropriate merchandise in quantities that mirror demand could increase future inventory write-downs. Additionally, our inventories are valued using the retail method in North America and Bijoux and average cost in UK and France. Fluctuations in demand for inventory affect the value of our inventory.

Asset Impairment

We invest in property and equipment in connection with the opening and remodeling of stores. We evaluate the recoverability of these assets periodically and record an impairment charge when we believe the cash flow may not be sufficient to recover the assets. Future adverse changes in market conditions or poor operating results of underlying assets could result in losses or an inability to recover the carrying value of the investments that may not be reflected in an investment’s current carrying value, thereby

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possibly requiring an impairment charge in the future. During Fiscal 2003, we recorded impairment charges of $2.7 million relating to fixed assets in our International segment due to those assets not being recoverable by estimated discounted cash flows.

Goodwill Impairment

We continually evaluate whether events and changes in circumstances warrant revised estimates of useful lives or recognition of an impairment loss of unamortized goodwill. The conditions that would trigger an impairment assessment of unamortized goodwill include a significant, sustained negative trend in our operating results or cash flows, a decrease in demand for our products, a change in the competitive environment and other industry and economic factors. We measure impairment of unamortized goodwill utilizing the discounted cash flow method. The estimated discounted cash flows are then compared to our goodwill amounts. If the unamortized balance of the goodwill exceeds the estimated discounted cash flows, the excess of the unamortized balance is written off. Future cash flows may not meet projected amounts, which could result in impairment.

Intangible Asset Impairment

We continually evaluate whether events and changes in circumstances warrant revised estimates of the useful lives or recognition of an impairment loss for intangible assets. Future adverse changes in market and legal conditions, or poor operating results of underlying assets could result in losses or an inability to recover the carrying value of the intangible asset, thereby possibly requiring an impairment charge in the future. The Company has concluded that certain intangible assets, comprised primarily of lease rights, qualify as indefinite-life intangible assets. Fair market value of the lease rights were determined through the use of third-party valuation. In addition, we make investments through our international subsidiaries in intangible assets upon the opening and acquisition of many of our store locations in Europe. These other intangible assets which are subject to amortization are amortized over the useful lives of the respective leases, not to exceed 25 years. We evaluate the market value of these assets periodically and record the impairment charge when we believe the asset has experienced a decline in value that is other than temporary. We recorded impairment charges of approximately $1.0 million in Fiscal 2003 because the market value of certain lease rights included in our international segment were determined to be less than their carrying values.

Accounting for Leases

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

Deferred Taxes

We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. The valuation allowance is determined based on estimates by management of future taxable income. Our estimates of future taxable income can be affected by a number of factors, including possible tax audits or general economic conditions or competitive pressures that could affect our future taxable income. While we have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance, in the event we were to determine that we would not be able to realize our deferred tax assets in the future, an adjustment to the valuation allowance would be made. Likewise, should we determine that we would not be able to realize all or part of a net deferred tax asset in the future, an adjustment to the deferred tax asset would be charged to income in the period such determination was made. Recorded within our financial statements is a valuation allowance of $4.1 million at February 1, 2003 due to uncertainties related to the ability to utilize

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some of our deferred tax assets, primarily consisting of net operating loss carryforwards of $11.5 million relating to the operations of our foreign subsidiaries, $11.0 million of which have indefinite expiration, and $.5 million of which expire in Fiscal 2006.

Although management believes that the estimates discussed above are reasonable and the related calculations conform to generally accepted accounting principles, actual results could differ from these estimates, and such differences could be material.

Certain Risk Factors Relating to our Business

The following are some of the factors that could cause actual results to differ materially from estimates contained in our forward-looking statements:

Fluctuations in consumer preference and economic conditions affect the demand of our products

Our retail jewelry and fashion accessories business fluctuates according to changes in consumer preferences which are dictated in part by fashion and season. In addition, certain economic conditions affect the level of consumer spending on merchandise that we offer, including, among others, business conditions, unemployment levels, interest rates, energy costs, taxation rates and consumer confidence in future economic conditions. Consumer preference and economic conditions may differ or change from time to time in each market in which we operate and negatively affect our net sales and profitability.

Purchases in advance of merchandise inventory, excessive markdowns, interruptions in distribution and material inventory shrinkage may
     negatively impact our profitability

Fluctuations in the demand for retail fashion accessories and apparel especially affect the inventory we own because we usually order our merchandise well in advance of the applicable season and sometimes before fashion trends are identified or evidenced by customer purchases. In addition, the cyclical nature of the retail business requires us to carry a significant amount of inventory, especially prior to peak selling seasons when we and other retailers generally build up inventory levels. We purchase merchandise from our suppliers well in advance of the applicable selling season. As a result, we are vulnerable to demand and pricing shifts and to suboptimal selection and timing of merchandise purchases.

We review our inventory aging in order to identify slow-moving merchandise and use markdowns to clear merchandise. Markdowns may be used if inventory exceeds customer demand for reasons of style, seasonal adaptation, changes in customer preference or lack of consumer acceptance of fashion items, or if it is determined that the inventory in stock will not sell at its currently marked price. Such markdowns may have an adverse impact on earnings, depending on the extent of the markdowns and amount of inventory affected.

Distribution functions for all of our North American stores are handled from our distribution center in Hoffman Estates, Illinois. Distribution functions for all of our stores in the United Kingdom, France and Ireland are handled from our distribution center in Birmingham, United Kingdom. Distribution facilities for all of our stores in Switzerland, Austria and Germany are handled from our distribution centers in Zurich, Switzerland and Vienna, Austria. Any significant interruption in the operation of these distribution centers, due to natural disaster or otherwise, would have a material effect on our business, financial condition and results of operations.

We have a loss prevention program in order to control inventory shrinkage, including surveillance systems, education of store personnel and monitoring of returns. However, there can be no assurance that these safeguards will prevent or adequately limit inventory shrinkage. Any material inventory shrinkage would have a material adverse effect on our net sales and profitability.

A disruption of imports from our foreign suppliers may increase our costs and reduce our supply of merchandise

We purchase merchandise from approximately 1,500 domestic and international suppliers. In Fiscal 2003, approximately 18% of all merchandise units purchased for our North American stores (representing

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approximately 29% of total cost) were purchased domestically and the remaining 82% of all merchandise units (71% of cost) were purchased from outside the United States. In Fiscal 2003, approximately 42% of our total merchandise units purchased for our North American stores (representing 42% of cost) were from China, including Hong Kong, with the remainder coming from 12 other foreign countries. An outbreak of Severe Acute Respiratory Syndrome (SARS) has recently been reported in Hong Kong, Singapore, and China. Any event, such as SARS, political instability or the imposition of additional import restrictions that disrupt or otherwise adversely affect our imports from China or other foreign countries, would be likely to have a material adverse effect on our operations. Substantially all of our foreign purchases of merchandise are negotiated and paid for in U.S. dollars.

We cannot predict whether any of the countries in which our products currently are manufactured or may be manufactured in the future will be subject to additional trade restrictions imposed by the U.S. and other foreign governments, including the likelihood, type or effect of any such restrictions. Trade restrictions, including increased tariffs or quotas, embargoes, and customs restrictions, against merchandise could increase the cost or reduce the supply of merchandise available to us and adversely affect our business, financial condition and results of operations. We pursue a diversified global sourcing strategy that includes relationships with vendors in 14 countries. These sourcing operations may be adversely affected by political and financial instability resulting in the disruption of trade from exporting countries, significant fluctuation in the value of the U.S. dollar against foreign currencies, restrictions on the transfer of funds and/or other trade disruptions.

Fluctuations in same-store net sales may affect the price of our stock

Our comparable same-store net sales results have fluctuated in the past, on a monthly, quarterly and annual basis, and are expected to continue to fluctuate in the future. A variety of factors affect our same-store net sales results, including changes in fashion trends, changes in our merchandise mix, calendar shifts of holiday periods, actions by competitors, weather conditions and general economic and geopolitical conditions. Our comparable store net sales results for any particular fiscal month, fiscal quarter or fiscal year in the future may decrease. As a result of these or other factors, our future comparable store net sales results are likely to have a significant effect on the market price of our common stock because investors may look to our same-store net sales results to determine how we performed from period to period absent sales attributable to new stores.

Store operations and expansion may affect our ability to increase net sales and operate profitably

Our continued success depends, in part, upon our ability to increase sales at existing store locations, to open new stores and to operate stores on a profitable basis and to maintain good relationships with mall developers and operators. Because we are primarily a mall-based retailer, our future growth is significantly dependent on our ability to open new stores in desirable locations, including malls. Our ability to open new stores depends on a number of factors, including our ability to locate and obtain favorable store sites primarily in malls, negotiate acceptable lease terms, obtain adequate supplies of merchandise and hire and train qualified employees. Our ability to operate stores on a profitable basis depends on, among other factors, whether we have to take additional merchandise markdowns due to excessive inventory levels compared to sales trends, and whether we can reduce the number of under-performing stores which have a higher level of fixed costs in comparison to net sales. There can be no assurance that our growth will result in enhanced profitability or that we will achieve our targeted growth rates with respect to new store openings.

The failure to execute our international expansion or successfully integrate our international operations may impede our strategy of
     increasing net sales and adversely affect our operating results

Our international expansion is an integral part of our strategy to increase our net sales through store growth. If our international expansion is not successful, our results of operations are likely to be adversely affected. Our ability to grow successfully in the continental European market depends in part on determining a sustainable formula to build customer loyalty and gain market share in the especially challenging retail environments of France and Germany. Additionally, the integration of our operations in foreign countries presents certain challenges not necessarily presented in the integration of our North

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American operations, such as integration of information systems. For example, we currently use the retail method to value our inventory in North America and Bijoux, but use the average cost method for valuing our inventory in the UK and France. The failure to expand and integrate our foreign operations could have a material adverse effect on our operating results and impede our strategy of increasing our net sales through expansion.

The useful life and value of our goodwill and intangible assets will continue to be reevaluated and could result in a write-down of our goodwill
     or intangible assets in a future period

As of February 1, 2003, intangible assets, which include goodwill and other separately identifiable intangible assets, totaled approximately 31% of our total assets. We acquire intangible assets when we purchase businesses or acquire lease rights. At the time of or following each acquisition by us of intangible assets, we evaluate each acquisition and establish an appropriate useful life and carrying value for all intangible assets, including goodwill, identified based on the specific underlying facts and circumstances of the acquisition. Subsequent to such initial evaluation, we annually, or more frequently if impairment indicators arise, reevaluate such facts and circumstances to determine if the related intangible assets, including goodwill, continue to be realizable and if the useful life continues to be appropriate. As the underlying facts and circumstances subsequent to the date of acquisition can change, there can be no assurance that we will realize the value of such intangible assets, including goodwill. We did not record any impairment charge during Fiscal 2003 with respect to our unamortized balance of goodwill. We recorded impairment charges of approximately $1.0 million in Fiscal 2003 because the market value of certain lease rights in our international segment were less than their carrying values. Any future determination, based on reevaluation of the underlying facts and circumstances that a significant impairment has occurred, would require the write-off of the impaired portion of unamortized goodwill and intangible assets, which could have a material adverse effect on our results of operations.

Changes in the anticipated seasonal business pattern could adversely effect our sales and profits and our quarterly results may fluctuate due to a
     variety of factors

Our business follows a seasonal pattern, peaking during the Christmas, Easter and back-to-school periods. During Fiscal 2003, these periods accounted for approximately 30% of our annual sales. Any decrease in sales or margins during these periods would be likely to have a material adverse effect on our business, financial condition and results of operations. Seasonal fluctuations also affect inventory levels, because we usually order merchandise in advance of peak selling periods. We must carry a significant amount of inventory in anticipation of these selling periods. Our quarterly results of operations may also fluctuate significantly as a result of a variety of factors, including the time of store openings; the amount of revenue contributed by new stores; the timing and level of mark downs; the timing of store closings, expansions and relocations; competitive factors; and general economic conditions.

Our industry is highly competitive

The specialty retail business is highly competitive. We compete with national, international, and local department stores, specialty and discount store chains, independent retail stores and internet and catalog businesses that market similar lines of merchandise. Some competitors have more resources than us. Given the large number of companies in the retail industry, we cannot estimate the number of our competitors.

Depth of selection in sizes, colors and styles of merchandise, merchandise procurement and pricing, ability to anticipate fashion trends and consumer preferences, inventory control, reputation, quality of merchandise, store design and location, brand recognition and customer service are all important factors in competing successfully in the retail industry.

Our successful performance in recent years has increased the amount of imitation by other retailers. Such imitation has made and will continue to make the retail environment in which we operate more competitive.

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In addition, our competitive position depends upon a number of factors relating to consumer spending, including future economic conditions affecting disposable consumer income such as unemployment, business conditions, interest rates, energy costs and taxation. A decline in consumer spending on fashion accessories and apparel could have a material adverse effect on our net sales and profitability.

A decline in number of people who go to malls could reduce the number of our customers and reduce our net sales

Substantially all of our North American stores are located in regional shopping malls. Our sales are derived, in part, from the high volume of traffic in those malls. We benefit from the ability of the mall’s “anchor” tenants, generally movie theaters, large department stores and other area attractions to generate consumer traffic around our stores and the continuing popularity of malls as shopping destinations for pre-teens and teenagers. Sales volume and mall traffic may be adversely affected by economic downturns in a particular area, competition from non-mall retailers, other malls where we do not have stores and the closing of anchor tenants in a particular mall. In addition, a decline in the popularity of mall shopping among our target customers, pre-teens and teenagers, and increased gasoline prices that may curtail customer visits to malls, could result in decreased sales that would have a material adverse affect on our business, financial condition and results of operations.

Terrorist attacks have heightened security concerns and war or the threat of war could result in lower customer traffic in our stores

In response to the terrorist attacks of September 11, 2001, security has been heightened in public areas. Any further threat of terrorist attacks or actual terrorist events, particularly in public areas, could lead to lower customer traffic in regional shopping malls. In addition, local authorities or mall management could close regional shopping malls in response to any immediate security concern. For example, on September 11, 2001, a substantial number of our stores were closed early due to closure of the malls in response to the terrorist attacks. Mall closures, lower customer traffic due to security concerns, increased gasoline prices that may curtail customer visits to malls, and war or the threat of war could result in decreased sales that would have a material adverse affect on our business, financial condition and results of operations.

We depend on key personnel

Our success and ability to properly manage our growth depends to a significant extent both upon the performance of our current executive and senior management team and our ability to attract, hire, motivate and retain additional qualified management personnel in the future. Since November 2002, our Chairman and Chief Executive Officer has been on a medical leave of absence, and our Vice-Chairmen have assumed the responsibilities of our Chairman and Chief Executive Officer. We also have commenced a search for a Chief Operating Officer of Claire’s Stores, Inc., our parent company, and are seeking to fill the vacancy of Chief Operating Officer of Europe. Our inability to recruit and retain such additional personnel, or our loss of the services of any of our executive officers, could have a material adverse impact on us.

Litigation matters incidental to our business could be adversely determined against us and our insurance coverage may not be adequate to
     protect our assets and operations

We are involved from time to time in litigation incidental to our business, including litigation instituted by persons injured upon premises under our control, litigation with present and former employees and proceedings to protect our trademark rights. Management believes that the outcome of current litigation will not have a material adverse effect on our results of operations or financial condition. However, management’s assessment of current litigation could change in light of the discovery of facts not currently known by us or determinations by judges, juries or other finders of fact not in accordance with management’s assessment of the outcome of our pending litigation. We may also become involved with litigation for businesses that we have acquired or businesses that we have disposed of, and we may be required to pursue our indemnification rights, to the extent available, under agreements with third parties for liabilities, if any, that might be assessed against us for these claims. Potential claims may also be

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asserted against us by creditors of Lux Corp. as a result of its recent bankruptcy filing. These potential claims may include or relate to obligations under real estate leases guaranteed by us, obligations under equipment and leasehold improvement leases assigned by us to Lux Corp., and payments received by us under the stock purchase agreement. See “Discontinued Operations.” Depending on the actual outcome of pending or future litigation, charges could be recorded in the future that may have an adverse effect on our operating results.

We carry general liability, comprehensive property damage, workers’ compensation and other insurance coverages that management considers adequate for the protection of our assets and operations. There can be no assurance, however, that the coverage limits of such policies will be adequate to cover losses and expenses for claims brought or which may be brought against us. A successful claim against us in excess of insurance coverages could have a material adverse effect on our operating results. We retain certain self-insurance risks for health benefits, workers compensation benefits and casualty insurance programs. Self-insurance reserves are established based on claims filed and estimates of claims incurred by not yet reported. There can be no assurance that our actual claims will not exceed our estimates.

The price of our stock may fluctuate in the future

The market price of our common stock has fluctuated in the past and there can be no assurance that the market price of our common stock will not continue to fluctuate significantly. Future announcements or management discussions concerning us or our competitors, sales and profitability results, quarterly variations in operating results or comparable store net sales, changes in earnings estimates by analysts or changes in accounting policies, among other factors, could cause the market price of our common stock to fluctuate substantially. In addition, stock markets have experienced extreme price and volume volatility in recent years.

Control by our Chairman

We have two classes of common stock, common stock and Class A common stock. The holders of our common stock are entitled to one vote per share, and the holders of our Class A common stock are entitled to 10 votes for each share. As of March 31, 2003, Mr. Rowland Schaefer, our Chairman, President and Chief Executive Officer, owns or has voting power over approximately 9.4% of our common stock and approximately 66.2% of our Class A common stock and, as a result, controls approximately 30.3% of our outstanding voting power on a combined basis. As a result, our Chairman substantially influences shareholder action, including the election of our directors. This influence of us by our Chairman may make us less attractive as a target for a takeover proposal. It may also make it more difficult to discourage a merger proposal or proxy contest for the removal of incumbent directors. As a result, this may deprive the holders of our common stock of an opportunity they might otherwise have to sell their shares at a premium over the prevailing market price in connection with a merger or acquisition of us or with or by another company.

Our wage expenses may increase as a result of increases in Federal minimum wage laws

Recent changes to Federal minimum wage laws have raised the mandatory minimum wage. Various states, including states where we operate our business, have enacted increases that are higher than the Federal minimum wage. Statutory increases in Federal and state minimum wages above our current wages could require corresponding increases in higher employee wage rates. Increases in wage rates that are not offset by corresponding increases in sales would adversely affect our results of operations.

We caution our investors that the risk factors described above could cause actual results or outcomes to differ materially from those expressed in any forward-looking statements made by or on behalf of us. Further, management cannot assess the impact of each such factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

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Results of Continuing Operations

The following table sets forth, for the periods indicated, percentages which certain items reflected in the financial statements bear to our net sales:

The operating results of Claire’s Nippon Co., Ltd. (Nippon) are accounted for under the equity method. As a result, any losses incurred by Nippon in excess of our investment and advances are not reflected in our income statement because the operations are not part of our consolidated group in accordance with generally accepted accounting principles. Accordingly, the operating results of Nippon are not included in the following analysis. In addition, the assets and liabilities of Nippon are not included in our consolidated balance sheets. Under the equity method, our original investment in Nippon was recorded at cost and had been adjusted periodically to recognize our proportionate share of earnings or losses from Nippon since the acquisition date. As of February 1, 2003 and February 2, 2002, our investment in Nippon was carried at zero on our consolidated balance sheet.

Our fiscal years end on the Saturday closest to January 31. As a result, our Fiscal 2003 and Fiscal 2002 results consisted of 52 weeks and our Fiscal 2001 results consisted of 53 weeks.

Matters Affecting Comparability

Effective February 3, 2002, we adopted Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 142 requires that goodwill and certain other intangible assets deemed to have indefinite useful lives are no longer amortized but are reviewed annually for impairment. SFAS No. 142 does not require retroactive restatement for all periods presented; however, it does require the disclosure of prior year effects adjusted for the elimination of amortization of goodwill and indefinite-lived intangible assets. Had the provision of SFAS No. 142 been applicable to Fiscal 2002 and Fiscal 2001, income from continuing operations would have been $.96 and $1.47, respectively, as compared to $.84 and $1.35, respectively, per diluted share. The initial impairment review as of the transition date of February 3, 2002 was completed in Fiscal 2003 and resulted in no goodwill impairment charge. Refer to Note 1 to our consolidated financial statements for further information.

Fiscal 2003 Compared to Fiscal 2002

Net sales increased by $82.8 million, or 9%, to $1.0 billion in Fiscal 2003 compared to $918.7 million for the year ended February 2, 2002, which is referred to as Fiscal 2002. This increase resulted primarily

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from same-store sales increases of 5% for the year. During Fiscal 2003, our sales in North America increased 6%, while our international sales increased 2% on a same-store sales basis. The same-store sales increase in North America was primarily a result of an increase in the average retail per transaction partially offset by fewer transactions per store.

Cost of sales, occupancy and buying expenses increased by $13.1 million, or 2.8%, to $486.9 million in Fiscal 2003 compared to $473.8 million in Fiscal 2002. As a percentage of net sales, these expenses decreased to 48.6% for Fiscal 2003 compared to 51.6% for Fiscal 2002. This decrease of 3.0% was primarily the result of increased merchandise margins as we reduced promotional activity and markdowns during the year through managing inventories efficiently.

Selling, general and administrative expenses increased by $24.1 million, or 7.3% to $355.1 million in Fiscal 2003 from $331.0 million in Fiscal 2002. This increase was primarily the result of higher operating costs, approximately $4.2 million of additional compensation earned by our Chairman in Fiscal 2003, approximately $3.7 million of impairment charges in our International operations, and approximately $2.7 million of additional store bonuses due to increased sales. As a percentage of net sales, these expenses decreased to approximately 35.4% in Fiscal 2003 compared to 36.0% in Fiscal 2002. The decrease was primarily caused by leverage on fixed costs. It has been our objective to close a number of under-performing or duplicative acquired Afterthoughts stores. As of February 1, 2003, 384 Afterthoughts stores had been closed or leases not renewed and 26 stores had been opened, resulting in 413 stores remaining within our North American operations. We expect to not renew the leases for approximately 89 stores in Fiscal 2004. During Fiscal 2003, we continued to eliminate redundant field operations and review under-performing stores.

Depreciation and amortization decreased by $5.0 million, or 11.7%, to $37.9 million in Fiscal 2003 from $42.9 million in Fiscal 2002. The decrease was primarily due to goodwill no longer being amortized in accordance with SFAS No. 142. Approximately $8.7 million of goodwill was amortized in Fiscal 2002. In addition, depreciation increased from our international divisions, partially offset by lower depreciation in North America.

Interest expense decreased from $10.4 million in Fiscal 2002 to $4.4 million in Fiscal 2003. The decrease of $6.0 million was primarily the result of lower interest rates and lower borrowings on our credit facility.

Interest and other income decreased from $4.0 million in Fiscal 2002 to $2.9 million in Fiscal 2003. The net decrease was primarily the result of lower interest rates on our invested cash balances, partially offset by the inclusion of approximately $1 million of fees received in consideration of performing certain administrative functions for the new owners of Lux Corp.

Income taxes increased by $18.7 million to $42.1 million in Fiscal 2003 compared to $23.5 million in Fiscal 2002. As a percentage of pre-tax income from continuing operations, income taxes decreased to 35.1% in Fiscal 2003 from 36.3% in Fiscal 2002. Our consolidated effective tax rate for Fiscal 2003 was 35%.

Fiscal 2002 Compared to Fiscal 2001

Net sales decreased by $28 million, or 3%, to $918.7 million in Fiscal 2002 compared to $946.7 million for the year ended February 3, 2001, which is referred to as Fiscal 2001. This decrease resulted primarily from same-store sales decreases of 2% for the year. During Fiscal 2002, our sales in North America decreased 3%, while our international sales increased 1% on a same-store sales basis. The same-store sales decrease in North America was primarily a result of fewer transactions per store, partially offset by an increase in the average retail per transaction.

Cost of sales, occupancy and buying expenses increased by $12.2 million, or 3%, to $473.8 million in Fiscal 2002 compared to $461.6 million in Fiscal 2001. As a percentage of net sales, these expenses increased to 51.6% for Fiscal 2002 compared to 48.8% for Fiscal 2001. This increase of 2.8% was primarily the result of additional merchandise markdowns required due to excessive inventory levels compared to sales trends in North America. These markdowns were recorded in the second quarter of

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Fiscal 2002. These markdowns helped us reduce inventory levels to be in line with planned sales for future periods. In addition, the decline in same-store sales discussed above resulted in the lack of leverage on fixed occupancy costs.

Selling, general and administrative expenses increased by $2.6 million, or 1% to $331 million in Fiscal 2002 from $328.4 million in Fiscal 2001. The increase was caused by inflationary cost increases, partially offset by cost savings achieved in store payroll by reducing hours worked to correspond with lower sales patterns. As a percentage of net sales, these expenses increased to approximately 36% in Fiscal 2002 compared to 34.7% in Fiscal 2001. The increase was primarily caused by lack of leverage on fixed costs. It has been our objective to close a number of under-performing or duplicative acquired Afterthoughts stores. As of February 2, 2002, 313 Afterthoughts stores had been closed or leases not renewed and 18 stores had been opened resulting in 476 stores remaining. During Fiscal 2002, we continued to eliminate redundant field operations and review under-performing stores. As a result of our review, we recorded a $2.2 million non-cash charge to write off the assets whose carrying value had been impaired.

Depreciation and amortization increased by $892,000, or 2%, to $42.9 million in Fiscal 2002 from $42 million in Fiscal 2001. The increase was primarily due to the increased depreciation from our international divisions, partially offset by lower depreciation in North America.

Interest expense decreased from $14.2 million in Fiscal 2001 to $10.4 million in Fiscal 2002. The decrease of $3.8 million was primarily the result of lower interest rates and lower borrowings on our credit facility.

Interest and other income decreased from $4.2 million in Fiscal 2001 to $4.0 million in Fiscal 2002. The net decrease of $0.2 million was primarily the result of lower interest rates on our invested cash balances.

Income taxes decreased by $13.5 million to $23.5 million in Fiscal 2002 compared to $37 million in Fiscal 2001. As a percentage of pre-tax income from continuing operations, income taxes increased to 36.3% in Fiscal 2002 from 35.3% in Fiscal 2001. The increase in the effective tax rate from continuing operations was affected by the tax benefits of losses in Lux Corp., being included in the loss from discontinued operations. Our consolidated effective tax rate for Fiscal 2002 was 35%.

Seasonality and Quarterly Results

Our business is seasonal by nature, with the Christmas, Easter and back-to-school periods historically accounting for the largest percentage of annual net sales. In Fiscal 2003, the Christmas, Easter and back-to-school periods together accounted for approximately 30% of our annual net sales. See note 11 of our consolidated financial statements.

Impact of Inflation

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

Discontinued Operations

In January 2002, our Board of Directors authorized the disposition of Lux Corp., which represented our apparel segment. In connection with the plan to dispose of Lux Corp., we recorded a loss on disposal of $13.0 million, net of tax, in the consolidated financial statements as of February 2, 2002.

On May 17, 2002, we 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 Lux Corp. were accounted for as a discontinued operation in our consolidated financial statements. The deferred payments aggregating $10 million were not included in our estimate of loss on

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disposition as the timing and amount could not be reasonably estimated due to the uncertainty of the financial condition of the acquired business. In January 2003, Lux Corp. filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Code in the United States Bankruptcy Court for the Southern District of California. In April 2003, Lux Corp. advised the Bankruptcy Court that it intends to liquidate its assets. As a result, no deferred payments have been made to us since the date of the bankruptcy filing, and there is no assurance that we will receive any future deferred payments. During Fiscal 2003, we recorded approximately $.2 million, net of tax, loss on disposal of Lux Corp.

As of February 1, 2003, we remain as a guarantor on 12 real estate leases for Mr. Rags store locations with future rental payments of approximately $10.2 million. As of February 1, 2003, we also had a contingent liability as lessee under a master lease agreement on $4.0 million of gross future lease payments on operating leases for equipment and leasehold improvements of Lux Corp. that were assigned to Lux Corp. at the time of the sale. Based on management’s review of the financial performance of Mr. Rags since the date of sale and, taking into consideration the bankruptcy filing by Lux Corp. in January 2003 and the related impact on Lux Corp.’s ability to fulfill the commitments under these real estate and operating leases, we accrued a liability of $5.7 million at February 1, 2003. We also entered into a service agreement with the new owner of Lux Corp. in May 2002 under which we perform certain transition services for the benefit of Mr. Rags, with no decision making authority. The service agreement was for an initial period of one year, with two three-month renewal options. Lux Corp. has exercised the first renewal option, so the service agreement is scheduled to terminate in August 2003, unless earlier terminated pursuant to the terms of the service agreement. As of February 1, 2003, we have received approximately $1 million for these services and have included this amount in “interest and other income” within our Consolidated Statements of Operations and Comprehensive Income for Fiscal 2003.

In order to conform to the separate presentation of the net assets and operating results of Lux Corp. as a discontinued operation, certain prior period amounts have been reclassified to conform to current period presentation.

Liquidity and Capital Resources

In connection with the acquisition of Afterthoughts in December 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 February 1, 2003 approximately $25 million was outstanding on this line of credit, while $85 million was outstanding under the term loan. Also, on February 1, 2003, the borrowings under this credit facility were bearing interest at 3%, and we 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 February 1, 2003, we had $15 million of availability under the revolving line of credit. We also had $1.2 million of issued letters of credit which are supported by and considered drawn against our 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. 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.

The Company’s non-U.S. subsidiaries have credit facilities totaling approximately $1.6 million with banks. The facilities are used for working capital requirements, letters of credit and various guarantees. These credit facilities have been arranged in accordance with customary lending practices in their

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respective countries of operation. At February 1, 2003, the borrowings totaled $916,000, bearing interest at rates at approximately 3%.

We finance certain leasehold improvements and equipment used in our stores through transactions accounted for as non-cancelable operating leases. As a result, the rental expense for these leasehold improvements and equipment is recorded during the term of the lease contract in our consolidated financial statements, generally over four to seven years. In the event that any of the real property leases where leasehold improvements or equipment is located that are subject to these non-cancelable operating leases is terminated by us or our landlord prior to the scheduled expiration date of the real property lease, we will be required to accrue all future rent payments under these operating leases. At February 1, 2003, we had $411,000 accrued related to future payment obligations on leasehold improvement leases for closed stores. We are guarantor on approximately $10.2 million of real estate leases of Mr. Rags of which we have accrued $1.7 million as a contingent liability. See “Discontinued Operations.”

As of February 1, 2003, the Company’s future financial commitments under these arrangements are as follows:

We review the operating performance of our stores on an on-going basis to determine which stores, if any, to expand, relocate or close. We closed 150 stores in Fiscal 2003 and anticipate closing approximately 89 stores in Fiscal 2004.

Our operations have historically provided a positive cash flow which, together with our cash balances, provide adequate liquidity to meet our operational needs and debt obligations. Cash and cash equivalents totaled $195.5 million at the end of Fiscal 2003.

Net cash provided by operating activities from continuing operations was $167.1 million in Fiscal 2003 compared to $101.4 million in Fiscal 2002 and $111.0 million in Fiscal 2001. The primary sources of net cash provided by operating activities in Fiscal 2003 was net income of $77.7 million, depreciation and amortization of $38.6 million, an increase in trade account payables and accrued expenses of $27.0 million and an increase in income taxes payable, partially offset by an increase in inventories of $6.8 million and an increase in prepaids and other assets of $15.0 million. Our current ratio (current assets over current liabilities) was 2.3:1.0 for Fiscal 2003 and 2.6:1.0 for Fiscal 2002.

At the end of Fiscal 2003, we increased our investment in inventories to $88.3 million, or 12.4%, from the Fiscal 2002 balance of $78.6 million. Our average store inventories vary throughout the year and increase in advance of the peak selling periods of Christmas, Easter and back-to-school. During Fiscal 2003,

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inventory turnover increased to 3.0 times from 2.8 times for Fiscal 2002. The increase in inventories was due to carrying appropriate levels of inventory to meet planned sales for the spring season. In addition, inventories on a per square foot basis increased 11.4%.

Net cash used in investing activities of $51.1 million in Fiscal 2003 was primarily a result of capital expenditures of $45.5 million, the acquisition of intangible assets (lease rights within our international segment) of $6.8 million offset by and the sale of short-term investments. During Fiscal 2003, we continued to expand and remodel our store base. Significant capital projects included the opening of 175 new stores and the remodeling of 141 stores. In Fiscal 2004, capital expenditures and acquisition of intangible assets (lease rights) are expected to be approximately $50 million and $15 million, respectively, as we continue to invest in expanding and remodeling our store base and technology.

Net cash used in financing activities of $24.8 million in Fiscal 2003 was primarily due to our payments on the credit facility of $20.2 million and dividends paid of $7.6 million, offset by $3.0 million received from the exercise of stock options.

Working capital at the end of Fiscal 2003 was $180.6 million compared to $131.9 million at the end of Fiscal 2002. The increase in working capital was primarily attributable to an increase in cash and cash equivalents of $95.6 million, inventories of $9.7 million and prepaid expenses and other current assets of $3.4 million, offset by an increase in current liabilities.

We believe that we will be able to finance our capital expenditure plans for Fiscal 2004 based on our consistent ability to generate cash flow from operations, significant cash balances and available funds under our credit facilities.

Recent Accounting Pronouncements

Effective February 3, 2002, we adopted Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets.” In accordance with SFAS 142, we ceased amortizing its goodwill effective February 3, 2002. We recorded $8.7 million of amortization during the year ended February 2, 2002 and would have recorded $8.6 million of amortization during the year ended February 1, 2003. Net income for the year ended February 2, 2002 would have been $25.2 million or $0.52 per diluted share without goodwill amortization expense during that period. We had $197.9 and $193.1 million of unamortized goodwill at February 1, 2003 and February 2, 2002, respectively.

SFAS 142 required us, upon our 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 us, 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, we were required to perform step two of the impairment test, which required us 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. We performed a transitional goodwill impairment test as required and determined that no goodwill impairment existed at February 3, 2002. The Company has concluded that certain intangible assets, comprised primarily of lease rights, qualify as indefinite-life intangible assets under SFAS 142. Fair market value of the lease rights were determined through the use of third-party valuation. In addition, the Company makes investments through the international subsidiaries in intangible assets upon the opening and acquisition of many of our store locations in Europe. These intangible assets, which are subject to amortization, are amortized over the useful lines of the respective leases, not to exceed 25 years. The Company evaluates the market value of these assets periodically and records the impairment charge when the Company believes the asset has experienced a decline in value that is other than temporary.

SFAS 142 also requires us to perform a goodwill and intangible asset 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 our statement of operations. We recorded impairment charges of

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approximately $1.0 million in Fiscal 2003 because the market value during Fiscal 2003 of certain lease rights included in our international segment were determined to be less than their carrying values. This impairment charge is included within the financial statement caption “Selling, general, administrative” expenses within our Consolidated Statements of Operations and Comprehensive Income.

On July 5, 2001, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations”. That standard requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. When the liability is initially recorded, the entity capitalizes a cost by increasing the carrying amount of the related long-lived asset. Over time, the liability is accreted to its present value each period, and the capitalized cost is depreciated over the useful life of the related asset. Upon settlement of the liability, an entity either settles the obligation for its recorded amount or incurs a gain or loss upon settlement. The standard is effective for fiscal years beginning after June 15, 2002, with earlier application encouraged. As a result, SFAS No. 143 was not effective for our Fiscal 2003 financial statements. Management has not determined the effect that SFAS No. 143 will have on our consolidated financial statements.

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. We adopted SFAS 144 on February 3, 2002. Management has determined that the adoption of SFAS 144 did not have a material effect on our financial statements. We recorded impairment charges of approximately $2.7 million during the year ended February 1, 2003 related to fixed assets in our International segment due to those assets not being recoverable by estimated discounted cash flows. This impairment charge is included within the financial statement caption “Selling, general, administrative” expenses within our Consolidated Statements of Operations and Comprehensive Income.

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

In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees and Indebtedness of Others.” FIN 45 elaborates on the disclosures to be made by the guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. It also requires that a guarantor recognize, at the inception of a guarantee, a liability for the fair value of the obligation

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undertaken in issuing the guarantee. The initial recognition and measurement provisions of this interpretation are applicable on a prospective basis to guarantees issued or modified after December 31, 2002; while the provisions of the disclosure requirements are effective for financial statements of interim or annual reports ending after December 13, 2002. We have determined that FIN 45 did not have a material impact on our financial statements.

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure.” SFAS No. 148 amends SFAS No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods for voluntary transition to SFAS No. 123’s fair value method of accounting for stock-based employee compensation (“the fair value method”). SFAS No. 148 also requires disclosure of the effects of an entity’s accountings policy with respect to stock-based employee compensation on reported net income (loss) and earnings (loss) per share in annual and interim financial statements. We are required to follow the prescribed disclosure format and have provided the additional disclosures required by SFAS No. 148 for the year ended February 1, 2003 (see Note 1) and must also provide the disclosures in our quarterly reports containing condensed financial statements for interim periods beginning with the quarterly period ending May 3, 2003.

In January 2003, the FASB issued Interpretation No. 46 “Consolidation of Variable Interest Entities”. The interpretation defines a variable interest entity as a corporation, partnership, trust or any other legal structure used for business purposes that either (a) does not have equity investors with voting rights or (b) has equity investors that do not provide sufficient financial resources for the equity to support its activities. A variable interest entity often holds financial assets, including loans or receivables, real estate or other property. A variable interest entity may be essentially passive or it may engage in research and development or other activities on behalf of another company. This interpretation requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or entitled to receive a majority of the entity’s residual returns or both. We would have to consolidate any of our variable interest entities that meet the above criteria as of July 1, 2003. The interpretation also requires disclosures about variable interest entities that we are not required to consolidate but in which we have a significant variable interest. Management is in the process of determining if our interests in unconsolidated entities qualify as variable interest entities and, if so, whether the assets, liabilities, non-controlling interest, and results of activities are required to be included in our consolidated financial statements.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Foreign Currency

We are exposed to market risk from foreign currency exchange rate fluctuations on the 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 Fiscal 2003, included in comprehensive income and stockholders’ equity is $23.9 million reflecting the unrealized gain on foreign currency translation. Based on our average net currency positions in Fiscal 2003, the potential gain or loss due to a 10% adverse change on foreign currency exchange rates could be significant to our 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 Fiscal 2003, a 10% increase in the average effective interest rate in Fiscal 2003 would not have materially impacted our annual net interest expense.

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Item 8. Financial Statements and Supplementary Data

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INDEPENDENT AUDITORS’ REPORT

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

We have audited the accompanying consolidated balance sheets of Claire’s Stores, Inc. and subsidiaries as of February 1, 2003 and February 2, 2002, and the related consolidated statements of operations and comprehensive income, changes in stockholders’ equity and cash flows for the fiscal years ended February 1, 2003, February 2, 2002 and February 3, 2001. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Claire’s Stores, Inc. and subsidiaries as of February 1, 2003 and February 2, 2002, and the results of their operations and their cash flows for the fiscal years ended February 1, 2003, February 2, 2002 and February 3, 2001 in conformity with accounting principles generally accepted in the United States of America.

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

/S/ KPMG LLP
Fort Lauderdale, Florida
March 12, 2003

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CLAIRE’S STORES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

                  See accompanying notes to consolidated financial statements.

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CLAIRE’S STORES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME