9.	STOCK OPTIONS AND STOCK-BASED COMPENSATION

On June 29, 2007, the Board of Directors and stockholders of Parent adopted the Claire’s Inc. Stock Incentive Plan (the “Plan”). The Plan provides employees and directors of Claire’s Inc., the Company and its subsidiaries, who are in a position to contribute to the long-term success of these entities, with shares or options to acquire shares in Parent to aid in attracting, retaining, and motivating individuals of outstanding ability.

The Plan was amended on July 23, 2007 and September 9, 2008 to increase the number of shares available for issuance to 6,860,000 and 8,200,000, respectively, and to provide for equity investments by employees and directors of the Company through the voluntary stock purchase program. As of February 2, 2013, 3,172,335 shares were available for future grants. The Board of Directors of Parent awarded certain employees and directors the opportunity to purchase common stock at a price of $10.00 per share, the estimated fair market value of the Company’s common stock. With each share purchased, the employee or director was granted a buy-one-get-one option, (the “BOGO Option”) to purchase an additional share at an exercise price of $10.00 per share.

The total stock-based compensation (benefit) expense recognized by the Company in Fiscal 2012, Fiscal 2011 and Fiscal 2010 was $(1.1) million, $(1.6) million and $5.0 million, respectively. During Fiscal 2012, the Company recorded a reversal of stock compensation expense of $3.2 million associated with forfeitures of stock options, including $1.7 million for our former executive officers. During Fiscal 2011, the Company recorded a reversal of stock compensation expense of $5.1 million associated with forfeitures of stock options, including $3.8 million for our former Chief Executive Officer. Related income tax expense (benefit) of approximately $0.4 million, $0.6 million and $(1.7) million were recognized in Fiscal 2012, Fiscal 2011 and Fiscal 2010, respectively. Stock-based compensation is recorded in “Selling, general and administrative” expenses in the Company’s Consolidated Statements of Operations and Comprehensive Income.

Performance Based Stock Option Exchange Offer

On June 15, 2012, Parent commenced an offer (the “Exchange Offer”) to exchange certain performance based stock options held by employees of the Company for new performance based stock options (the “New Options”) granted on a 1 for 2 basis. The Exchange Offer was completed on July 16, 2012. The New Options expire on July 16, 2019.

The New Options issued under the Exchange Offer provide for the following performance condition:

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Vest in equal installments on the first two anniversaries after the first to occur of:

(i) the date of an initial public offering (“IPO”) at a price of at least $25 per share,

(ii) any date following an IPO when the average stock price over the preceding 30 consecutive trading days exceeds $25, or

(iii) any date before an IPO where more than 25% of the outstanding shares of the Parent are sold for cash or marketable consideration having a value of at least $25 per share;

•

Vest immediately if, on or after the occurrence of an event described in (i), (ii) or (iii), but prior to the second anniversary thereof, there occurs a change of control of Parent.

The Exchange Offer resulted in $1.2 million in total incremental compensation cost that will be recognized when a performance condition occurs. The Exchange Offer affected approximately 125 employees.

Incentive Plan Modifications

On May 20, 2011, the Compensation Committee of the Company approved amendments to the Company’s Stock Incentive Plan (the “Incentive Plan”), the form of option grant letter and certain outstanding options (the “Outstanding Options”) held by various employees (collectively, the “Plan Amendments”).

The Plan Amendments (which apply to Outstanding Options and, unless otherwise specified at the time of grant, any future option grants under the amended Incentive Plan, and, where applicable, any shares held by employees) generally provide for the following:

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Eliminated the holding period after vesting for Performance and Stretch Performance options;

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Changed the definition of “Qualified IPO”;

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Eliminated certain restrictions on transfer of shares in the event of a Qualified IPO;

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Provided each optionee the right to satisfy the exercise price and any withholding tax obligation triggered by such exercise by any combination of cash and/or shares (including both previously owned shares and shares otherwise to be delivered upon exercise of the option); and

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Added two additional vesting events applicable to Performance Options and to certain Stretch Performance Options if they occur prior to or concurrent with the end of the Company’s fiscal 2012 year.

The incremental compensation cost associated with the modifications to the Company’s Incentive Plan totaled $2.2 million, of which $0.2 million was initially recognized in the second fiscal quarter 2011 and $0.3 million in the third fiscal quarter 2011. The plan modification affected approximately 155 employees. During the fourth quarter of Fiscal 2011, the Company determined that the achievement of vesting events for the Performance Stock Options was not probable, and therefore, reversed the stock option expense that was previously recognized for these stock options.

BOGO Option Offer

On May 20, 2011, the Compensation Committee of the Company also approved an offer pursuant to the amended Incentive Plan to certain employees to purchase a specified number of shares of the common stock of the parent of the Company at a price per share of $10.00 (the “Offer”). For each share purchased, the employee received an option to purchase an additional share at $10.00 (a “BOGO Option”). The Offer was made available to employees who had not previously accepted similar offers from the Parent. The Company granted 179,000 BOGO Options and recognized stock-based compensation expense of approximately $0.3 million in Fiscal 2011 related to these options.

During the period from May 29, 2007 through February 2, 2008, the Board of Directors of Parent approved the grant of a total of approximately 3,265,000 stock options under the Plan to certain employees of the Company. In addition, the Board approved approximately 1,850,000 stock options to certain senior executives. The stock options consist of a “Time Option” and “Performance Option” as those terms are defined in the standard form of the option grant letter. The stock options have an exercise price of $10.00 per share, the estimated fair market value of the underlying shares at the date of grant, and expire seven years after the date of grant. Time Options vest and become exercisable based on continued service to the Company. The Time Options vest in four equal annual installments, commencing one year from date of grant. Performance Options vest based on growth in the stock price between May 29, 2007 and specific quarterly measurement dates commencing with the last day of the eighth full fiscal quarter after May 29, 2007. Upon achievement of the performance target, the Performance Options vest and become exercisable in two equal annual installments on the first two anniversaries of the measurement date. During Fiscal 2012, Fiscal 2011 and Fiscal 2010, the Board of Directors approved the grant of approximately 3,025,164, 713,800 and 995,000, respectively, of similar stock options. The Company recognized stock-based compensation (benefit) expense of $(1.2) million, $(2.2) million and $4.2 million in Fiscal 2012, Fiscal 2011 and Fiscal 2010, respectively, related to Time and Performance Options.

During the period from May 29, 2007 through February 2, 2008, the Board of Directors also granted approximately 970,000 BOGO options which are immediately exercisable and expire in seven years. The period from May 29, 2007 through February 2, 2008 included options to purchase an aggregate of 312,500 BOGO options granted outside of the Plan to certain senior executive officers and directors. During Fiscal 2012, Fiscal 2011, and Fiscal 2010, the Board of Directors granted 55,000, 186,000 and 6,000, respectively, BOGO options. The Company recognized stock-based compensation expense of $197,000, $497,000 and $702,000 in Fiscal 2012, Fiscal 2011 and Fiscal 2010, respectively, related to these options.

The following is a summary of activity in the Company’s stock option plan from January 28, 2012 through February 2, 2013:


	Number of Shares			Weighted Average Exercise Price		Weighted Average Remaining Contractual Term (Years)

Outstanding as of January 28, 2012		6,343,756		$	10.00
Options granted		3,080,164		$	10.00
Options exercised		—			—
Options forfeited		(3,011,188	)	$	10.00
Options expired		(1,385,067	)	$	10.00

Outstanding as of February 2, 2013		5,027,665		$	10.00		4.9


Options vested and expected to vest at February 2, 2013		4,495,783		$	10.00		4.7


Exercisable at end of period		1,788,007		$	10.00		2.3

The weighted average grant date fair value of options granted in Fiscal 2012, Fiscal 2011 and Fiscal 2010 was $1.61, $2.63 and $3.35, respectively.

As of February 2, 2013, there was $3.9 million of unrecognized stock-based compensation expense, net of estimated forfeitures, related to non-vested stock options that is expected to be recognized over a weighted-average period of approximately 3.7 years.

For options granted during Fiscal 2012, Fiscal 2011 and Fiscal 2010, the fair value of each option was estimated on the date of grant using the Black-Scholes and Monte Carlo option pricing models with the following assumptions:


Time Options and BOGO Options (Black-Scholes)	Fiscal 2012		Fiscal 2011		Fiscal 2010
Expected dividend yield		0.00%		0.00%		0.00%
Weighted average expected stock price volatility		59.96%		58.79%		59.25%
Weighted average risk-free interest rate		0.70%		1.23%		2.04%
Range of risk-free interest rate		0.56% - 1.04%		0.69% - 2.20%		1.05% - 2.54%
Weighted average expected term (years)		4.92		4.57		4.74


Performance Options (Monte Carlo)	Fiscal 2012		Fiscal 2011		Fiscal 2010
Expected dividend yield		0.00%		0.00%		0.00%
Weighted average expected stock price volatility		54.19%		55.61%		58.66%
Weighted average risk-free interest rate		0.81%		1.63%		2.45%
Range of risk-free interest rate		0.53% - 1.56%		1.24% - 2.59%		1.42% - 2.93%
Weighted average expected term (years)		N/A		N/A		N/A

The expected term of Time Options and BOGO Options has been based on the “simplified” method in accordance with SEC Staff Accounting Bulletin (“SAB”) No. 107, Share-Based Payment, as amended by SEC SAB No. 110, because the Company has no readily available relevant historical data on option-hold-periods by employees. The Company’s historical option exercise data does not provide a reasonable basis upon which to estimate an expected term of an option due to new ownership of the Company establishing new equity-based compensation arrangements and different classifications of employees receiving grants. The risk-free interest rate for periods within the contractual life of the options is based on the U.S. Treasury yield curve in effect at the time of the grant. Expected stock price volatility was based on peer company data as of the date of each option grant.

Parent will issue new shares to satisfy exercise of stock options. During Fiscal 2012, Fiscal 2011 and Fiscal 2010, no options were exercised and no cash was used to settle equity instruments granted under share-based payment arrangements.

Time-Vested Restricted Stock Awards

On May 29, 2007, Parent issued 125,000 shares of restricted common stock to certain members of executive management of the Company. The shares are subject to certain transfer restrictions and the shares are forfeited if a recipient leaves the Company. The shares vested at the rate of 25% on each of May 29, 2008, May 29, 2009, May 29, 2010, and May 29, 2011. Vesting is based on continued service to the Company. The weighted average grant date fair value was $10.00 per share and the shares had an aggregate fair value at date of grant of $1.25 million. Stock-based compensation expense relating to these shares recorded in Fiscal 2011 and Fiscal 2010 approximated $15,000 and $67,000, respectively. At January 28, 2012, all restricted shares were vested and unearned stock-based compensation related to these shares was $0.