10-K 1 d457275d10k.htm 10-K 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 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 2, 2013

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission File Nos. 1-8899, 333-148108 and 333-175171

 

 

Claire’s Stores, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Florida   59-0940416

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

2400 West Central Road,

Hoffman Estates, Illinois

  60192
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code: (847) 765-1100

Securities registered pursuant to Section 12(b) or 12(g) of the Act: None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.    Yes  x    No  ¨

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  ¨    No  x    Explanatory Note: While Claire’s Stores, Inc. is not subject to the filing requirement of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, it filed all reports pursuant thereto during the preceding twelve months.

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) 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.  x

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   x    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

The aggregate market value of the registrant’s voting and non-voting common equity held by non-affiliates of the registrant is zero. The registrant is a privately held corporation.

As of April 1, 2013, 100 shares of the Registrant’s common stock, $.001 par value were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

None

 

 

 


Table of Contents

TABLE OF CONTENTS

 

Item

       Page No.  

PART I.

     3   

Item 1.

 

Business

     5   

Item 1A.

 

Risk Factors

     12   

Item 1B.

 

Unresolved Staff Comments

     23   

Item 2.

 

Properties

     23   

Item 3.

 

Legal Proceedings

     24   

Item 4.

 

Mine Safety Disclosures

     24   

PART II

     24   

Item 5.

 

Market for Registrant’s Common Equity, Related Stockholder Matters an Issuer Purchases of Equity Securities

     24   

Item 6.

 

Selected Financial Data

     25   

Item 7.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     26   

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

     46   

Item 8.

 

Financial Statements and Supplementary Data

     48   

Item 9.

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

     95   

Item 9A.

 

Controls and Procedures

     95   

Item 9B.

 

Other Information

     95   

PART III.

     96   

Item 10.

 

Directors, Executive Officers and Corporate Governance

     96   

Item 11.

 

Executive Compensation

     96   

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     96   

Item 13.

 

Certain Relationships and Related Transactions and Director Independence

     96   

Item 14.

 

Principal Accountant Fees and Services

     96   

PART IV.

     97   

Item 15.

 

Exhibits, Financial Statement Schedules

     97   

Signatures

       102   

 

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PART I.

Explanatory Notes

We refer to Claire’s Stores, Inc., a Florida corporation, as “Claire’s,” the “Company,” “we,” “our” or similar terms, and typically these references include our subsidiaries.

History

In May 2007, the Company was acquired by Apollo Management VI, L.P. (“Apollo Management”), together with certain affiliated co-investment partnerships (collectively the “Sponsors”), through a merger (the “Merger”) and Claire’s Stores, Inc. became a wholly-owned subsidiary of Claire’s Inc. The Merger was financed by the issuance of $250.0 million of 9.25% senior notes due 2015 (the “Senior Fixed Rate Notes”), $350.0 million of 9.625%/10.375% senior toggle notes due 2015 (the “Senior Toggle Notes” and together with the Senior Fixed Rate Notes, the “Senior Notes”), $335.0 million of 10.50% senior subordinated notes due 2017 (the “Senior Subordinated Notes” and together with the Senior Notes, the “Merger Notes”) and borrowings under the senior secured term loan facility (the “Former Term Loan”) and revolving credit facility, (the “Former Revolver” and collectively with the Former Term Loan, the “Former Credit Facility”) of $1.65 billion. The aforementioned transactions, including the Merger and payment of costs related to these transactions as well as the related borrowings, are collectively referred to as the “Transactions.” The purchase of the Company by the Sponsors is referred to as the “Acquisition.”

On March 4, 2011, we issued $450.0 million aggregate principal amount of 8.875% senior secured second lien notes that mature on March 15, 2019 (the “Senior Secured Second Lien Notes”). We used the net proceeds of the offering of the Senior Secured Second Lien Notes to reduce indebtedness under our Former Credit Facility, including the entire amount outstanding under our Former Revolver (without terminating the commitment).

On February 28, 2012, March 12, 2012 and September 20, 2012, we issued $400.0 million, $100.0 million and $625.0 million, respectively, aggregate principal amount of the same series of 9.00% Senior Secured First Lien Notes that mature on March 15, 2019 (the “9.0% Senior Secured First Lien Notes”). We used the net proceeds of the offering of the 9.0 % Senior Secured First Lien Notes to reduce indebtedness under our Former Credit Facility. On September 20, 2012, we paid in full the remaining Former Term Loan and entered into an amended and restated credit agreement that replaced the Former Revolver with a $115.0 million 5-year senior secured revolving credit facility (the” Credit Facility”).

On March 1, 2013, we commenced a tender offer to repurchase a total of $210.0 million aggregate principal amount of Senior Fixed Rate Notes and Senior Toggle Notes. On March 15, 2013, we issued $210.0 million aggregate principal amount of 6.125% Senior Secured First Lien Notes that mature on March 15, 2020 (the “6.125% Senior Secured First Lien Notes” and together with the Merger Notes, the Senior Secured Second Lien Notes and the 9.0% Senior Secured First Lien Notes, the “Notes”). On March 15, 2013, we used approximately $63.3 million of the net proceeds of the 6.125% Senior Secured First Lien Note offering to purchase early tendered Senior Notes. On March 28, 2013, the tender offer expired, and, as of that date, $20,000 of additional Senior Fixed Rate Notes were validly tendered and not validly withdrawn. On April 1, 2013, we used approximately $20,000 of the net proceeds of the offering of the 6.125% Senior Secured First Lien Notes to purchase the additional tendered Senior Notes in accordance with the tender offer. We intend to use the remaining net proceeds, together with cash on hand, to repurchase an additional $149.5 million aggregate principal amount of Senior Notes pursuant to a subsequent redemption.

Fiscal Year

Our fiscal year ends on the Saturday closest to January 31. We refer to our fiscal year end based on the year in which the fiscal year begins. As a result, our fiscal year ended February 2, 2013 (“Fiscal 2012”) consisted of 53 weeks, while both of our fiscal years ended January 28, 2012 (“Fiscal 2011”) and January 29, 2011 (“Fiscal 2010”) consisted of 52 weeks.

 

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Part III Information

An amendment to this Annual Report on Form 10-K to include the items required by Part III of Form 10-K will be filed with the Securities and Exchange Commission no later than 120 days after the end of Fiscal 2012.

Statement Regarding Forward-Looking Disclosures

This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We and our representatives may from time to time make written or oral forward-looking statements, including statements contained in this and other filings with the Securities and Exchange Commission and in our press releases and reports to stockholders. All statements which address operating performance, events or developments that we expect or anticipate will occur in the future, including statements relating to our future financial performance, business strategy, planned capital expenditures, ability to service our debt, and new store openings for future fiscal years, are forward-looking statements. The forward-looking statements are and will be based on management’s then current views and assumptions regarding future events and operating performance, and we assume no obligation to update any forward-looking statement. The forward-looking statements may use the words “expect,” “anticipate,” “plan,” “intend,” “project,” “may,” “believe,” “forecast,” and similar expressions. Forward-looking statements involve known or unknown risks, uncertainties and other factors, including changes in estimates and judgments discussed under “Critical Accounting Policies and Estimates” which may cause our actual results, performance or achievements, or industry results to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Some of these risks, uncertainties and other factors are as follows: our level of indebtedness; general economic conditions; changes in consumer preferences and consumer spending; competition; general political and social conditions such as war, political unrest and terrorism; natural disasters or severe weather events; currency fluctuations and exchange rate adjustments; failure to maintain our favorable brand recognition; failure to successfully market our products through new channels, such as e-commerce; uncertainties generally associated with the specialty retailing business; disruptions in our supply of inventory; inability to increase same store sales; inability to renew, replace or enter into new store leases on favorable terms; significant increases in our merchandise markdowns; inability to grow our store base in Europe, China, or expand to grow our international store base through franchise or similar licensing arrangements; inability to design and implement new information systems; data security breaches of confidential information or other cyber attacks; delays in anticipated store openings or renovations; changes in applicable laws, rules and regulations, including changes in North America, Europe, or China or other international laws and regulations governing the sale of our products, particularly regulations relating to heavy metal and chemical content in our products; changes in employment laws relating to overtime pay, tax laws and import laws; product recalls; loss of key members of management; increase in the costs of healthcare for our employees; increases in the cost of labor; labor disputes; unwillingness of vendors and service providers to supply goods or services pursuant to historical customary credit arrangements; increases in the cost of borrowings; unavailability of additional debt or equity capital; and the impact of our substantial indebtedness on our operating income and our ability to grow. In addition, we typically earn a disproportionate share of our operating income in the fourth quarter due to seasonal buying patterns, which are difficult to forecast with certainty. The Company undertakes no obligation to update or revise any forward-looking statements to reflect subsequent events or circumstances.

Trademarks and Tradenames

Certain of the titles and logos referenced in this Form 10-K are our trademarks and service marks. All other trademarks, service marks and trade names referred to in this Form 10-K are the property of their respective owners.

 

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Item 1. Business

The Company

We are one of the world’s leading specialty retailers of fashionable jewelry and accessories for young women, teens, tweens and kids. Our vision is to inspire girls and women around the world to become their best selves by providing products and experiences that empower them to express their own unique individual styles. Our broad and dynamic selection of merchandise is unique, and over 90% of our products are proprietary. Claire’s® is our primary global brand that we operate in 41 countries through company-owned or franchise stores. Claire’s® offers a differentiated and fun store experience with a “treasure hunt” setting that encourages our customer to visit often to explore and find merchandise that appeals to her. We believe by maintaining a highly relevant merchandise assortment and offering a compelling value proposition, Claire’s® has universal appeal to teens, pre-teens and kids. Icing® is our other brand which we currently operate in North America through company-owned stores. Icing® offers an inspiring merchandise assortment of fashionable products that helps a young woman to say something about herself, whatever the occasion. We believe Icing® provides us with significant potential to reach young women in age groups beyond our Claire’s® core demographic.

We believe Claire’s® represents a “Girl’s Best Friend” and a favorite shopping destination for teens, tweens, and kids. Claire’s® target customer is a girl between 3-18 years old with a particular focus on a core demographic of girls between 10-14 years old. According to our estimates, we have over 95% brand awareness within this target demographic in our largest markets. As of February 2, 2013, Claire’s® had a presence in 41 countries through the 3,085 company operated Claire’s® stores in North America, Europe and China, and 392 franchised stores in numerous other geographies.

Our Icing® brand targets a young woman in the 18-35 year age group with a focus on our core 21-25 year olds who have recently entered the workforce. This customer is independent, fashion-conscious, and has enhanced spending ability. We believe that expansion of our Icing® store base both in existing and new markets over time presents a significant opportunity to leverage our core merchandising, sourcing and marketing expertise to cater to a wider demographic. As of February 2, 2013, we operated 380 Icing® stores across the United States, Canada, and Puerto Rico.

We are organized by geography through our North America division, our Europe division and our China division, recently formed to operate our existing and future stores in China. In North America, our stores are located primarily in shopping malls and average approximately 985 square feet of selling space. The differentiation of our Claire’s® and Icing® brands allows us to operate multiple stores within a single location. In Europe, our stores are located primarily on high streets, in shopping malls and in high traffic urban areas and average approximately 655 square feet of selling space.

We believe that the strength of our business model and our disciplined operating philosophy has enabled us to deliver strong financial performance:

 

   

Our same store sales growth was 1.8% in Fiscal 2012; and we have reported positive same store sales growth for twelve out of the last thirteen quarters through the end of Fiscal 2012.

 

   

Our global store base grew to 3,477 stores at the end of Fiscal 2012 from 3,354 stores at the end of Fiscal 2009, opening 443 new stores from the end of Fiscal 2009 through the end of Fiscal 2012.

 

   

Our net sales increased to $1,557.0 million in Fiscal 2012 from $1,342.4 million in Fiscal 2009. Excluding the 53rd week of sales in Fiscal 2012, net sales increased at a compound annual growth rate of approximately 4.5% from Fiscal 2009 through Fiscal 2012.

Our Competitive Strengths

Category Defining Claire’s® Brand

According to our estimates, over 95% of our target demographic in our largest markets recognizes the Claire’s® brand. A Claire’s® store is located in approximately 88% of all major United States shopping malls across all 50 states and in 40 countries outside of the United States, including markets where we

 

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franchise. We are a “Girl’s Best Friend” and believe we serve as an authority in jewelry and accessories for 3 – 18 years olds. We believe that our reputation for providing age-appropriate merchandise and shopping experience allows parents to trust the Claire’s® brand for their daughters. Our Claire’s® brand is regularly featured in editorial coverage and relevant fashion periodicals. Additionally, we leverage our e-commerce platform and social media to enhance our brand awareness and strengthen our customer relationships.

Preferred Shopping Destination

We are recognized as a favorite shopping destination for young women, teens, tweens, and kids. We believe our customer finds our store an engaging and stimulating experience that allows her to explore and share discoveries, thereby encouraging frequency of visits. Besides jewelry and accessories, we also offer an exciting assortment of beauty products, lifestyle accessories and seasonal items to keep our customer engaged. As part of our jewelry offering, our stores have pierced the ears of over 83 million customers over the years, including 3.7 million in Fiscal 2012. We believe this seminal point of contact helps our stores establish an important relationship with our core customer. We believe our store environment, product assortment and low average dollar ticket differentiate us from other retail concepts as well as pure play online platforms.

Attractive Unit Economics with Strong Cash Flow

Our stores have relatively low build out costs and moderate inventory requirements. For a new store investment, we target a payback period of three years or less. The majority of our new store investments in recent years have met or exceeded this target. We manage our portfolio on a store-by-store basis to optimize overall returns and minimize risk. As a result, approximately 95% of our stores are cash flow positive.

Our cash flow is driven by our strong gross margins, efficient operating structure, low annual maintenance capital expenditures and flexible growth capital expenditure initiatives. Our moderate working capital requirements result from high merchandise margins, low unit cost of merchandise, relatively lower seasonality of our business and relatively strong inventory turnover.

Globally Diversified with Proven Ability to Enter New Countries

The Claire’s® concept has a global scale and proven geographic portability. As of February 2, 2013, we operated or franchised a total of 3,477 Claire’s® stores across all 50 states of the United States and in 40 additional countries across the world. During Fiscal 2012, we entered large and high potential markets of China and Italy through company operated stores and also entered the Latin American and Southeast Asian markets through our franchising program. During Fiscal 2011, we entered the strategically significant countries of Mexico and India through franchising relationships. In the past 10 fiscal years, we have expanded into 26 new countries.

Cost-Efficient Global Sourcing Capabilities

Our merchandising strategy is supported by efficient, low-cost global sourcing capabilities diversified across approximately 660 suppliers located primarily outside the United States. Our vertically integrated Hong Kong buying office was established over 20 years ago and now sources a majority of our purchases. Our strategy of proprietary merchandise coupled with vertically-integrated local buying capabilities is designed to enable us to source rapidly and cost effectively, thus allowing us to maintain inventory efficiency and achieve high merchandise margins.

Strong and Passionate Senior Management Team with Significant Experience

Our senior management team has extensive global, retail experience and complementary expertise across a broad range of disciplines in specialty retail, including merchandising, supply chain, real estate and finance. Our Chief Executive Officer Jim Fielding was formerly President of Disney Stores, and has prior management experience at The Gap, Lands’ End and Dayton Hudson. Linda Hefner Filler, President of our North America Division, brings to the Company 25 years of retail and consumer products experience, including executive positions with Wal-Mart Corporation, Kraft Foods and Sara Lee Corporation. Beatrice

 

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Lafon, President of our Europe Division, brings to the Company 25 years of Pan-European retail experience, including executive positions with TJ Hughes and Animal Ltd. in the United Kingdom, Etam Group in the Netherlands, and Woolworths Group. Per Brodin, our Executive Vice President and Chief Financial Officer, has over 20 years of financial accounting and management experience, including senior leadership positions with Centene Corporation and May Department Stores as well as working for thirteen years at an international public accounting firm.

Business Strategy

Our business strategy is designed to maximize our sales opportunities and to generate our earnings growth and cash flow:

Generate Organic Growth

Continue To Enhance Merchandise and In-Store Experience

We are focused on enhancing the fashion-orientation and quality of our product offerings to deliver a unique, proprietary assortment that is highly relevant to our target customers. We believe we can drive growth through intensifying key merchandise categories, especially in higher margin products such as jewelry.

We believe we can drive increased frequency of visits through our unique and compelling in-store environment. We aim to provide a consistent, engaging and brand-right customer experience across all of our owned and franchised stores worldwide. Additionally, we focus on improving ease of shopping and increasing sales productivity by enhancing store layout and merchandise displays. We will continue to invest in our store management teams and sales associates to emphasize in-store operational excellence.

Deepen Customer Relationship & Loyalty

We will continue to drive brand awareness and deepen customer relationships with our branding efforts conducted through in-store marketing collateral and ongoing social media, email, and text campaigns. Maintaining and improving our leadership in ear piercing also allows us to solidify the customer’s experience with Claire’s® and establish brand loyalty early. We believe we can leverage our online community and proprietary customer database to drive increased customer engagement for Claire’s® and Icing®.

Expand and Upgrade Company-Owned Store Base

We opened 110 new Claire’s® stores in Fiscal 2012; of which 79 openings were in Europe, 28 were in North America and 3 were in China. We plan to open approximately 150 new stores in Fiscal 2013 across all of our markets in Europe, North America and China. We recently entered the countries of China and Italy and believe these countries present significant growth opportunities. In North America, the Claire’s® brand has significant penetration but we continue to opportunistically pursue new locations. Also, we plan to remodel key locations in both North America and Europe in order to create a more contemporary ambience and a visually appealing display of our innovative product offerings, and to further enhance our customer’s in-store experience.

We believe the Icing® brand has significant long-term growth potential in North America and plan approximately 35 new store openings in Fiscal 2013. Over time, we plan to launch Icing® internationally to countries where we can leverage the existing Claire’s expertise and infrastructure.

Franchise in New International Countries

Developing a robust franchising model has allowed us to gain a foothold in multiple international geographies and we believe that significant high potential “white space” opportunities remain. In 2012, we entered Latin America and Southeast Asia. Within Latin America, we have partnered with a single franchisee to develop stores in sixteen new countries and opened franchise stores in four of these countries in Fiscal 2012. Within Southeast Asia, we have partnered with another single franchisee to develop stores in five new countries and opened a franchise store in one of these countries in Fiscal 2012. We are

 

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currently studying our brand introduction strategy for Brazil, Russia, and Australia via our franchise model. In 2011, under our franchise model, we entered into the countries of Mexico and India which we believe offer high growth opportunities. We will continue to evaluate new countries for franchised stores. In addition, we believe the Icing® brand represents an additional opportunity for franchise growth.

Grow Our E-Commerce Sales

We believe that the increasing penetration of internet enabled devices within our customer base offers an opportunity to better connect with our customer and complement our in-store experience. We launched our e-commerce and mobile platforms in the United States during Fiscal 2011 and Fiscal 2012, respectively, to allow our target customer to shop with Claire’s® at her convenience. In addition, our on-line channel allows us to expand product offerings to include complementary products not available in our stores. In Fiscal 2013 we intend to expand Claire’s® e-commerce internationally starting in the United Kingdom, Republic of Ireland, and Canada and also launch our e-commerce platform for Icing®.

We believe that, over time, our digital platform represents a valuable tool for engaging with our customer, gathering feedback on her preferences and enhancing our product testing capabilities, all of which should drive higher sales productivity both in-store and online.

Merchandising

The Claire’s® mission is to be the “Girl’s Best Friend” brand for fun, fashionable, and value priced jewelry and accessories targeted at our core demographic of girls 3-18. Our merchandising team is keenly aware of the psychographics of our core customer and her ever-changing tastes and attitudes. We strive to connect with her as our “friend” with whom we share her most personal milestones – be it a first ear piercing, a first day at school, a first date, or a first job. We work to present a broad yet curated product assortment in an environment where girls and young women feel encouraged to express their personalities, creativity, and individuality. Our merchandising strategy leverages our authority as a jewelry destination and ear piercing specialist. Besides our core jewelry and accessories products, other important categories include hair accessories, our licensed product assortment, and our beauty businesses. Our other accessories categories allow us to reflect seasonal changes in the business and the customer mindset, and we develop strong event assortments to capitalize on key traffic periods, like Prom, Back-To-School, Halloween, and Holiday.

For Fiscal 2012, the company-wide average in-store unit selling price for our products was $6.17 and the average transaction value was $15.61. Each Claire’s® store offers approximately 7,000 SKUs in the following major product categories:

 

   

Jewelry: Includes earrings, necklaces, bracelets, body jewelry and rings, as well as our ear piercing service; and

 

   

Accessories: Includes fashion and seasonal accessories, including headwear, legwear, hairgoods, handbags and small leather goods, attitude glasses, scarves, armwear and belts, sunglasses, hats, gloves, slippers and earmuffs; and our beauty product offerings.

The company-wide average in-store unit selling price for our products was $7.11 for jewelry and $5.44 for accessories. The following table shows a comparison of sales by product category:

 

     Percentage of Total  

Product Category

   Fiscal 2012      Fiscal 2011      Fiscal 2010  

Jewelry

     47.9         46.1         45.5   

Accessories

     52.1         53.9         54.5   
  

 

 

    

 

 

    

 

 

 
     100.0         100.0         100.0   
  

 

 

    

 

 

    

 

 

 

 

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Icing’s® mission is to be the “Say Something” brand focused on smart, trend right products that are appropriate for young women 18-35, with a particular focus on women in their mid 20’s. Jewelry is the dominant category for Icing®, but the Accessories business in highly penetrated as well. Key accessory categories include handbags, small leather goods, and tech accessories. Hair accessories are also important, and the beauty business is developing an excellent range of nail, eye, lip, and beauty tools products. The Icing® customer expresses her unique style and individuality through our products, and we enable the many dimensions of her personality and viewpoints to shine.

Over 90% of our merchandise consists of proprietary designs that carry the Claire’s® or Icing® label. The remainder consists of licensed products featuring brands such as Disney, Hello Kitty or selected entertainment properties. Our wide range of products allows us to capitalize on a spectrum of trends, ideas and merchandise concepts, while not being dependent on any one of them.

Purchasing and Distribution

Our global sourcing group purchases merchandise from a diversified base of approximately 660 suppliers. Our vertically integrated buying office in Hong Kong has been in operation for over two decades and sources a majority of our products. We purchased 86% of our merchandise from vendors based outside the United States, including 70% purchased from China. We are not dependent on any single supplier for our products. In Fiscal 2012, we sourced at least 90% of our merchandise from approximately 100 suppliers, none of which represented more than five percent of total purchases.

Our distribution facility in Hoffman Estates, Illinois, a suburb of Chicago, ships merchandise to our North America and China stores. Our distribution facility in Birmingham, United Kingdom services all of our stores in Europe. We distribute merchandise to our franchisees from a third party operated distribution center in Hong Kong. Our distribution centers ship merchandise by common carrier to our individual store locations. To keep our assortment fresh and exciting, we typically ship merchandise to our stores three to five times per week.

Stores

As of February 2, 2013, we operated a total of 3,085 stores, including 380 Icing® stores, and also franchised 392 stores globally. Our stores, company-wide, average net sales of approximately $506,000 and net sales per square foot of $502 for fiscal year 2012.

Store Design and Environment

The in-store shopping experience is integral to the Claire’s® and Icing® brands. Our Claire’s® stores are designed and merchandised to allow our customer to discover appealing merchandise in a “treasure hunt” setting. We strive to maintain a consistent look and experience across all of our owned and franchised stores through a disciplined plan-o-gram process that coordinates floor plan changes 8-10 times per year.

Our stores in North America are located primarily in shopping malls and average approximately 985 square feet of selling space. Our stores in Europe are located on high streets, in shopping malls and in high traffic urban locations and average approximately 655 square feet of selling space. Our store hours are dictated by shopping mall operations which are typically 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. In Fiscal 2012, approximately 48% of our sales were made in cash, with the balance made by checks, debit cards, and credit cards.

Each of our stores is typically led by a manager and a full-time assistant manager. In addition, each store has one or more part-time employees, depending on store volume. We utilize a labor scheduling model that optimizes the number of hours allocated to appropriately staff for varying sales volumes expected during each week.

New Stores and Store Economics

We have a standardized procedure for efficient opening of new stores and their integration into our information and distribution systems. The floor plan, merchandise layout and marketing efforts are developed specific to each new location. In addition, we maintain qualified store opening teams to provide training to new store employees. On average, we open a new store within two-to-three months after signing a lease.

 

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Our stores generate attractive returns. Our new stores immediately deleverage due to low target average build-out costs of $225,000 per store and moderate inventory requirements. For a new store investment, we generally target a payback period of three years or less. The vast majority of our new stores have met or exceeded this target. In addition, over 95% of our worldwide stores today are cash flow positive.

Store Openings, Closings and Future Growth

In Fiscal 2012, we opened 110 stores and closed 96 underperforming stores, for a net increase of 14 stores. In Europe, we increased our store count by 43 stores, net resulting in a total of 1,161 stores. In North America, we decreased our store count by 32 stores, net, to 1,921 stores. “Stores, net” refers to stores opened, net of closings. In China, we opened 3 stores, net resulting in a total of 3.

 

Store Openings (Closings):    Fiscal
2012
    Fiscal
2011
    Fiscal
2010
 

North America

      

Openings

     28        28        13   

Closings

     (60     (47     (34
  

 

 

   

 

 

   

 

 

 

Net

     (32     (19     (21
  

 

 

   

 

 

   

 

 

 

Europe

      

Openings

     79        129        69   

Closings

     (36     (20     (15
  

 

 

   

 

 

   

 

 

 

Net

     43        109        54   
  

 

 

   

 

 

   

 

 

 

China

      

Openings

     3        —          —     

Closings

     —          —          —     
  

 

 

   

 

 

   

 

 

 

Net

     3        —          —     
  

 

 

   

 

 

   

 

 

 

Consolidated

      

Openings

     110        157        82   

Closings

     (96     (67     (49
  

 

 

   

 

 

   

 

 

 

Total

     14        90        33   
  

 

 

   

 

 

   

 

 

 

We plan to open approximately 150 company-owned stores globally in Fiscal 2013. We also plan to continue opening stores when suitable locations are found and satisfactory lease negotiations are concluded. In addition to the investment in leasehold improvements and fixtures, we may also purchase intangible assets or incur initial direct costs for leases relating to certain store locations in our Europe operations.

 

Store Count as of:    February 2,
2013
     January 28,
2012
     January 29,
2011
 

North America

     1,921         1,953         1,972   

Europe

     1,161         1,118         1,009   

China

     3         —           —     
  

 

 

    

 

 

    

 

 

 

Subtotal Company-Owned

     3,085         3,071         2,981   
  

 

 

    

 

 

    

 

 

 

Franchise

     392         381         395   
  

 

 

    

 

 

    

 

 

 

Total

     3,477         3,452         3,376   
  

 

 

    

 

 

    

 

 

 

Financial Information About Segments

See Note 14 – Segment Reporting in the Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K which is incorporated herein by reference.

 

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Marketing and Advertising

We rely on a multi-channel approach to marketing and advertising with a very limited reliance on traditional television, radio and print mediums. Given Claire’s focus as a shopping destination, we invest in locating our stores in prominent, high-traffic locations. Our stores feature colorful displays showcasing our merchandise and latest trends, thus adding to the fun and playful atmosphere of the store. Our brands are also featured on the tags attached to most of our products. We believe that our target customer develops an affinity for our stores through frequent visits and through word-of-mouth publicity from her peers.

Our digital marketing effort includes our United States e-commerce site launched in Fiscal 2011, which has a look and feel consistent with the in-store experience. We also drive brand awareness and relevance with social media, email and text campaigns which are complementary to in-store marketing. We leverage our Facebook presence by posting content such as celebrity looks and Claire’s promotions that are relevant to our target customer and have received over 1.4 million Likes on Facebook. We use our email database to send weekly emails to over 900,000 customers who have provided their email addresses through our website or in-store registration process, including when customers get their ears pierced.

Trademarks and Service Marks

We are the owner in the United States of various marks, including “Claire’s®,” “Claire’s Accessories®,” and “Icing®.” We have also registered these marks outside of the United States. We currently license certain of our marks under franchising arrangements in Japan, the Middle East, Turkey, Greece, Guatemala, Malta, Ukraine, Mexico, India, Dominican Republic, El Salvador, Venezuela, Panama, Honduras, and Indonesia. We believe our rights in our marks are important to our business and intend to maintain our marks and the related registrations.

Information Technology

Information technology is important to our business success. Our information and operational systems use a broad range of both purchased and internally developed applications to support our retail operations, financial, real estate, merchandising, inventory management and marketing processes. Sales information is generally collected from point of sale terminals in our stores on a daily basis. We have developed proprietary software to support key decisions in various areas of our business including merchandising, allocation and operations. We periodically review our critical systems to evaluate disaster recovery plans and the security of our systems.

Competition

The specialty retail business is highly competitive. We compete on a global, national, regional, and local level with other specialty and discount store chains and independent retail stores. Our competition also includes Internet, direct marketing to consumer, and catalog businesses. We also compete with department stores, mass merchants, and other chain store concepts. 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 brand recognition, merchandise assortments for each target customer, compelling value, store location and the shopping experience.

Seasonality

Sales of each category of merchandise vary from period to period depending on current 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 Fiscal 2012 were 22%, 23%, 23% and 32%, respectively.

Employees

On February 2, 2013, we employed approximately 18,800 employees, 63% of whom were part-time. Part-time employees typically work up to 20 hours per week. We consider employee relations to be good.

 

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Further Information

We make available free of charge through the financial page of our website at www.clairestores.com our Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission.

Item 1A. Risk Factors

These risks could have a material adverse effect on our business, financial position or results of operations. The following risk factors may not include all of the important factors that could affect our business or our industry or that could cause our future financial results to differ materially from historic or expected results.

Risks Relating to Our Business

Economic conditions may adversely impact demand for our merchandise, which could adversely impact our business, results of operations, financial condition and cash flows.

Consumer purchases of discretionary items, including our merchandise, generally decline during recessionary periods and other periods where disposable income is adversely affected. Some of the factors impacting discretionary consumer spending include general economic conditions, wages and employment, consumer debt, the availability of customer credit, currency exchange rates, taxation, fuel and energy prices, interest rates, consumer confidence and other macroeconomic factors. Downturns in the economy typically affect consumer purchases of merchandise and could adversely impact our results of operations and continued growth.

Fluctuations in consumer preferences may adversely affect the demand for our products and result in a decline in our sales.

Our retail fashion jewelry and accessories business fluctuates according to changes in consumer preferences. If we are unable to anticipate, identify or react to changing styles or trends, our sales may decline, and we may be faced with excess inventories. If this occurs, we may be forced to rely on additional markdowns or promotional sales to dispose of excess or slow moving inventory, which could have a material adverse effect on our results of operations and adversely affect our margins. In addition, if we miscalculate customer tastes and our customers come to believe that we are no longer able to offer merchandise that appeals to them, our brand image may suffer.

Advance purchases of our merchandise make us vulnerable to changes in consumer preferences and pricing shifts and may negatively affect our results of operations.

Fluctuations in the demand for retail jewelry and accessories especially affect the inventory we sell because we enter into contracts for the purchase and manufacture of merchandise with our suppliers in advance of the applicable season and sometimes before 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. As a result, we are vulnerable to demand and pricing shifts and it is more difficult for us to respond to new or changing customer needs. Our financial condition could be materially adversely affected if we are unable to manage inventory levels and respond to short-term shifts in client demand patterns. Inventory levels in excess of client demand may result in excessive markdowns and, therefore, lower than planned margins. If we underestimate demand for our merchandise, on the other hand, we may experience inventory shortages resulting in missed sales and lost revenues. Either of these events could negatively affect our operating results and brand image.

 

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

We do not own or operate any manufacturing facilities. We purchased merchandise from approximately 660 suppliers in Fiscal 2012. Approximately 86% of our Fiscal 2012 merchandise was purchased from suppliers outside the United States, including approximately 70% purchased from China. Any event causing a sudden disruption of imports from China or other foreign countries, including political and financial instability, would likely have a material adverse effect on our operations. 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 United States. 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, on merchandise that we purchase could increase the cost or reduce the supply of merchandise available to us and adversely affect our business, financial condition and results of operations. The United States has previously imposed trade quotas on specific categories of goods and apparel imported from China, and may impose additional quotas in the future. International pressure on China regarding revaluation of the Chinese yuan, continues, which has included proposed United States Federal legislation to impose tariffs on imports from China unless the Chinese government revalues the Chinese yuan.

Fluctuations in foreign currency exchange rates could negatively impact our results of operations.

Substantially all of our foreign purchases of merchandise are negotiated and paid for in United States dollars. As a result, our sourcing operations may be adversely affected by significant fluctuation in the value of the United States dollar against foreign currencies. We are also exposed to the gains and losses resulting from the effect that fluctuations in foreign currency exchange rates have on the reported results in our Consolidated Financial Statements due to the translation of operating results and financial position of our foreign subsidiaries. We purchased approximately 70% of our merchandise from China in Fiscal 2012. During Fiscal 2012, the Chinese yuan strengthened against the United States dollar, and this trend may continue in Fiscal 2013. An increase in the Chinese yuan against the dollar means that we will have to pay more in United States dollars for our purchases from China. If we are unable to negotiate commensurate price decreases from our Chinese suppliers, these higher prices would eventually translate into higher costs of sales, which could have a material adverse effect on our operating results.

Our business depends on the willingness of vendors and service providers to supply us with goods and services pursuant to customary credit arrangements which may not be available to us in the future.

Like most companies in the retail sector, we purchase goods and services from trade creditors pursuant to customary credit arrangements. If we are unable to maintain or obtain trade credit from vendors and service providers on terms favorable to us, or at all, or if vendors and service providers are unable to obtain trade credit or factor their receivables, then we may not be able to execute our business plan, develop or enhance our products or services, take advantage of business opportunities or respond to competitive pressures, any of which could have a material adverse affect on our business. In addition, the tightening of trade credit could limit our available liquidity.

The failure to grow our store base outside of North America, expand our international franchising business or grow our e-commerce business may adversely affect our business.

Our growth plans include expanding our store base outside of North America, with plans to expand our store base in Europe, Asia, and South America. We opened our first Claire’s store in China in the last quarter of Fiscal 2012, and have plans for accelerated growth in China in the near future. We have limited experience in operating in some of these locations outside of North America, including China. Our ability to grow successfully outside of North America depends in part on determining a sustainable formula to build customer loyalty and gain market share in certain especially challenging international retail environments. Customers in our new markets may not be as familiar with our brands, and we may need to build brand awareness in these markets through greater investments in promotional activities. As a result, our sales may not be at volumes we plan or not result in the margins we anticipate. In addition, in many of these markets, the real estate, employment and labor, transportation and logistics, regulatory, and other operating requirements differ dramatically from those in the places where we have experience. Also, the

 

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integration of our operations in foreign countries presents certain challenges not necessarily presented in the integration of our North America operations. If our expansion plans outside of North America are unsuccessful or do not deliver an appropriate return on our investments, our consolidated operations and financial results could be materially and adversely affected.

We also plan to expand into new countries by entering into franchising and licensing agreements with unaffiliated third parties who are familiar with the local retail environment and have sufficient retail experience to operate stores in accordance with our business model, which requires strict adherence to the guidelines established by us in our franchising agreements. Failure to identify appropriate franchisees or negotiate acceptable terms in our franchising and licensing agreements that meet our financial targets would adversely affect our international expansion goals, and could have a material adverse effect on our operating results and impede our strategy of increasing our net sales through expansion.

We launched our United States e-commerce business in 2011, and have plans to launch our e-commerce business for Claire’s in Canada, Icing in North America, and Claire’s in Europe in Fiscal 2013. Failure to grow our current e-commerce business in the United States, or successfully launch and grow our e-commerce business in these new markets, could have a material adverse effect on our operating results and impede our growth strategy.

We experience fluctuations in our comparable sales and margins, which could impact our credit ratings and reduce the trading price of our Notes.

Our success depends in part on our ability to improve sales, A variety of factors affect comparable sales, including fashion trends, competition, current economic conditions, the timing of new merchandise releases, changes in our merchandise mix, and weather conditions. These factors may cause our comparable sales results to differ materially from prior periods and from expectations. Our comparable sales have fluctuated significantly in the past on an annual, quarterly, and monthly basis.

Our ability to deliver strong comparable sales results and margins depends in large part on accurately forecasting demand and fashion trends, providing an appropriate mix of merchandise for our customer base, managing inventory effectively, using effective pricing strategies, selecting effective marketing techniques, and optimizing store performance. Failure to meet the expectations of our investors or credit rating agencies in one or more future periods could cause our credit ratings to decline and reduce the trading price of our Notes.

Our cost of doing business could increase as a result of changes in federal, state, local and international regulations regarding the content of our merchandise.

The Consumer Product Safety Improvement Act of 2008 (“CPSIA”), in general, bans the sale of children’s products containing lead in excess of certain maximum standards, and imposes other restrictions and requirements on the sale of children’s products, including importing, testing and labeling requirements. In addition, various states, from time to time, propose or enact legislation regarding heavy metals or chemicals in products that differ from federal laws. We are also subject to various other health and safety rules and regulations, such as the Federal Food Drug and Cosmetic Act and the Federal Hazardous Substance Act. Our inability to comply with these regulatory requirements, including the new initiatives labeled as “green chemistry,” or other existing or newly adopted regulatory requirements, could increase our cost of doing business or result in significant fines or penalties that could have a material adverse effect on our business, results of operations, financial condition and cash flows.

In addition to regulations governing the sale of our merchandise in the United States and Canada, we are also subject to regulations governing the sale of our merchandise in our Europe and China stores. The European Union “REACH” legislation requires identification and disclosure of chemicals in consumer products, including chemicals that might be in the merchandise that we sell. Over time, this regulation, among other items, may require us to substitute certain chemicals contained in our products with substances the European Union considers safer. In China, we are subject to similar product and safety laws. Our failure to comply with this foreign legislation could result in significant fines or penalties and increase our cost of doing business.

 

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Recalls, product liability claims, and government, customer or consumer concerns about product safety could harm our reputation, increase costs or reduce sales.

We are subject to regulation by the Consumer Product Safety Commission and similar state and international regulatory authorities, and our products could be subject to involuntary recalls and other actions by these authorities. Concerns about product safety, including but not limited to concerns about the safety of products manufactured in China (where most of our products are manufactured), could lead us to recall selected products. Recalls and government, customer or consumer concerns about product safety could harm our reputation, increase costs or reduce sales, any of which could have a material adverse effect on our financial results.

If we are unable to renew or replace our store leases or enter into leases for new stores on favorable terms, or if any of our current leases are terminated prior to the expiration of their stated term and we cannot find suitable alternate locations, our growth and profitability could be adversely affected.

All of our stores are leased. Our ability to renew any expired lease or, if such lease cannot be renewed, our ability to lease a suitable alternate location, and our ability to enter into leases for new stores on favorable terms will depend on many factors which are not within our control, such as conditions in the local real estate market, competition for desirable properties, our relationships with current and prospective landlords, and negotiating acceptable lease terms that meet our financial targets. Our ability to operate stores on a profitable basis depends on various factors, including whether we can reduce the number of under-performing stores which have a higher level of fixed costs in comparison to net sales, and our ability to maintain a proportion of new stores to mature stores that does not harm existing sales. If we are unable to renew existing leases or lease suitable alternate locations, enter into leases for new stores on favorable terms, or increase our same store sales, our growth and our profitability could be adversely affected.

Additionally, the economic environment may at times make it difficult to determine the fair market rent of retail real estate properties within the countries that we operate. This could impact the quality of our decisions to exercise lease options at previously negotiated rents, renew expiring leases or enter into new leases, in each case at negotiated rents. These decisions could also impact our ability to retain real estate locations adequate to meet our financial targets or efficiently manage the profitability of our existing store portfolio and could have a material adverse effect on our results of operations.

Natural disasters or unusually adverse weather conditions or potential emergence of disease or pandemic could adversely affect our net sales or supply of inventory.

Unusually adverse weather conditions, natural disasters, potential emergence of disease or pandemic or similar disruptions, especially during peak holiday selling seasons, but also at other times, could significantly reduce our net sales. In addition, these disruptions could also adversely affect our supply chain efficiency and make it more difficult for us to obtain sufficient quantities of merchandise from suppliers, which could have a material adverse effect on our financial position, earnings, and cash flow.

Information technology systems changes may disrupt our supply of merchandise.

Our success depends, in large part, on our ability to source and distribute merchandise efficiently. We continue to evaluate and leverage the best of both our North America and Europe information systems to support our product supply chain, including merchandise planning and allocation, inventory and price management in those markets and also in China. We also continue to evaluate and implement modifications and upgrades to our information technology systems. Modifications involve replacing legacy systems with successor systems or making changes to the legacy systems and our ability to maintain effective internal controls. We are aware of inherent risks associated with replacing and changing these core systems, including accurately capturing data, and possibly encountering supply chain disruptions. There can be no assurances that we will successfully launch these new systems as planned or that they will occur without disruptions to our operations. Information technology system disruptions, if not anticipated and appropriately mitigated, could have a material adverse effect on our operations.

 

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If we experience a data security breach and confidential customer information is disclosed, we may be subject to penalties and experience negative publicity, which could affect our customer relationships and have a material adverse effect on our business, and we may incur increasing costs in an effort to minimize these cybersecurity risks.

We are continuing to expand our digital reach through various channels, including e-commerce. As we continue to expand these channels, our risks regarding data privacy and possible cyber attacks increase. We and our customers could suffer harm if customer information were accessed by third parties due to a security failure in our systems. The collection of data and processing of transactions require us to receive and store a large amount of personally identifiable data. This type of data is subject to legislation and regulation in various jurisdictions. Data security breaches suffered by well-known companies and institutions have attracted a substantial amount of media attention, prompting state and federal legislative proposals addressing data privacy and security. We may become exposed to potential liabilities with respect to the data that we collect, manage and process, and may incur legal costs if our information security policies and procedures are not effective or if we are required to defend our methods of collection, processing and storage of personal data. Future investigations, lawsuits or adverse publicity relating to our methods of handling personal data could adversely affect our business, results of operations, financial condition and cash flows due to the costs and negative market reaction relating to such developments.

We may not have the resources or technical expertise to anticipate or prevent rapidly-evolving types of cyber attacks. Attacks may be targeted at us, our customers, or others who have entrusted us with information. Actual or anticipated attacks may cause us to incur increasing costs, including costs to hire additional personnel, purchase additional protection technologies, train employees, and engage third-party experts and consultants. Advances in computer capabilities, new technological discoveries, or other developments may result in the technology used by us to protect data being breached or compromised. In addition, data and security breaches can also occur as a result of non-technical issues, including breach by us or by persons with whom we have commercial relationships that result in the unauthorized release of personal or confidential information. Any compromise or breach of our security could result in violation of applicable privacy and other laws, significant legal and financial exposure, and a loss of confidence in our security measures, which could have a material adverse effect on our results of operations and our reputation.

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

Our business typically follows a seasonal pattern, peaking during the Christmas, Easter and back-to-school periods. Seasonal fluctuations also affect inventory levels, because we usually order merchandise in advance of peak 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 markdowns, the timing of store closings, expansions and relocations, competitive factors and general economic conditions.

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

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

 

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Our industry is highly competitive.

The specialty retail business is highly competitive. We compete with international, national and local department stores, specialty and discount store chains, independent retail stores, e-commerce services, digital content and digital media devices, web services, direct marketing to consumers and catalog businesses that market similar lines of merchandise. Many of our competitors are companies with substantially greater financial, marketing and other resources. Given the large number of companies in the retail industry, we cannot estimate the number of our competitors. Although we launched our Claire’s United States e-commerce site in 2011, and plan to launch our e-commerce sites for Claire’s in Canada, Icing in North America, and Claire’s in Europe in Fiscal 2013, significant shifts in customer buying patterns to purchasing fashionable jewelry and accessories at affordable prices through channels other than traditional shopping malls, such as e-commerce, could have a material adverse effect on our financial results.

Adoption of new or revised employment and labor laws and regulations could make it easier for our employees to obtain union representation and our business could be adversely impacted.

Currently, none of our employees in North America are represented by unions. However, our employees have the right at any time under the National Labor Relations Act to form or affiliate with a union. If some or all of our workforce were to become unionized and the terms of the collective bargaining agreement were significantly different from our current compensation arrangements, it could increase our costs and adversely impact our profitability. Any changes in regulations, the imposition of new regulations, or the enactment of new legislation could have an adverse impact on our business, to the extent it becomes easier for workers to obtain union representation.

Higher health care costs and labor costs could adversely affect our business.

With the passage in 2010 of the U.S. Patient Protection and Affordable Care Act, we are required to, provide affordable coverage, as defined in the Act, to all employees, or otherwise be subject to a payment per employee based on the affordability criteria in the Act. Many of these requirements will be phased in over a period of time. Additionally, some states and localities have passed state and local laws mandating the provision of certain levels of health benefits by some employers. Increased health care and insurance costs could have a material adverse effect on our business, financial condition and results of operations. In addition, changes in the federal or state minimum wage or living wage requirements or changes in other workplace regulations could adversely affect our ability to meet our financial targets.

Our profitability could be adversely affected by high petroleum prices.

The profitability of our business depends to a certain degree upon the price of petroleum products, both as a component of the transportation costs for delivery of inventory from our vendors to our stores and as a raw material used in the production of our merchandise. We are unable to predict what the price of crude oil and the resulting petroleum products will be in the future. We may be unable to pass along to our customers the increased costs that would result from higher petroleum prices. Therefore, any such increase could have a material adverse impact on our business and profitability.

The possibility of war and acts of terrorism could disrupt our information or distribution systems and increase our costs of doing business.

A significant act of terrorism could have a material adverse impact on us by, among other things, disrupting our information or distributions systems, causing dramatic increases in fuel prices, thereby increasing the costs of doing business and affecting consumer spending, or impeding the flow of imports or domestic products to us.

We depend on our key personnel.

Our ability to anticipate and effectively respond to changing trends and consumer preferences depends in part on our ability to attract and retain key personnel in our design, merchandising, marketing and other functions. We cannot be sure that we will be able to attract and retain a sufficient number of qualified personnel in future periods. The loss of services of key members of our senior management team or of certain other key employees could also negatively affect our business.

 

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Litigation matters incidental to our business could be adversely determined against us.

We are involved from time to time in litigation incidental to our business. Management believes that the outcome of current litigation will not have a material adverse effect on our results of operations or financial condition. Depending on the actual outcome of pending litigation, charges would be recorded in the future that may have an adverse effect on our operating results.

Goodwill and indefinite-lived intangible assets comprise a significant portion of our total assets. We must test goodwill and indefinite-lived intangible assets for impairment at least annually or whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable; which could result in a material, non-cash write-down of goodwill or indefinite-lived intangible assets and could have a material adverse impact on our results of operations.

Goodwill and indefinite-lived intangible assets are subject to impairment assessments at least annually (or more frequently when events or circumstances indicate that an impairment may have occurred) by applying a fair-value test. Our principal intangible assets, other than goodwill, are tradenames, franchise agreements, and leases that existed at date of acquisition with terms that were favorable to market at that date. We may be required to recognize additional impairment charges in the future. Additional impairment losses could have a material adverse impact on our results of operations and stockholder’s deficit.

There are factors that can affect our provision for income taxes.

We are subject to income taxes in numerous jurisdictions, including the United States, individual states and localities, and internationally. Our provision for income taxes in the future could be adversely affected by numerous factors including, but not limited to, the mix of income and losses from our foreign and domestic operations that may be taxed at different rates, changes in the valuation of deferred tax assets and liabilities, and changes in tax laws, regulations, accounting principles or interpretations thereof, which could adversely impact earnings in future periods. In addition, the estimates we make regarding domestic and foreign taxes are based on tax positions that we believe are supportable, but could potentially be subject to successful challenge by the Internal Revenue Service or other authoritative agencies. If we are required to settle matters in excess of our established accruals for uncertain tax positions, it could result in a charge to our earnings.

If we or our independent manufacturers, franchisees or licensees do not use ethical business practices or comply with applicable laws and regulations, our brand name could be harmed due to negative publicity and our results of operations could be adversely affected.

While our internal and vendor operating guidelines promote ethical business practices, we do not control our independent manufacturers, franchisees or licensees, or their business practices. Accordingly, we cannot guarantee their compliance with our guidelines. Violation of labor or other laws, such as the Foreign Corrupt Practices Act, the U.K. Bribery Act, and sanction laws administered by Office of Foreign Assets Control (OFAC) by our independent manufacturers, franchisees or licensees, or the divergence from labor practices generally accepted as ethical in the United States, could diminish the value of our brand and reduce demand for our merchandise if, as a result of such violation, we were to attract negative publicity. In addition, we also conduct business directly in many countries and increased our international activities with the opening of company-owned stores in China in the latter part of Fiscal 2012. Accordingly, we are also subject to the Foreign Corrupt Practices Act, the U.K. Bribery Act, and OFAC sanction laws. Acts by our employees that violate these laws could subject us to criminal or civil sanctions and penalties. As a result, our results of operations could be adversely affected.

We rely on third parties to deliver our merchandise and if these third parties do not adequately perform this function, our business would be disrupted.

The efficient operation of our business depends on the ability of our third party carriers to ship merchandise directly to our distribution facilities and individual stores. These carriers typically employ

 

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personnel represented by labor unions and have experienced labor difficulties in the past. Due to our reliance on these parties for our shipments, interruptions in the ability of our vendors to ship our merchandise to our distribution facilities or the ability of carriers to fulfill the distribution of merchandise to our stores could adversely affect our business, financial condition and results of operations.

We depend on single North America, Europe and International distribution facilities.

We handle merchandise distribution for all of our North America and China stores from a single facility in Hoffman Estates, Illinois, a suburb of Chicago, Illinois. We handle merchandise distribution for all of our Europe operations from a single facility in Birmingham, United Kingdom. We handle merchandise distribution for all of our international franchise operations from a single facility in Hong Kong. Independent third party transportation companies deliver our merchandise to our stores and our clients. Any significant interruption in the operation of our distribution facilities or the domestic transportation infrastructure due to natural disasters, accidents, inclement weather, system failures, work stoppages, slowdowns or strikes by employees of the transportation companies, or other unforeseen causes could delay or impair our ability to distribute merchandise to our stores, which could result in lower sales, a loss of loyalty to our brands and excess inventory and would have a material adverse effect on our business, financial condition and results of operations.

We may be unable to protect our tradenames and other intellectual property rights.

We believe that our tradenames and service marks are important to our success and our competitive position due to their name recognition with our customers. There can be no assurance that the actions we have taken to establish and protect our tradenames and service marks will be adequate to prevent imitation of our products by others or to prevent others from seeking to block sales of our products as a violation of the tradenames, service marks and proprietary rights of others. The laws of some foreign countries may not protect proprietary rights to the same extent as do the laws of the United States, and it may be more difficult for us to successfully challenge the use of our proprietary rights by other parties in these countries. Also, others may assert rights in, or ownership of, our tradenames and other proprietary rights, and we may be unable to successfully resolve those types of conflicts to our satisfaction.

Our success depends on our ability to maintain the value of our brands.

Our success depends on the value of our Claire’s® and Icing® brands. The Claire’s® and Icing® names are integral to our business as well as to the implementation of our strategies for expanding our business. Maintaining, promoting and positioning our brands will depend largely on the success of our design, merchandising, and marketing efforts and our ability to provide a consistent, enjoyable quality client experience. Our brands could be adversely affected if we fail to achieve these objectives for one or both of these brands and our public image and reputation could be tarnished by negative publicity. Any of these events could negatively impact sales.

We may be unable to rely on liability indemnities given by foreign vendors which could adversely affect our financial results.

The quality of our globally sourced products may vary from our expectations and sources of our supply may prove to be unreliable. In the event we seek indemnification from our suppliers for claims relating to the merchandise shipped to us, our ability to obtain indemnification may be hindered by the supplier’s lack of understanding of North America, Europe and China product liability laws. Our ability to successfully pursue indemnification claims may also be adversely affected by the financial condition of the supplier. Any of these circumstances could have a material adverse effect on our business and financial results.

We are controlled by Affiliates of Apollo, and its interests as an equity holder may conflict with the interests of our creditors.

We are controlled by Affiliates of Apollo Global Management, LLC and its subsidiaries, including Apollo Management (collectively, “Apollo”), and Apollo has the ability to elect all of the members of our board of directors and thereby control our policies and operations, including the appointment of management, future issuances of our common stock or other securities, the payments of dividends, if any, on our common stock, the incurrence of debt by us, amendments to our articles of incorporation and bylaws and

 

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the entry into extraordinary transactions. The interests of Apollo may not in all cases be aligned with the interests of our creditors. For example, if we encounter financial difficulties or are unable to pay our indebtedness as it matures, the interests of Apollo as an equity holder might conflict with the interests of our creditors. In addition, Apollo may have an interest in pursuing acquisitions, divestitures, financings or other transactions that, in its judgment, could enhance its equity investments, even though such transactions might involve risks to our creditors. Furthermore, Apollo may in the future own businesses that directly or indirectly compete with us. Apollo also may pursue acquisition opportunities that may be complementary to our business, and as a result, those acquisition opportunities may not be available to us. So long as Apollo continues to own a significant amount of our combined voting power, even if such amount is less than 50%, it will continue to be able to strongly influence or effectively control our decisions. In addition, because our equity securities are not registered under the Exchange Act and are not listed on any United States securities exchange, we are not subject to any of the corporate governance requirements of any United States securities exchange.

Risks Relating to Our Indebtedness

Our substantial leverage could adversely affect our ability to raise additional capital to fund our operations, limit our ability to react to changes in the economy or our industry and prevent us from meeting our obligations under the Credit Facility and Notes.

We are significantly leveraged. As of February 2, 2013, our total debt was approximately $2.39 billion, consisting of borrowings under our Notes and a capital lease obligation. During Fiscal 2012, we issued $1,142.1 million of 9.0% Senior Secured First Lien Notes that mature on March 15, 2019. We used the net proceeds from the note offerings, together with cash on hand, to repay $1,154.3 million of indebtedness under the former senior secured term loan facility and to terminate the Former Credit Facility. In September 2012, we replaced our existing $200.0 million senior secured Former Revolver maturing May 29, 2013 with the $115.0 million five-year senior secured revolving Credit Facility. On March 15, 2013, we issued $210.0 million aggregate principal amount of the 6.125% Senior Secured First Lien Notes that mature on March 15, 2020. On March 15, 2013, we used approximately $63.3 million of the net proceeds of the 6.125% Senior Secured First Lien Note offering to purchase early tendered Senior Notes. On March 28, 2013, the tender offer expired, and, as of that date, $20,000 of additional Senior Fixed Rate Notes were validly tendered and not validly withdrawn. On April 1, 2013, we used approximately $20,000 of the net proceeds of the offering of the 6.125% Senior Secured First Lien Notes to purchase the additional tendered Senior Notes in accordance with the tender offer. We intend to use the remaining net proceeds, together with cash on hand, to repurchase an additional $149.5 million aggregate principal amount of Senior Notes pursuant to a subsequent redemption. We cannot assure you that we will have the financial resources required, or that the conditions of the capital markets will support, any future refinancing or restructuring of those facilities or other indebtedness.

Our substantial leverage could adversely affect our ability to raise additional capital to fund our operations, limit our ability to react to changes in the economy or our industry, expose us to interest rate risk to the extent of our variable rate debt and prevent us from meeting our obligations under the Credit Facility and Notes. Our high degree of leverage could have important consequences, including:

 

   

increasing our vulnerability to adverse economic, industry or competitive developments;

 

   

requiring a substantial portion of cash flow from operations to be dedicated to the payment of principal and interest on our indebtedness, therefore reducing our ability to use our cash flow to fund our operations, capital expenditures and future business opportunities;

 

   

exposing us to the risk of increased interest rates because certain of our borrowings, including borrowings under our Credit Facility, will be at variable rates of interest;

 

   

making it more difficult for us to satisfy our obligations with respect to our indebtedness, including the Notes, and any failure to comply with the obligations of any of our debt instruments, including restrictive covenants and borrowing conditions, could result in an event of default under the indentures governing the Notes and the agreements governing such other indebtedness;

 

   

restricting us from making strategic acquisitions or causing us to make non-strategic divestitures;

 

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imposing restrictions on the operating of our business that may hinder our ability to take advantage of strategic opportunities to grow our business;

 

   

limiting our ability to obtain additional financing for working capital, capital expenditures, product development, debt service requirements, acquisitions and general corporate or other purposes, which could be exacerbated by further volatility in the credit markets; and

 

   

limiting our flexibility in planning for, or reacting to, changes in our business or market conditions and placing us at a competitive disadvantage compared to our competitors who are less highly leveraged and who therefore, may be able to take advantage of opportunities that our leverage prevents us from exploiting.

Despite our substantial high indebtedness, we and our subsidiaries are still able to incur significant additional amounts of debt, which could further exacerbate the risks associated with our substantial indebtedness.

We and our subsidiaries may be able to incur substantial additional indebtedness in the future. The indentures governing the Notes and our Credit Facility each contain restrictions on the incurrence of additional indebtedness. However, these restrictions are subject to a number of significant qualifications and exceptions, and under certain circumstances, the amount of indebtedness that could be incurred in compliance with these restrictions could be substantial. Accordingly, we and our subsidiaries may be able to incur substantial additional indebtedness in the future. As of February 2, 2013, we had undrawn availability under our Credit Facility of $110.5 million. If new debt is added to our and our subsidiaries’ existing debt levels, the related risks that we now face would increase. In addition, the indentures governing the Notes and our Credit Facility will not prevent us from incurring obligations that do not constitute indebtedness under those agreements.

Our debt agreements contain restrictions that limit our flexibility in operating our business.

Our Credit Facility and the indentures governing the Notes contain various covenants that limit our ability to engage in specified types of transactions. These covenants limit our, our parent’s and our restricted subsidiaries’ ability to, among other things:

 

   

incur additional indebtedness or issue certain preferred shares;

 

   

pay dividends on, repurchase or make distributions in respect of our capital stock or make other restricted payments;

 

   

make certain investments;

 

   

transfer or sell certain assets;

 

   

create liens;

 

   

consolidate, merge, sell or otherwise dispose of all or substantially all of our assets; and

 

   

enter into certain transactions with our affiliates.

A breach of any of these covenants could result in a default under one or more of these agreements, including as a result of cross default provisions, and, in the case of the Credit Facility, permit the lenders to cease making loans to us. Upon the occurrence of an event of default under our indebtedness, the lenders and/or note holders could elect to declare all amounts outstanding to be immediately due and payable and, in the case of the Credit Facility, terminate all commitments to extend further credit. Such actions could cause cross defaults under our other indebtedness. If we were unable to repay such amounts, the lenders under our Credit Facility and the holders of our secured Notes could proceed against the collateral granted to them to secure that indebtedness.

We may not be able to generate sufficient cash to service all of our indebtedness, and may be forced to take other actions to satisfy our obligations under our indebtedness, which may not be successful.

Our ability to make scheduled payments on or to refinance our debt obligations depends on our financial condition and operating performance, which is subject to prevailing economic and competitive conditions

 

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and to certain financial, business and other factors beyond our control. We may not be able to maintain a level of cash flows from operating activities sufficient to permit us to pay the principal and interest on our indebtedness.

If our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay investments and capital expenditures, or to sell assets, seek additional capital or restructure or refinance our indebtedness, including the Notes. Our ability to restructure or refinance our debt will depend on the condition of the capital markets and our financial condition at such time. Any refinancing of our debt could be at higher interest rates and may require us to comply with more onerous covenants, which could further restrict our business operations. The terms of our Credit Facility and the indentures governing the Notes or any future debt instruments that we may enter into may restrict us from adopting some of these alternatives. In addition, any failure to make payments of interest and principal on our outstanding indebtedness on a timely basis would likely result in a reduction of our credit rating, which could harm our ability to incur additional indebtedness. These alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations.

Repayment of our debt is dependent on cash flow generated by our subsidiaries.

Our subsidiaries own a significant portion of our assets and conduct a significant portion of our operations. Accordingly, repayment of our indebtedness is dependent, to a significant extent, on the generation of cash flow by our subsidiaries and their ability to make such cash available to us, by dividend, debt repayment or otherwise. Unless they are guarantors of the notes, our subsidiaries do not have any obligation to pay amounts due on the notes or to make funds available for that purpose. Our subsidiaries may not be able to, or may not be permitted to, make distributions to enable us to make payments in respect of our indebtedness. Each subsidiary is a distinct legal entity and, under certain circumstances, legal and contractual restrictions may limit our ability to obtain cash from our subsidiaries. While the indentures governing the Notes limit the ability of our subsidiaries to incur consensual restrictions on their ability to pay dividends or make other intercompany payments to us, these limitations are subject to certain qualifications and exceptions. In the event that we do not receive distributions from our subsidiaries, we may be unable to make required principal and interest payments on our indebtedness.

To service our debt obligations, we may need to increase the portion of the income of our foreign subsidiaries that is expected to be remitted to the United States, which could increase our income tax expense.

The amount of the income of our foreign subsidiaries that we expect to remit to the United States may significantly impact our United States federal income tax expense. We record United States federal income taxes on that portion of the income of our foreign subsidiaries that is expected to be remitted to the United States. In order to service our debt obligations, we may need to increase the portion of the income of our foreign subsidiaries that we expect to remit to the United States, which may significantly increase our income tax expense. Consequently, our income tax expense has been, and will continue to be, impacted by our strategic initiative to make substantial capital investments outside the United States.

If we default on our obligations to pay our other indebtedness, the holders of our debt could exercise rights that could have a material effect on us.

If we are unable to generate sufficient cash flow and are otherwise unable to obtain funds necessary to meet required payments of principal, premium, if any, and interest on our indebtedness, or if we otherwise fail to comply with the various covenants, including financial and operating covenants in the instruments governing our indebtedness, we could be in default under the terms of the agreements governing such indebtedness. In the event of such default,

 

   

the holders of such indebtedness may be able to cause all of our available cash flow to be used to pay such indebtedness and, in any event, could elect to declare all the funds borrowed thereunder to be due and payable, together with accrued and unpaid interest;

 

   

the lenders under our Credit Facility could elect to terminate their commitments thereunder, cease making further loans and institute foreclosure proceedings against our assets; and

 

   

we could be forced into bankruptcy or liquidation.

 

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If our operating performance declines, we may in the future need to obtain waivers from the required lenders under our Credit Facility to avoid being in default. If we breach our covenants under our Credit Facility and seek a waiver, we may not be able to obtain a waiver from the required lenders. If this occurs, we would be in default under our Credit Facility, the lenders could exercise their rights, as described above, and we could be forced into bankruptcy or liquidation.

Item 1B. Unresolved Staff Comments

None.

Item 2. Properties

Our stores are located in all 50 states of the United States, Puerto Rico, Canada, the Virgin Islands, the United Kingdom, Ireland, France, Spain, Portugal, Belgium, Switzerland, Austria, Netherlands, Germany, Poland, Czech Republic, Hungary, China, Italy and Luxembourg. We lease all of our 3,085 store locations, generally for terms ranging from five to approximately 10 years. Under the terms of the leases, we pay a fixed minimum rent and/or rentals based on a percentage of net sales. 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 third parties and constructed by external contractors.

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

The following table sets forth the location, use and size of our distribution, sourcing, buying, merchandising, and corporate facilities as of February 2, 2013. The properties are leased with the leases expiring at various times through 2030, subject to renewal options.

 

Location

  

Use

  Approximate
Square
Footage
 

Hoffman Estates, Illinois

  

Global and Division management and distribution center

    538,000  (1) 

Birmingham, United Kingdom

  

Division management and distribution center

    126,552  (2) 

Pembroke Pines, Florida

  

Accounting

    36,000   

Shanghai, China

  

Division management

    11,005   

Hong Kong

  

Sourcing and buying

    10,400   

Paris, France

  

Field support

    5,900  (3) 

Madrid, Spain

  

Field support

    2,700  (3) 

 

(1) On February 19, 2010, we sold the Property to a third party. Contemporaneously with the sale of the Property, we entered into a lease agreement that provides for (a) an initial expiration date of February 28, 2030 with two (2) five (5) year renewal periods, each at our option, and (b) basic rent of $2.1 million per annum (subject to annual increases). This transaction is accounted for as a capital lease. Prior to February 19, 2010, we owned central buying and store operations offices and the North America distribution center located in Hoffman Estates, Illinois (the “Property”) which is on approximately 28.4 acres of land. The Property has buildings with approximately 538,000 total square feet of space, of which 371,000 square feet is devoted to receiving and distribution and 167,000 square feet is devoted to office space.
(2)

Our subsidiary, Claire’s Accessories UK Ltd., or “Claire’s UK,” leases distribution and office space in Birmingham, United Kingdom. The facility consists of approximately 23,900 square feet of office space

 

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  and approximately 102,600 square feet of distribution space. The lease expires in December 2024, and Claire’s UK has the right to assign or sublet this lease at any time during the term of the lease, subject to landlord approval. The Birmingham, United Kingdom distribution center currently services our owned stores in Europe.
(3) We maintain our human resource and select operating functions for these countries at these facilities.

In addition, we have contracted a third party vendor in Hong Kong to provide distribution center services for our franchise stores.

Item 3. Legal Proceedings

We are, from time to time, involved in routine litigation incidental to the conduct of our business, including litigation instituted by persons injured upon premises under our control; litigation regarding the merchandise that we sell, including product and safety concerns regarding heavy metal and chemical content in our merchandise; litigation with respect to various employment matters, including wage and hour litigation; litigation with present or former employees; and litigation regarding intellectual property rights. Although litigation is routine and incidental to the conduct of our business, like any business of our size which employs a significant number of employees and sells a significant amount of merchandise, such litigation can result in large monetary awards when judges, juries or other finders of facts do not agree with management’s evaluation of possible liability or outcome of litigation. Accordingly, the consequences of these matters cannot be finally determined by management. However, in the opinion of management, we believe that current pending litigation will not have a material adverse effect on our consolidated financial results.

Item 4. Mine Safety Disclosure

Not applicable.

PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market Information

There is no established public trading market for our common stock.

Holders

As of April 1, 2013, there was one holder of record of our common stock, our parent, Claire’s Inc.

Dividends

We have paid no cash dividends since the Merger. Our Credit Facility and the indentures governing the Notes restrict our ability to pay dividends.

 

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Item 6. Selected Financial Data

The balance sheet data as of February 2, 2013 and January 28, 2012 and statement of operations data for the fiscal years ended February 2, 2013, January 28, 2012 and January 29, 2011 are derived from our Consolidated Financial Statements included herein and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our Consolidated Financial Statements and the related notes thereto appearing elsewhere in this Annual Report. The Consolidated Balance Sheet data as of January 29, 2011, January 30, 2010, and January 31, 2009 and the Consolidated Statement of Operations and Comprehensive Income data for the fiscal years ended January 30, 2010 and January 31, 2009 are derived from our Consolidated Financial Statements which are not included herein.

 

     Fiscal Year
Ended
    Fiscal Year
Ended
    Fiscal Year
Ended
    Fiscal Year
Ended
    Fiscal Year
Ended
 
     February 2,     January 28,     January 29,     January 30,     January 31,  
     2013 (1)     2012     2011     2010     2009  
     (In thousands, except for ratios and store data)  

Statement of Operations Data:

          

Net sales

   $ 1,557,020      $ 1,495,900      $ 1,426,397      $ 1,342,389      $ 1,412,960   

Cost of sales, occupancy and buying expenses (exclusive of depreciation and amortization shown separately below)

     755,996        724,775        685,111        663,269        724,832   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     801,024        771,125        741,286        679,120        688,128   

Other expenses:

          

Selling, general and administrative

     503,254        504,360        493,081        466,965        513,752   

Depreciation and amortization

     64,879        68,753        65,198        71,471        85,093   

Impairment of assets

     —          —          12,262        3,142        498,490   

Severance and transaction-related costs

     2,828        6,928        741        921        15,928   

Other (income) expense, net

     (6,105     (1,254     5,542        (5,493     (4,499
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     564,856        578,787        576,824        537,006        1,108,764   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income (loss)

     236,168        192,338        164,462        142,114        (420,636

Gain (loss) on early debt extinguishment

     (9,707     6,405        13,388        36,412        —     

Impairment of equity investment

     —          —          6,030        —          25,500   

Interest expense, net

     210,797        176,475        157,706        177,418        195,947   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations before income taxes

     15,664        22,268        14,114        1,108        (642,083

Income tax expense

     14,382        10,636        9,791        11,510        1,509   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations

   $ 1,282      $ 11,632      $ 4,323      $ (10,402   $ (643,592
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other Financial Data:

          

Capital expenditures:

          

New stores and remodels (2)

   $ 64,398      $ 63,705      $ 40,126      $ 17,103      $ 38,241   

Other

     9,455        12,912        9,689        8,395        23,135   

Total capital expenditures

     73,853        76,617        49,815        25,498        61,376   

Cash interest expense (3)

     165,495        136,533        108,923        126,733        168,567   

Store Data:

          

Number of stores (at period end)

          

North America (4)

     1,924        1,953        1,972        1,993        2,026   

Europe

     1,161        1,118        1,009        955        943   

Total number of stores (at period end)

     3,085        3,071        2,981        2,948        2,969   

Total gross square footage (000’s) (at period end)

     3,117        3,092        3,012        2,982        3,011   

Net sales per store (000’s) (5)

   $ 506      $ 494      $ 481      $ 454      $ 461   

Net sales per square foot (6)

   $ 502      $ 490      $ 476      $ 448      $ 453   

Balance Sheet Data (at period end)

          

Cash and cash equivalents (7)

   $ 166,956      $ 174,374      $ 279,766      $ 198,708      $ 204,574   

Total assets

     2,799,272        2,763,025        2,866,449        2,834,105        2,881,095   

Total debt (inlcuding capital lease)

     2,390,652        2,403,672        2,524,286        2,521,878        2,581,772   

Total stockholder’s deficit

     (14,440     (22,296     (26,515     (34,642     (55,843

 

(1) Consists of 53 weeks.
(2) For Fiscal 2012, Fiscal 2011, Fiscal 2010, Fiscal 2009, and Fiscal 2008 include expenditures for store related intangible assets in the amounts of $5,049, $5,709, $1,104, $546 and $1,971.
(3) Cash interest expense does not include amortization of debt issuance costs, interest expense paid in kind or accretion of debt premium.
(4) Includes 3 China stores opened in the fourth quarter of Fiscal 2012.
(5) Net sales per store are calculated based on the average number of stores during the period.
(6) Net sales per square foot are calculated based on the average gross square feet during the period.
(7) At February 2, 2013, January 28, 2012 and January 29, 2011, cash and cash equivalents included restricted cash of $0 million, $4.4 million, and $23.9 million, respectively.

 

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

Management’s Discussion and Analysis of Financial Condition and Results of Operations is designed to provide the reader of the financial statements with a narrative on our results of operations, financial position and liquidity, risk management activities, and significant accounting policies and critical estimates. Management’s Discussion and Analysis should be read in conjunction with the Consolidated Financial Statements and related notes thereto contained elsewhere in this document.

Our fiscal year ends on the Saturday closest to January 31, and we refer to the fiscal year by the calendar year in which it began. As a result, our fiscal year ended February 2, 2013 consisted of 53 weeks, while both of our fiscal years ended January 28, 2012 and January 29, 2011 consisted of 52 weeks.

We include a store in the calculation of same store sales once it has been in operation sixty weeks after its initial opening and, effective in the third quarter of fiscal 2012, we include sales from e-commerce. A store which is temporarily closed, such as for remodeling, is removed from the same store sales computation if it is closed for nine consecutive weeks. The removal is effective prospectively upon the completion of the ninth consecutive week of closure. A store which is closed permanently, such as upon termination of the lease, is immediately removed from the same store sales computation. We compute same store sales on a local currency basis, which eliminates any impact for changes in foreign currency exchange rates.

Acquisition of the Company by Apollo Management VI, L.P.

As a result of the Merger on May 29, 2007, described under “History” in this Annual Report, there was a significant change in the Company’s capital structure, including:

 

   

the closing of the Company’s Former Credit Facility of $1.65 billion;

 

   

the closing of the Company’s Merger Notes in the aggregate principal amount of $935.0 million; and

 

   

the equity investment by the Sponsors, of approximately $595.7 million.

The purchase of the Company and the related fees and expenses were financed through the issuance of the Merger Notes, borrowing under the Former Credit Facility, equity investment by the Sponsors, and cash on hand at the Company.

The aforementioned transactions, including the Merger and payment of costs related to these transactions, are collectively referred to as the “Transactions.”

The acquisition of Claire’s Stores, Inc. was accounted for as a business combination using the purchase method of accounting, whereby the purchase price was allocated to the assets and liabilities based on the estimated fair market values at the date of acquisition.

See Note 1 – Nature of Operations and Acquisition of Claire’s Stores, Inc. and Note 5 – Debt, respectively, in the Notes to Consolidated Financial Statements for details of the acquisition and current indebtedness.

Results of Consolidated Operations

Management overview

We are one of the world’s leading specialty retailers of fashionable jewelry and accessories for young women, teens, tweens, and kids. We are organized into two operating segments: North America and Europe. We identify our operating segments by how we manage and evaluate our business activities. We operate owned stores throughout the United States, Puerto Rico, Canada, the U.S. Virgin Islands and China (North America segment) and the United Kingdom, Switzerland, Austria, Germany, France, Ireland, Spain, Portugal, Netherlands, Belgium, Poland, Czech Republic, Hungary, Italy and Luxembourg (Europe segment). We operate our stores under two brand names: Claire’s® and Icing®.

 

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We also franchise stores in Japan, the Middle East, Turkey, Greece, Guatemala, Malta, Ukraine, Mexico, India, Dominican Republic, El Salvador, Venezuela, Panama, Honduras, and Indonesia. Until September 2, 2010, we operated stores in Japan through a 50:50 joint venture. Beginning September 2, 2010, these stores began to operate as franchise stores. We account for the goods we sell to third parties under franchising agreements within “Net sales” and “Cost of sales, occupancy and buying expenses” in our Consolidated Statements of Operations and Comprehensive Income. The franchise fees we charge under the franchising agreements are reported in “Other (income) expense, net” in our Consolidated Statements of Operations and Comprehensive Income.

Financial activity for Fiscal 2012 includes the following:

 

   

Sales growth of 4.1%; excluding the additional week of net sales, sales growth would have been 2.5%.

 

   

Same store sales growth (1) :

 

     Fiscal
2012
 

Consolidated

     1.8

North America

     1.9

Europe

     1.7

 

(1) 

Computed on comparable 52 week basis: 52 weeks ended January 26, 2013 compared to the 52 weeks ended January 28, 2012.

 

   

Operating income growth of 22.8%; excluding the additional week of operations, operating income growth would have been 19.6%.

 

   

Operating income margin of 15.2 %; excluding the additional week of operations, income margin would have been 15.0%.

During Fiscal 2012, we issued $1,142.1 million of the 9.0% Senior Secured First Lien Notes that mature on March 15, 2019. We used the net proceeds from the note offerings, together with cash on hand, to repay $1,154.3 million of indebtedness under the Former Credit Facility. In September 2012, we replaced our existing $200.0 million senior secured Former Revolver maturing May 29, 2013 with our current $115.0 million five-year senior secured revolving Credit Facility. In March 2013, after our fiscal year end, we commenced a tender offer to repurchase a total of $210.0 million aggregate principal amount of Senior Fixed Rate Notes and Senior Toggle Notes. On March 15, 2013, we issued $210.0 million aggregate principal amount of 6.125% Senior Secured First Lien Notes that mature March 15, 2020. On March 15, 2013, we used approximately $63.3 million of the net proceeds of the 6.125% Senior Secured First Lien Note offering to purchase early tendered Senior Notes. On March 28, 2013, the tender offer expired, and, as of that date, $20,000 of additional Senior Fixed Rate Notes were validly tendered and not validly withdrawn. On April 1, 2013, we used approximately $20,000 of the net proceeds of the offering of the 6.125% Senior Secured First Lien Notes to purchase the additional tendered Senior Notes in accordance with the tender offer. We intend to use the remaining net proceeds, together with cash on hand, to repurchase an additional $149.5 million aggregate principal amount of Senior Notes pursuant to a subsequent redemption.

Operational activity for Fiscal 2012 includes the following:

 

   

Opened 110 new company-owned stores; entered 3 new countries on an owned basis, including China and Italy.

 

   

Partnered with franchisees to develop stores in 21 new countries; opened franchised stores in 6 new countries.

 

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A summary of our consolidated results of operations is as follows (dollars in thousands):

 

     Fiscal 2012     Fiscal 2011     Fiscal 2010  

Net sales

   $ 1,557,020      $ 1,495,900      $ 1,426,397   

Increase in same store sales

     1.8     0.1     6.5

Gross profit percentage

     51.4     51.5     52.0

Selling, general and administrative expenses as a percentage of net sales

     32.3     33.7     34.6

Depreciation and amortization as a percentage of net sales

     4.2     4.6     4.6

Severance and transaction-related costs as percentage of net sales

     0.2     0.5     0.1

Impairment of assets

   $ —        $ —        $ 12,262   

Operating income

   $ 236,168      $ 192,338      $ 164,462   

Gain (loss) on early debt extinguishment

   $ (9,707   $ 6,405      $ 13,388   

Impairment of equity investment

   $ —        $ —        $ 6,030   

Net income

   $ 1,282      $ 11,632      $ 4,323   

Number of stores at the end of the period (1)

     3,085        3,071        2,981   

 

(1) Number of stores excludes stores operated under franchise agreements.

Net sales

Net sales in Fiscal 2012 increased $61.1 million, or 4.1%, from Fiscal 2011. Fiscal 2012 included 53 weeks of operations compared to Fiscal 2011. The increase was attributable to new store sales of $66.8 million, an increase in same store sales of $25.9 million, the additional week of net sales of $23.6 million, increased shipments to franchisees of $2.7 million, partially offset by a decrease of $32.1 million due to the effect of store closures and an unfavorable foreign currency translation effect of our non-U.S. net sales of $25.8 million. Excluding the extra week of net sales in Fiscal 2012, net sales would have increased 2.5%, or 4.3%, excluding the impact from foreign currency exchange rate changes.

Net sales in Fiscal 2011 increased $69.5 million, or 4.9%, from Fiscal 2010. This increase was attributable to new store sales of $59.7 million, a favorable foreign currency translation effect of our non-U.S. store sales of $30.7 million, increased shipments to franchisees of $2.4 million and an increase in same stores sales of $1.4 million, or 0.1%, partially offset by a decrease of $24.7 million due to the effect of store closures. Net sales would have increased 2.7% excluding the impact from foreign currency exchange rate changes.

The increase in same store sales was primarily attributable to an increase in average transaction value of 4.2%, partially offset by a decrease in average number of transactions per store of 2.2%.

The following table compares our sales of each product category for the last three fiscal years:

 

     Percentage of Total  

Product Category

   Fiscal 2012      Fiscal 2011      Fiscal 2010  

Jewelry

     47.9         46.1         45.5   

Accessories

     52.1         53.9         54.5   
  

 

 

    

 

 

    

 

 

 
     100.0         100.0         100.0   
  

 

 

    

 

 

    

 

 

 

Gross profit

In calculating gross profit and gross profit percentages, we exclude our distribution center cost and depreciation and amortization expense. These costs are included instead in “Selling, general and administrative” expense and “Depreciation and Amortization” expense, respectively, in our Consolidated Statements of Operations and Comprehensive Income. Other retail companies may include these costs in cost of sales, so our gross profit percentages may not be comparable to those retailers.

In Fiscal 2012, gross profit percentage decreased 10 basis points to 51.4% compared to the prior fiscal year of 51.5%. The decrease in gross profit percentage consisted of an 80 basis point decrease in merchandise margin, partially offset by a 60 basis point decrease in occupancy costs and a 10 basis point decrease in buying and buying-related costs. The decrease in merchandise margin resulted primarily from an increase in markdowns and higher inventory shrink. The decrease in occupancy rate resulted primarily from the leveraging effect of an increase in same store sales.

 

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In Fiscal 2011, gross profit percentage decreased 50 basis points to 51.5% compared to the prior fiscal year of 52.0%. The decrease in gross profit percentage consisted of a 40 basis point increase in occupancy costs and a 20 basis point decrease in merchandise margin, partially offset by a 10 basis point decrease in buying and buying-related costs. The increase in the occupancy rate resulted primarily from the deleveraging effect of a reduction in same store sales in Europe. The decrease in merchandise margin resulted primarily from an increase in markdowns.

Selling, general and administrative expenses

In Fiscal 2012, selling, general and administrative expenses decreased $1.1 million, or 0.2%, over the prior fiscal year. As a percentage of net sales, selling, general and administrative expenses decreased 140 basis points compared to the prior year. Excluding the extra week of operations in Fiscal 2012 and a favorable $9.9 million foreign currency translation effect, selling, general and administrative expenses would have increased $0.4 million.

In Fiscal 2011, selling, general and administrative expenses increased $11.3 million, or 2.3%, over the prior fiscal year. As a percentage of net sales, selling, general and administrative expenses decreased 90 basis points compared to the prior year. Excluding an unfavorable $10.1 million foreign currency translation effect, selling, general and administrative expenses would have increased $0.3 million.

Depreciation and amortization expense

Depreciation and amortization expense decreased $3.9 million to $64.9 million during Fiscal 2012 compared to Fiscal 2011. Excluding a favorable $1.0 million foreign currency translation effect, the decrease in depreciation and amortization expense would have been $2.9 million.

Depreciation and amortization expense increased $3.6 million to $68.8 million during Fiscal 2011 compared to Fiscal 2010. Excluding an unfavorable $1.1 million foreign currency translation effect, the increase in depreciation and amortization expense would have been $2.5 million. The majority of this increase is due to the effect of asset additions during Fiscal 2011.

Impairment charges

During Fiscal 2012 and Fiscal 2011, we did not recognize any impairment charges.

During the fourth quarter of Fiscal 2010, management performed a strategic review of its franchising business. The inability of certain franchisees’ to achieve store development expectations in select markets prompted us to reevaluate our franchise development strategy and to perform a valuation of the franchise agreements, which are definite-lived intangible assets. We utilized a discounted cash flow model and determined the franchise agreements intangible assets were impaired. This resulted in us recording a non-cash impairment charge of $12.3 million in Fiscal 2010, which was included in “Impairment of assets” on the Company’s Consolidated Statements of Operations and Comprehensive Income.

During the second quarter of Fiscal 2010, we recorded a non-cash impairment charge related to the investment in a 50:50 joint venture called Claire’s Nippon of $6.0 million. The joint venture’s continuing operating losses prompted us to perform a valuation of our investment in Claire’s Nippon. Effective September 2, 2010, the Claire’s Nippon stores are no longer operated through this joint venture.

See Note 3 – Impairment Charges in the Notes to Consolidated Financial Statements for further discussion of the impairment charges.

Severance and transaction-related costs

Since 2007, we have incurred severance and various transaction-related costs. These costs consisted primarily of severance costs resulting from reductions in workforce occurring from time-to-time and financial advisory and legal fees. During Fiscal 2012, we incurred $2.8 million of such costs, including costs for the remaining payments due under the employment contract of certain former officers. During Fiscal 2011 and Fiscal 2010, we incurred $6.9 million and $0.7 million of such costs, respectively.

 

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Other (income) expense, net

The following is a summary of other (income) expense activity for Fiscal 2012, Fiscal 2011 and Fiscal 2010 (in thousands):

 

     Fiscal 2012     Fiscal 2011     Fiscal 2010  

Foreign currency exchange loss (gain), net

   $ (1,437   $ 899      $ 5,131   

Franchise fees

     (4,668     (1,904     (1,638

Equity loss

     —          —          2,529   

Other income

     —          (249     (480
  

 

 

   

 

 

   

 

 

 
   $ (6,105   $ (1,254   $ 5,542   
  

 

 

   

 

 

   

 

 

 

Gain (loss) on early debt extinguishment

During Fiscal 2012, we recognized a $9.7 million loss on early debt extinguishment attributed to the write-off of unamortized debt issuance costs associated with the early repayment of $1,154.3 million of indebtedness under our Former Credit Facility and replacement of our Former Revolver.

The following is a summary of our note repurchase activity during Fiscal 2011 and Fiscal 2010 (in thousands): There was no debt repurchase activity during Fiscal 2012.

 

     Fiscal 2011  
     Principal      Repurchase      Recognized  

Notes Repurchased

   Amount      Price      Gain (1)  

Senior Fixed Rate Notes

   $ 15,730       $ 15,213       $ 260   

Senior Toggle Notes

     69,617         63,130         6,145   
  

 

 

    

 

 

    

 

 

 
   $ 85,347       $ 78,343       $ 6,405   
  

 

 

    

 

 

    

 

 

 

 

(1) Net of deferred issuance cost write-offs of $257 for the Senior Fixed Rate Notes and $796 for the Senior Toggle Notes, and accrued interest write-off of $455 for the Senior Toggle Notes.

 

     Fiscal 2010  
     Principal      Repurchase      Recognized  

Notes Repurchased

   Amount      Price      Gain (1)  

Senior Fixed Rate Notes

   $ 14,000       $ 12,268       $ 1,467   

Senior Toggle Notes

     57,173         49,798         7,612   

Senior Subordinated Notes

     22,625         17,799         4,309   
  

 

 

    

 

 

    

 

 

 
   $ 93,798       $ 79,865       $ 13,388   
  

 

 

    

 

 

    

 

 

 

 

(1) Net of deferred issuance cost write-offs of $265 for the Senior Fixed Rate Notes, $922 for the Senior Toggle Notes and $517 for the Senior Subordinated Notes, and accrued interest write-off of $1,159 for the Senior Toggle Notes.

Interest expense, net

Interest expense for Fiscal 2012 aggregated $210.8 million, an increase of $34.3 million compared to the prior year. The increase is primarily due to indebtedness incurred under the 9.0% Senior Secured First Lien Notes that bear a higher rate of interest than the Former Credit Facility, partially offset by lower outstanding balance under our Former Credit Facility, a Euro denominated loan, and Senior Toggle Notes. For Fiscal 2012, interest expense includes approximately $9.9 million of amortization of deferred debt issuance costs and approximately $0.8 million of accretion of debt premium.

Interest expense for Fiscal 2011 aggregated $176.5 million, an increase of $18.8 million compared to the prior year. This increase is primarily due to indebtedness incurred under the $450.0 million Senior Secured Second Lien Notes that bears a higher rate of interest than the Former Credit Facility and additional indebtedness incurred under a Euro denominated loan, partially offset by lower outstanding balances under our Former Credit Facility and Senior Notes. For Fiscal 2011, interest expense includes approximately $13.1 million of amortization of deferred debt issuance costs and $11.8 million of paid in kind interest.

 

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Interest expense for Fiscal 2010 aggregated $157.7 million, a decrease of $19.7 million compared to the prior year. This decrease is primarily the result of Merger Notes repurchases. For Fiscal 2010, interest expense includes approximately $10.0 million of amortization of deferred debt issuance costs and $36.9 million of paid in kind interest.

See Note 5 – Debt in the Notes to Consolidated Financial Statements for components of interest expense (income), net.

Income taxes

In Fiscal 2012, our income tax expense was $14.4 million and our effective income tax rate was 91.8%. Our effective income tax rate for Fiscal 2012 reflects income tax expense of $13.5 million on earnings of foreign subsidiaries and income tax expense of $14.7 million related to the effect of changes to our valuation allowance on deferred tax assets, partially offset by income tax benefits of $17.9 million on income in our foreign jurisdictions that are taxed at lower income tax rates. In Fiscal 2012, we made net cash income tax payments of $14.8 million primarily for Europe.

In Fiscal 2011, our income tax expense was $10.6 million and our effective income tax rate was 47.8%. Our effective income tax rate for Fiscal 2011 reflects income tax expense of $6.1 million on earnings of foreign subsidiaries and income tax expense of $3.6 million related to the effect of changes to our valuation allowance on deferred tax assets, partially offset by income tax benefits of $9.2 million on income in our foreign jurisdictions that are taxed at lower income tax rates. In Fiscal 2011, we made net cash income tax payments of $14.3 million primarily for Europe.

In Fiscal 2010, our income tax expense was $9.8 million and our effective income tax rate was 69.4%. Our effective income tax rate for Fiscal 2010 reflects income tax expense of $0.4 million on earnings of foreign subsidiaries, income tax expense of $12.7 million related to the effect of changes to our valuation allowance on deferred tax assets and income tax expense of $2.6 million relating to other permanent items, partially offset by income tax benefits of $11.6 million on income in our foreign jurisdictions that are taxed at lower income tax rates. In Fiscal 2010, we made net cash income tax payments of $6.3 million.

In Fiscal 2008, we recorded a charge of $95.8 million to establish a valuation allowance against its deferred tax assets in the U.S. We concluded that a valuation allowance was appropriate in light of the significant negative evidence, which was objective and verifiable, such as cumulative losses in recent fiscal years in our U.S. operations. While our long-term financial outlook in the U.S. remains positive, we concluded that its ability to rely on its long-term outlook as to future taxable income was limited due to the relative weight of the negative evidence from its recent U.S. cumulative losses. Our conclusion regarding the need for a valuation allowance against U.S. deferred tax assets could change in the future based on improvements in operating performance, which may result in the full or partial reversal of the valuation allowance. The foreign valuation allowances relate to net operating loss carryforwards that, in the opinion of management, are more likely than not to expire unutilized.

See Note 11 – Income Taxes in the Notes to Consolidated Financial Statements for further details.

Segment Operations

We are organized into two business segments – North America, which includes our new stores in China, and Europe. The following is a discussion of results of operations by business segment.

 

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North America

Key statistics and results of operations for our North America division are as follows (dollars in thousands):

 

     Fiscal 2012     Fiscal 2011     Fiscal 2010  

Net sales

   $ 977,310      $ 942,278      $ 914,149   

Increase in same store sales

     1.9     2.8     7.8

Gross profit percentage

     52.9     52.6     52.1

Number of stores at the end of the period (1)

     1,924        1,953        1,972   

 

(1) Number of stores excludes stores operated under franchise agreements and includes 3 China stores.

Net sales

Net sales in North America during Fiscal 2012 increased $35.0 million, or 3.7% from Fiscal 2011. Fiscal 2012 included 53 weeks of operations compared to Fiscal 2011. The increase was attributable to new store sales of $18.7 million, an increase in same store sales of $17.1 million, the additional week of net sales of $13.4 million, increased shipments to franchisees of $2.7 million, partially offset by a decrease of $16.7 million due to the effect of store closures and an unfavorable foreign currency translation effect of our non-U.S. net sales of $0.2 million. Excluding the extra week of net sales in Fiscal 2012, net sales would have increased 2.3%, or unchanged, excluding the impact from foreign currency exchange rate changes.

The increase in same store sales was primarily attributable to an increase in average transaction value of 5.1%, partially offset by a decrease in average number of transactions per store of 2.5%.

Net sales in North America during Fiscal 2011 increased $28.1 million, or 3.1%, from Fiscal 2010. The increase was attributable to an increase in same store sales of $24.7 million, or 2.8%, new store sales of $9.8 million, an increase in shipments to franchisees of $2.3 million and a favorable foreign currency translation effect of our non-U.S. net sales of $2.1 million, partially offset by a decrease of $10.8 million due to the effect of store closures.

The increase in same store sales was primarily attributable to an increase in average transaction value of 5.4%, partially offset by a decrease in average number of transactions per store of 2.3%.

Gross profit

In Fiscal 2012, gross profit percentage increased 30 basis points to 52.9% compared to the gross profit percentage for Fiscal 2011 of 52.6%. The increase in gross profit percentage consisted of a 50 basis point decrease in occupancy costs and a 20 basis point decrease in buying and buying-related costs, partially offset by a 40 basis point decrease in merchandise margin. The improvement in occupancy rate resulted primarily from the leveraging effect of an increase in same store sales. The decrease in merchandise margin resulted primarily from an increase in markdowns, partially offset by improvement in initial markups.

In Fiscal 2011, gross profit percentage increased 50 basis points to 52.6% compared to the gross profit percentage for Fiscal 2010 of 52.1%. The increase in gross profit percentage consisted of a 40 basis point decrease in occupancy costs and a 10 basis point increase in merchandise margin. The improvement in occupancy rate is due to the leveraging effect of higher sales.

The following table compares our sales of each product category for the last three fiscal years:

 

     Percentage of Total  

Product Category

   Fiscal 2012      Fiscal 2011      Fiscal 2010  

Jewelry

     52.6         50.8         50.2   

Accessories

     47.4         49.2         49.8   
  

 

 

    

 

 

    

 

 

 
     100.0         100.0         100.0   
  

 

 

    

 

 

    

 

 

 

 

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Europe

Key statistics and results of operations for our Europe division are as follows (dollars in thousands):

 

     Fiscal 2012     Fiscal 2011     Fiscal 2010  

Net sales

   $ 579,710      $ 553,622      $ 512,248   

Increase (decrease) in same store sales

     1.7     (4.4 )%      4.3

Gross profit percentage

     49.0     49.8     51.7

Number of stores at the end of the period (1)

     1,161        1,118        1,009   

 

(1) Number of stores excludes stores operated under franchise agreements.

Net sales

Net sales in Europe during Fiscal 2012 increased $26.1 million, or 4.7%, from Fiscal 2011. Fiscal 2012 included 53 weeks of operations compared to Fiscal 2011. The increase was attributable to new store sales of $48.1 million, the additional week of net sales of $10.2 million, an increase in same store sales of $8.8 million, partially offset by an unfavorable foreign currency translation effect of our non-U.S. net sales of $25.6 million and a decrease of $15.4 million due to the effect of store closures. Excluding the extra week of sales in Fiscal 2012, net sales would have increased 2.9%, or 7.8%, excluding the impact from foreign currency exchange rate changes.

The increase in same store sales was primarily attributable to an increase in average transaction value of 4.2%, partially offset by a decrease in average number of transactions per store of 3.3%.

Net sales in Europe during Fiscal 2011 increased $41.4 million, or 8.1%, from Fiscal 2010. This increase was attributable to new store sales of $49.9 million and favorable foreign currency translation of our non-U.S net sales of $28.7 million, partially offset by a decrease in same stores sales of $23.3 million, (4.4)%, and a decrease of $13.9 million due to the effect of store closures.

The decrease in same store sales was primarily attributable to a decrease in average number of transactions per store of 7.6%, partially offset by an increase in average transaction value of 2.0%.

Gross profit

In Fiscal 2012, gross profit percentage decreased 80 basis points to 49.0% compared to the gross profit percentage for Fiscal 2011 of 49.8%. The decrease in gross profit percentage consisted of a 160 basis point decrease in merchandise margin and a 10 basis point increase in buying and buying-related costs, partially offset by a 90 basis point decrease in occupancy costs. The decrease in merchandise margin resulted from a reduction in initial markups and an increase in inventory shrink. The improvement in occupancy rate resulted primarily from the leveraging effect of an increase in same store sales.

In Fiscal 2011, gross profit percentage decreased 190 basis points to 49.8% compared to the gross profit percentage for Fiscal 2010 of 51.7%. The decrease in gross profit percentage consisted of a 130 basis point increase in occupancy costs and a 70 basis point decrease in merchandise margin, partially offset by a 10 basis point decrease in buying and buying-related costs. The increase in occupancy rate resulted primarily from the deleveraging effect of a reduction in same store sales. The decrease in merchandise margin resulted primarily from an increase in markdowns.

The following table compares our sales of each product category for the last three fiscal years:

 

     Percentage of Total  

Product Category

   Fiscal 2012      Fiscal 2011      Fiscal 2010  

Jewelry

     40.3         38.2         37.3   

Accessories

     59.7         61.8         62.7   
  

 

 

    

 

 

    

 

 

 
     100.0         100.0         100.0   
  

 

 

    

 

 

    

 

 

 

Liquidity and Capital Resources

Our operating liquidity requirements are funded through internally generated cash flow from net sales and cash on hand. Our primary uses of cash are debt service requirements, new store expenditures, and

 

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working capital requirements. Cash outlays for the payment of interest are significantly higher in Fiscal 2012 than in prior years as a result of cash interest payments for the 9.0% Senior Secured First Lien Notes and Senior Secured Toggle Notes. Our current capital structure generates tax losses in our U.S. operations because of debt service requirements. Accordingly, we expect to pay minimal cash taxes in the U.S. in the near term, while our foreign cash taxes are less affected by our capital structure and debt service requirements. We anticipate that the existing cash and cash equivalents and cash generated from operations will be sufficient to meet our debt service requirements as they become due, new store expenditures, and future working capital requirements for at least the next twelve months. However, our ability to make scheduled payments of interest on, to pay principal on, or refinance indebtedness, to satisfy any other present or future debt obligations and our ability to fund future capital expenditures and operating expenses will depend on future operating performance. Our future operating performance and liquidity may also be adversely affected by general economic, financial, and other factors beyond our control, including those disclosed in Part I, Item 1A – Risk Factors.

Credit Facility

Our Former Credit Facility provided senior secured financing of up to $1.65 billion that consisted of the $1.45 billion Former Term Loan and the $200.0 million Former Revolver. On May 29, 2007, upon closing of the Transactions, we borrowed $1.45 billion under our Former Term Loan facility and were issued a $4.5 million letter of credit. The letter of credit was subsequently increased to $6.0 million and later reduced to $4.8 million.

During Fiscal 2012, we issued $1,142.1 million of the 9.0% Senior Secured First Lien Notes that mature on March 15, 2019. We used the net proceeds from the note offerings, together with cash on hand, to repay $1,154.3 million of indebtedness under the Former Term Loan and to terminate the Former Credit Facility.

On September 20, 2012, the Company entered into an Amended and Restated Credit Agreement by and among Claire’s Inc. (“Parent”), the Company, Credit Suisse AG, as Administrative Agent, and the other Lenders named therein (the “Credit Facility”), pursuant to which the Company replaced its existing $200.0 million senior secured Former Revolver maturing May 29, 2013 with a $115.0 million five-year senior secured revolving credit facility.

Borrowings under the Credit Facility bear interest at a rate equal to, at the Company’s option, either (a) an alternate base rate determined by reference to the higher of (1) the prime rate in effect on such day, (2) the federal funds effective rate plus 0.50% and (3) the one-month LIBOR rate plus 1.00%, or (b) a LIBOR rate with respect to any Eurodollar borrowing, determined by reference to the costs of funds for U.S. dollar deposits in the London Interbank Market for the interest period relevant to such borrowing, adjusted for certain additional costs, in each case plus an applicable margin of 4.50% for LIBOR rate loans and 3.50% for alternate base rate loans. The Company also pays a facility fee of 0.50% per annum of the committed amount of the Credit Facility whether or not utilized.

All obligations under the Credit Facility are unconditionally guaranteed by (i) Parent, prior to an initial public offering of the Company’s stock, and (ii) the Company’s existing and future direct or indirect wholly-owned domestic subsidiaries, subject to certain exceptions.

All obligations under the Credit Facility, and the guarantees of those obligations, are secured, subject to certain exceptions and permitted liens, by a first priority lien on, (i) all of the Company’s capital stock, prior to an initial public offering of its stock, and (ii) substantially all of the Company’s material owned assets and the material owned assets of subsidiary guarantors, limited in the case of equity interests held by the Company or any subsidiary guarantor in a foreign subsidiary, to 100% of the non-voting equity interests and 65% of the voting equity interests of such foreign subsidiary held directly by the Company or a subsidiary guarantor. The liens securing the Credit Facility rank equally to the liens securing the 9.0% Senior Secured First Lien Notes.

The Credit Facility contains customary provisions relating to mandatory prepayments, voluntary payments, affirmative and negative covenants, and events of default; however, it does not contain any covenants that require the Company to maintain any particular financial ratio or other measure of financial performance

 

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except that so long as the revolving loans and letters of credit outstanding exceed $15 million, the Company will be required to comply with a maximum Total Net Secured Leverage Ratio of 5.5 to 1.0 based upon the ratio of its net senior secured debt to adjusted earnings before interest, taxes, depreciation and amortization for the period of four consecutive fiscal quarters most recently ended.

The Credit Facility does not contain any covenants that require the Company to maintain any particular financial ratio or other measure of financial performance; however, it does contain various covenants that limit our ability to engage in specified types of transactions. These covenants limit the Company’s Parent’s and the Company’s restricted subsidiaries’ ability to, among other things:

 

   

incur additional indebtedness or issue certain preferred shares;

 

   

pay dividends on, repurchase or make distributions in respect of our capital stock or make other restricted payments;

 

   

make certain investments;

 

   

sell certain assets;

 

   

create liens;

 

   

consolidate, merge, sell or otherwise dispose of all or substantially all of our assets; and

 

   

enter into certain transactions with our affiliates.

A breach of any of these covenants could result in an event of default. Upon the occurrence of an event of default, the lenders could elect to declare all amounts outstanding under the Credit Facility to be immediately due and payable and terminate all commitments to extend further credit. Such actions by those lenders could cause cross defaults under the Company’s other indebtedness. If the Company were unable to repay those amounts, the lenders under the Credit Facility could proceed against the collateral granted to them to secure that indebtedness.

Merger Notes

In connection with the Transactions, we also issued three series of notes.

Our Senior Notes were issued in two series: (1) $250.0 million of 9.25% senior notes due 2015 (the “Senior Fixed Rate Notes”); and (2) $350.0 million of 9.625%/10.375% senior toggle notes 2015 (the “Senior Toggle Rate Notes” and together with the Senior Fixed Rate Notes, the “Senior Notes”). The Senior Fixed Rate Notes are unsecured obligations, mature on June 1, 2015 and bear interest at a rate of 9.25% per annum. The Senior Toggle Rate Notes are senior obligations and will mature on June 1, 2015. For any interest period through June 1, 2011, we may, at our option, elect to pay interest on the Senior Toggle Rate Notes (i) entirely in cash, (ii) entirely by increasing the principal amount of the outstanding Senior Toggle Rate Notes or by issuing payment in kind (PIK) Notes, or (iii) 50% as cash interest and 50% as PIK interest. Cash interest on the Senior Toggle Rate Notes will accrue at the rate of 9.625% per annum and be payable in cash. PIK interest on the Senior Toggle Rate Notes will accrue at the cash interest rate per annum plus 0.75% and be payable by issuing PIK notes. When we made a PIK interest election, our debt increased by the amount of such interest and we issued PIK notes on the scheduled semi-annual payment dates. We elected to pay interest in kind on our 9.625%/10.375% Senior Toggle Rate Notes for the interest periods beginning June 2, 2008 through June 1, 2011. This election, net of reductions for note repurchases, increased the principal amount on the Senior Toggle Rate Notes by $109.5 million as of February 2, 2013 and January 28, 2012, respectively. The accrued payment in kind interest is included in “Long-term debt” in the Consolidated Balance Sheets. Effective June 2, 2011, the Company began accruing cash interest.

We also issued 10.50% senior subordinated notes due 2017 (the “Senior Subordinated Notes” and together with the Senior Notes, the “Merger Notes”) in an initial aggregate principal amount of $335.0 million. The Senior Subordinated Notes are senior subordinated obligations, will mature on June 1, 2017 and bear interest at a rate of 10.50% per annum.

 

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Interest on the Merger Notes is payable semi-annually to holders of record at the close of business on May 15 or November 15 immediately preceding the interest payment date on June 1 and December 1 of each year, commencing December 1, 2007. The Merger Notes are also subject to certain redemption and repurchase rights as described in Note 5 – Debt in the Notes to Consolidated Financial Statements.

Senior Secured Second Lien Notes

On March 4, 2011, we issued $450.0 million aggregate principal amount of 8.875% senior secured second lien notes that mature on March 15, 2019 (the “Senior Secured Second Lien Notes”). The Senior Secured Second Lien Notes are guaranteed on a second-priority senior secured basis by all of our existing and future direct or indirect wholly-owned domestic subsidiaries that guarantee the Credit Facility. The Senior Secured Second Lien Notes and related guarantees are secured by a second-priority lien on substantially all of the assets that secure our and our subsidiary’s guarantors’ obligations under the Credit Facility. We used the net proceeds of the offering of the Senior Secured Second Lien Notes to reduce the entire amount outstanding under our Former Revolver (without terminating the commitment) and indebtedness under the Former Term Loan.

Interest on the Senior Secured Second Lien Notes is payable semi-annually to holders of record at the close of business on March 1 or September 1 immediately preceding the interest payment date on March 15 and September 15 of each year, commencing on September 15, 2011. The notes are also subject to certain redemption and repurchase rights as discussed in Note 5 – Debt in the Notes to Consolidated Financial Statements.

9.0% Senior Secured First Lien Notes

On February 28, 2012, the Company issued $400.0 million aggregate principal amount of 9.00% senior secured first lien notes that mature on March 15, 2019 (the “9.0% Senior Secured First Lien Notes”). The notes were issued at a price equal to 100.00% of the principal amount. On March 12, 2012, the Company issued an additional $100.0 million aggregate principal amount of the same series of 9.0% Senior Secured First Lien Notes at a price equal to 101.50% of the principal amount. On September 20, 2012, the Company issued an additional $625.0 million aggregate principal amount of the same series of 9.0% Senior Secured First Lien Notes at a price equal to 102.5% of the principal amount. Interest on the 9.0% Senior Secured First Lien Notes is payable semi-annually to holders of record at the close of business on March 1 or September 1 immediately preceding the interest payment date on March 15 and September 15 of each year, commencing on September 15, 2012. The 9.0% Senior Secured First Lien Notes are guaranteed on a first-priority senior secured basis by all of the Company’s existing and future direct or indirect wholly-owned domestic subsidiaries that guarantee the Company’s Credit Facility. The 9.0% Senior Secured First Lien Notes and related guarantees are secured by a first-priority lien on substantially all of the assets that secure the Company’s and its subsidiary guarantors’ obligations under the Company’s Credit Facility. The Company used the net proceeds of the offerings of the 9.0% Senior Secured First Lien Notes, together with cash on hand, to repay $1,154.3 million of indebtedness under the Former Term Loan.

6.125% Senior Secured First Lien Notes

On March 15, 2013, after the end of our Fiscal 2012, we issued $210.0 million aggregate principal amount of 6.125% Senior Secured First Lien Notes due March 15, 2020. (The “6.125% Senior Secured First Lien Notes”). See Note 16 – Subsequent Events in the Notes to Consolidated Financial Statements for further description of the 6.125% Senior Secured First Lien Notes.

Covenants

Our 9.0% Senior Secured First Lien Notes, 6.125% Senior Secured First Lien Notes, Senior Secured Second Lien Notes, Senior Fixed Rate Notes, Senior Toggle Notes and Senior Subordinated Notes (collectively, the “Notes”) and Credit Facility contain certain covenants that, among other things, and subject to certain exceptions and other basket amounts, restrict our ability and the ability of our subsidiaries to:

 

   

incur additional indebtedness;

 

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pay dividends or distributions on our capital stock, repurchase or retire our capital stock and redeem, repurchase or defease any subordinated indebtedness;

 

   

make certain investments;

 

   

create or incur certain liens;

 

   

create restrictions on the payment of dividends or other distributions to us from our subsidiaries;

 

   

transfer or sell assets;

 

   

engage in certain transactions with our affiliates; and

 

   

merge or consolidate with other companies or transfer all or substantially all of our assets.

Certain of these covenants, such as limitations on the Company’s ability to make certain payments such as dividends, or incur debt, will no longer apply if the Notes have investment grade ratings from both of the rating agencies of Moody’s Investor Services, Inc. (“Moody’s”) and Standard & Poor’s Ratings Group (“S&P”) and no event of default has occurred. Since the date of issuance of the Notes, the Notes have not received investment grade ratings from Moody’s or S&P. Accordingly, all of the covenants under the Notes currently apply to the Company. None of these covenants, however, require the Company to maintain any particular financial ratio or other measure of financial performance except as previously disclosed herein for the Credit Facility. As of February 2, 2013, the Company is in compliance with the covenants.

Europe Credit Facilities

Our non-U.S. subsidiaries have bank credit facilities totaling $2.5 million. These facilities are used for working capital requirements, letters of credit and various guarantees. These credit facilities have been arranged in accordance with customary lending practices in their respective countries of operation. At February 2, 2013, the entire amount of $2.5 million was available for borrowing by us, subject to a reduction of $2.2 million for outstanding bank guarantees.

Analysis of Consolidated Financial Condition

A summary of cash flows provided by (used in) operating, investing and financing activities is outlined in the table below (in thousands):

 

     Fiscal 2012     Fiscal 2011     Fiscal 2010  

Operating activities

   $ 106,695      $ 102,560      $ 151,259   

Investing activities

     (68,494     (57,384     (56,952

Financing activities

     (40,179     (132,687     (38,139

Our working capital at the end of Fiscal 2012 was $122.1 million compared to $154.6 million at the end of Fiscal 2011, a decrease of $32.5 million. The decrease in working capital mainly reflects an increase in accrued liabilities of $31.4 million, an increase in trade accounts and income tax payables of $13.0 million, a decrease in cash and cash equivalents and restricted cash of $7.4 million, partially offset by an increase in inventories of $15.4 million and an increase in prepaid expense and other items of $3.9 million.

Cash flows from operating activities

In Fiscal 2012, cash provided by operations increased $4.1 million compared to Fiscal 2011. The primary reason for the increase was an increase in operating income before depreciation and amortization expense, stock compensation benefit and foreign exchange loss on the Euro Loan of $42.1 million; partially offset by an increase in interest payments of $29.0 million and, an increase in net change in working capital and other items, excluding cash and cash equivalents and restricted cash, of $9.0 million.

In Fiscal 2011, cash provided by operations activities decreased $48.7 million compared to Fiscal 2010. The primary reasons for the decrease were an increase in interest payments of $27.6 million; an increase in net change in working capital items, excluding cash and cash equivalents and restricted cash, of $25.6 million; an increase in income tax payments of $8.0 million; partially offset by an increase in operating income before impairment of assets, depreciation and amortization expense and stock compensation expense of $12.5 million.

 

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Cash flows from investing activities

In Fiscal 2012, cash used in investing was $68.5 million and primarily consisted of $72.8 million for net capital expenditures, partially offset by a $4.4 million decrease in restricted cash associated with the termination of the interest rate swap agreement.

In Fiscal 2011, cash used in investing activities was $57.4 million and primarily consisted of $76.6 million for capital expenditures, partially offset by a decrease in restricted cash primarily resulting from a return of our deposit securing a Euro denominated loan. Cash used in investing activities was $57.0 million in Fiscal 2010 and primarily consists of capital expenditures for new store openings, the remodeling of existing stores, improvements to technology systems, acquisitions of lease rights and an increase in restricted cash, partially offset by proceeds received from our sale-leaseback transaction.

In Fiscal 2013, we currently expect to incur approximately $85.0 million to $90.0 million of capital expenditures to open new stores, and remodel existing stores.

Cash flows from financing activities

In Fiscal 2012, cash used in investing activities was $40.2 million and primarily consisted of the issuance of $1,142.1 million of 9.0% Senior Secured First Lien Notes used, together with cash on hand, to repay $1,154.3 million of indebtedness under the Former Term Loan and to pay $28.0 million in financing costs.

In Fiscal 2011, cash used in financing activities was $132.7 million which consisted primarily of note repurchases of $78.3 million to retire $15.7 million of Senior Fixed Rate Notes and $69.6 million of Senior Toggle Notes, payment of $54.7 to retire a Euro denominated loan and net proceeds from the issuance of $450.0 million of Senior Secured Second Lien Notes used to reduce the entire $194.0 million outstanding under the Former Revolver and repay $244.9 million of indebtedness under the Former Term Loan.

We or our affiliates have purchased and may, from time to time, purchase portions of our indebtedness. All of our purchases have been privately-negotiated, open market transactions.

Cash position

As of February 2, 2013, we had cash and cash equivalents of $167.0 million and all cash equivalents were maintained in one money market fund invested exclusively in U.S. Treasury Securities.

As of February 2, 2013, our foreign subsidiaries held cash and cash equivalents of $106.3 million. In Fiscal 2012 and Fiscal 2011, we did not repatriate any cash held by foreign subsidiaries, but we expect a portion of our foreign subsidiaries’ future cash flow generation to be repatriated to the U.S. to meet certain liquidity needs. Based upon the amount of our remaining U.S. net operating loss carryforwards at February 2, 2013, we do not expect to pay U.S. income tax on Fiscal 2013 repatriations. When our U.S. net operating loss carryforwards are no longer available, we would be required to accrue and pay U.S. income taxes on any such repatriation.

Critical Accounting Policies and Estimates

Our Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America, which require us to make certain estimates and assumptions about future events. These estimates and the underlying assumptions affect the amounts of assets and liabilities reported, disclosures regarding contingent assets and liabilities and reported amounts of revenues and expenses. Such estimates include, but are not limited to, the value of inventories, goodwill, intangible assets and other long-lived assets, legal contingencies and assumptions used in the calculation of income taxes, stock-based compensation, derivative and hedging activities, residual values and other items. These estimates and assumptions are based on our best estimates and judgment. We evaluate our estimates and assumptions on an ongoing basis using historical experience and other factors, including the current economic environment, which we believe to be reasonable under the circumstances.

 

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We adjust such estimates and assumptions when facts and circumstances dictate. Illiquidity in credit markets, volatility in each of the equity, foreign currency, and energy markets and declines in consumer spending have combined to increase the uncertainty inherent in such estimates and assumptions. As future events and their effects cannot be determined with precision, actual results could differ significantly from these estimates. Changes in those estimates will be reflected in the financial statements in those future periods when the changes occur.

Inventory

Our inventories in North America and China are valued at the lower of cost or market, with cost determined using the retail method. Inherent in the retail inventory calculation are certain significant management judgments and estimates including, among others, merchandise markups, markdowns and shrinkage, which impact the ending inventory valuation at cost as well as resulting gross margins. The methodologies used to value merchandise inventories include the development of the cost-to-retail ratios, the groupings of homogeneous classes of merchandise, development of shrinkage reserves and the accounting for retail price changes. Our inventories in Europe are accounted for under the lower of cost or market method, with cost determined using the average cost method at an individual item level. Market is determined based on the estimated net realizable value, which is generally the merchandise selling price. Inventory valuation is impacted by the estimation of slow moving goods, shrinkage and markdowns. Management monitors merchandise inventory levels to identify slow-moving items and uses markdowns to clear such inventories. Changes in consumer demand of our products could affect our retail prices, and therefore impact the retail method and lower of cost or market valuations.

Long-Lived Assets

We evaluate the carrying value of long-lived assets whenever events or changes in circumstances indicate that a potential impairment has occurred. A potential impairment has occurred if the projected future undiscounted cash flows are less than the carrying value of the assets. The estimate of cash flows includes management’s assumptions of cash inflows and outflows directly resulting from the use of the asset in operations. When a potential impairment has occurred, an impairment charge is recorded if the carrying value of the long-lived asset exceeds its fair value. Fair value is measured based on a projected discounted cash flow model using a discount rate we feel is commensurate with the risk inherent in our business. A prolonged decrease in consumer spending would require us to modify our models and cash flow estimates, and could create a risk of an impairment triggering event in the future. Our impairment analyses contain estimates due to the inherently judgmental nature of forecasting long-term estimated cash flows and determining the ultimate useful lives of assets. Actual results may differ from those estimates, which could materially impact our impairment assessment.

During Fiscal 2010, we recorded a non-cash impairment charge of $6.0 million related to our former investment in our joint venture, Claire’s Nippon.

Goodwill

We continually evaluate whether events and changes in circumstances warrant recognition of an impairment of goodwill. The conditions that would trigger an impairment assessment of 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 conduct our annual impairment test to determine whether an impairment of the value of goodwill has occurred in accordance with the guidance set forth in Accounting Standards Codification (“ASC”) Topic 350, Intangibles - Goodwill and Other. ASC Topic 350 has a two-step process for determining goodwill impairment. In accordance with ASU 2011-08, Intangibles – Goodwill and Other (Topic 350), we have the option of performing a qualitative assessment before calculating the fair value of our reporting units or bypassing the qualitative assessment for any reporting unit for any period and proceeding directly to the first step of the two-step goodwill impairment test. If we determine, on the basis of qualitative factors, it is not more likely than not that the fair value of the reporting unit is less than the carrying amount, then performing the two-step impairment test would be unnecessary. We opted to bypass the qualitative assessment and proceeded directly to the first step of the two-step goodwill impairment test. The first step in this process compares the fair value of the reporting unit to its carrying value. If the carrying value of

 

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the reporting unit exceeds its fair value, the second step of the impairment test is performed to measure the impairment. In the second step, the fair value of the reporting unit is allocated to all of the assets and liabilities of the reporting unit to determine an implied goodwill value. This allocation is similar to a purchase price allocation performed in purchase accounting. If the carrying amount of the reporting unit’s goodwill exceeds the implied goodwill value, an impairment loss is recognized in an amount equal to that excess. We have two reporting units as defined under ASC Topic 350. These reporting units are our North America segment and our Europe segment.

Fair value is determined using appropriate valuation techniques. All valuation methodologies applied in a valuation of any form of property can be broadly classified into one of three approaches: the asset approach, the market approach and the income approach. We rely on the income approach using discounted cash flows and market approach using comparable public company entities in deriving the fair values of our reporting units. The asset approach is not used as our reporting units have significant intangible assets, the value of which is dependent on cash flow.

The fair value of each reporting unit determined under Step 1 of the goodwill impairment test was based on a three-fourths weighting of a discounted cash flow analysis under the income approach using forward-looking projections of estimated future operating results and a one-fourth weighting of a guideline company methodology under the market approach using earnings before interest, taxes, depreciation and amortization (“EBITDA”) multiples. Our determination of the fair value of each reporting unit incorporates multiple assumptions and contains inherent uncertainties, including significant estimates relating to future business growth, earnings projections, and the weighted average cost of capital used for purposes of discounting. Decreases in revenue growth, decreases in earnings projections and increases in the weighted average cost of capital will all cause the fair value of the reporting unit to decrease, which could require us to modify future models and cash flow estimates, and could result in an impairment triggering event in the future.

We have weighted the valuation of our reporting units at three-fourths using the income approach and one-fourth using the market based approach. We believe that this weighting is appropriate since it is difficult to find other comparable publicly traded companies that are similar to our reporting units’ heavy penetration of jewelry and accessories sales and margin structure. It is our view that the future discounted cash flows are more reflective of the value of the reporting units.

The projected cash flows used in the income approach cover the periods consisting of the fourth quarter Fiscal 2012 and the fiscal years 2013 through 2017. Beyond fiscal year 2017, a terminal value was calculated using the Gordon Growth Model. We developed the projected cash flows based on estimates of forecasted same store sales, new store openings, operating margins and capital expenditures. Due to the inherent judgment involved in making these estimates and assumptions, actual results could differ from those estimates. The projected cash flows reflect projected same store sales increases representative of our past performance post-recession.

A weighted average cost of capital reflecting the risk associated with the projected cash flows was calculated for each reporting unit and used to discount each reporting unit’s projected cash flows and terminal value. Key assumptions made in calculating a weighted average cost of capital include the risk-free rate, market risk premium, volatility relative to the market, cost of debt, specific company premium, small company premium, tax rate and debt-to-equity ratio.

The calculation of fair value is significantly impacted by each reporting unit’s projected cash flows and the discount interest rates used. Accordingly, any sustained volatility in the economic environment could impact these assumptions and make it reasonably possible that another impairment charge could be recorded some time in the future. However, since the terminal value is a significant portion of each reporting unit’s fair value, the impact of any such near-term volatility on our fair value would be lessened.

Our annual impairment analysis did not result in any impairment of goodwill during Fiscal 2012, Fiscal 2011 and Fiscal 2010. The excess of fair value over carrying value for each of our reporting units as of October 27, 2012, the annual testing date for Fiscal 2012, ranged from approximately $282.0 million to approximately $436.0 million. In order to evaluate the sensitivity of the fair value calculations on the goodwill impairment test, we applied a hypothetical 10% decrease to the fair values of each reporting unit. This hypothetical 10% decrease would result in excess fair value over carrying value ranging from approximately $182.0 million to approximately $231.0 million for each of our reporting units.

 

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Intangible Assets

Intangible assets include tradenames, franchise agreements, lease rights, territory rights and leases that existed at the date of acquisition with terms that were favorable to market at that date. We continually evaluate whether events and changes in circumstances warrant revised estimates of the useful lives, residual values 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.

We evaluate the market value of the intangible assets periodically and record an impairment charge when we believe the carrying amount of the asset is not recoverable. Indefinite-lived intangible assets are tested for impairment annually or more frequently when events or circumstances indicate that impairment may have occurred. Definite-lived intangible assets are tested for impairment when events or circumstances indicate that the carrying amount may not be recoverable. We estimate the fair value of these intangible assets primarily utilizing a discounted cash flow model. The forecasted cash flows used in the model contain inherent uncertainties, including significant estimates and assumptions related to growth rates, margins and cost of capital. Changes in any of the assumptions utilized could affect the fair value of the intangible assets and result in an impairment triggering event. A prolonged decrease in consumer spending would require us to modify our models and cash flow estimates, with the risk of an impairment triggering event in the future. We did not recognize any impairment charges during Fiscal 2012 and Fiscal 2011. During Fiscal 2010, we recorded a non-cash impairment charge of $12.3 million related to certain franchise agreements which are definite-lived intangible assets.

Income Taxes

We are subject to income taxes in many jurisdictions, including the United States, individual states and localities and internationally. Our annual consolidated provision for income taxes is determined based on our income, statutory tax rates and the tax implications of items treated differently for tax purposes than for financial reporting purposes. Tax law requires certain items to be included in the tax return at different times than the items are reflected on the financial statements. Some of these differences are permanent, such as expenses that are not deductible in our tax return, and some differences are temporary, reversing over time, such as depreciation expense. We establish deferred tax assets and liabilities as a result of these temporary differences.

Our judgment is required in determining any valuation allowance recorded against deferred tax assets, specifically net operating loss carryforwards, tax credit carryforwards and deductible temporary differences that may reduce taxable income in future periods. In assessing the need for a valuation allowance, we consider all available evidence including past operating results, estimates of future taxable income and tax planning opportunities. In the event we change our determination as to the amount of deferred tax assets that can be realized, we will adjust our valuation allowance with a corresponding impact to income tax expense in the period in which such determination is made.

During Fiscal 2012, we reported an increase of $9.4 million in valuation allowance against our U.S. deferred tax assets and an increase of $4.3 million in valuation allowance against our foreign deferred tax assets. Our conclusion regarding the need for a valuation allowance against U.S. and foreign deferred tax assets could change in the future based on improvements in operating performance, which may result in the full or partial reversal of the valuation allowance.

During Fiscal 2011, we reported an increase of $4.0 million in valuation allowance against our U.S. deferred tax assets and no change in valuation allowance against our foreign deferred tax assets.

During Fiscal 2010, we reported a decrease of $11.8 million in valuation allowance against our U.S. deferred tax assets and an increase of $1.5 million in valuation allowance against our foreign deferred tax assets. The foreign increase primarily relates to foreign jurisdictions that have a history of losses.

 

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In Fiscal 2008, we recorded a charge of $95.8 million to establish a valuation allowance against our deferred tax assets in the U.S. We concluded that such a valuation allowance was appropriate in light of the significant negative evidence, which was objective and verifiable, such as the cumulative losses in recent fiscal years in our U.S. operations. While our long-term financial outlook in the U.S. remains positive, we concluded that our ability to rely on our long-term outlook as to future taxable income was limited due to the relative weight of the negative evidence from our recent U.S. cumulative losses.

We establish accruals for uncertain tax positions in our Consolidated Financial Statements based on tax positions that we believe are supportable, but are potentially subject to successful challenge by the taxing authorities. We believe these accruals are adequate for all open audit years based on our assessment of many factors including past experience, progress of ongoing tax audits and interpretations of tax law. If changing facts and circumstances cause us to adjust our accruals, or if we prevail in tax matters for which accruals have been established, or we are required to settle matters in excess of established accruals, our income tax expense for a particular period will be affected.

Income tax expense also reflects our best estimates and assumptions regarding, among other things, the geographic mix of income and losses from our foreign and domestic operations, interpretation of tax laws and regulations of multiple jurisdictions, plans for repatriation of foreign earnings, and resolution of tax audits. Our effective income tax rates in future periods could be impacted by changes in the geographic mix of income and losses from our foreign and domestic operations that may be taxed at different rates, changes in tax laws, repatriation of foreign earnings, and the resolution of unrecognized tax benefits for amounts different from our current estimates. Given our capital structure, we will continue to experience volatility in our effective tax rate over the near term.

Stock-Based Compensation

We issue stock options and other stock-based awards to executive management, key employees and directors under our stock-based compensation plans.

On January 29, 2006, we adopted ASC Topic 718, Compensation—Stock Compensation (“ASC Topic 718”), using the modified prospective method. The calculation of stock-based compensation expense requires the input of highly subjective assumptions, including the expected term of the stock-based awards, stock price volatility and pre-vesting forfeitures. The assumptions used in calculating the fair value of stock-based awards represent our best estimates, but these estimates involve inherent uncertainties and the application of management’s judgment. As a result, if factors change and we were to use different assumptions, our stock-based compensation expense could be materially different in the future. In addition, we are required to estimate the expected forfeiture rate and only recognize expense for those shares expected to vest. We estimate forfeitures based on our historical experience of stock-based awards granted, exercised and cancelled, as well as considering future expected behavior. If the actual forfeiture rate is materially different from our estimate, stock-based compensation expense could be different from what we have recorded in the current period.

Under ASC Topic 718, time-vested stock awards are accounted for at fair value at date of grant. The compensation expense is recorded over the requisite service period. Stock-based compensation expense for time-vested stock awards granted in Fiscal 2012, Fiscal 2011 and Fiscal 2010 was recorded over the requisite service period using the graded-vesting method for the entire award.

Performance-vested awards, which qualified as equity plans under ASC Topic 718, were accounted for based on fair value at date of grant. The stock-based compensation expense was based on the number of shares expected to be issued when it became probable that performance targets required to receive the award would be achieved. The expense was recorded over the requisite service period.

Buy one, get one (“BOGO”) options issued prior to May 2011 were immediately vested, exercisable upon issuance, and accounted for at fair value at date of grant. The compensation expense for these BOGOs was recognized over a four year period due to the terms of the option requiring forfeiture in certain cases including the grantee’s voluntary resignation from the Company’s employ prior to May 2011. BOGOs issued subsequent to May 2011 are accounted for at the fair value at date of grant and the compensation expense is recognized over the requisite service period.

 

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The fair values of time-vested stock options and BOGO options granted during Fiscal 2012, Fiscal 2011 and Fiscal 2010 were determined using the Black-Scholes option-pricing model. The fair values of performance based stock options issued during Fiscal 2012, Fiscal 2011 and Fiscal 2010 were based on the Monte Carlo model. Both models incorporate various assumptions such as expected dividend yield, risk-free interest rate, expected life of the options and expected stock price volatility.

Performance Based Stock Option Exchange Offer

On June 15, 2012, Claire’s Inc., the parent corporation (“Parent”), of the Company 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 conditions:

 

   

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 a performance condition 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:

 

   

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

 

   

Changed the definition of “Qualified IPO”;

 

   

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

 

   

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

 

   

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, we determined that the achievement of vesting events for the Performance Stock Options was not probable and therefore, reversed the stock compensation expense that

 

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was previously recognized for these options. Additionally, we 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.

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 of the Company. 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.

Our estimates of stock price volatility, interest rate, grant date fair value and expected term of options and restricted stock are affected by illiquidity in credit markets, consumer spending and current and future economic conditions. As future events and their effects can not be determined with precision, actual results could differ significantly from our estimates. See Note 9 – Stock Options and Stock-Based Compensation in the Notes to Consolidated Financial Statements.

Derivatives and Hedging

We account for derivative instruments in accordance with ASC Topic 815, Derivatives and Hedging (“ASC Topic 815”). In accordance with ASC Topic 815, we report all derivative financial instruments on our Consolidated Balance Sheet at fair value. We formally designate and document the financial instrument as a hedge of a specific underlying exposure, as well as the risk management objectives and strategies for undertaking the hedge transaction. We formally assess both at inception and at least quarterly thereafter, whether the financial instruments that are used in hedging transactions are effective at offsetting changes in either the fair value or cash flows of the related underlying exposure. We measure the effectiveness of our cash flow hedges by evaluating the following criteria: (i) the re-pricing dates of the derivative instrument match those of the debt obligation; (ii) the interest rates of the derivative instrument and the debt obligation are based on the same interest rate index and tenor; (iii) the variable interest rate of the derivative instrument does not contain a floor or cap, or other provisions that cause a basis difference with the debt obligation; and (iv) the likelihood of the counterparty not defaulting is assessed as being probable.

We primarily employ derivative financial instruments to manage our exposure to market risk from interest rate changes and to limit the volatility and impact of interest rate changes on earnings and cash flows. We do not enter into derivative financial instruments for trading or speculative purposes. We face credit risk if the counterparties to the financial instruments are unable to perform their obligations. However, we seek to mitigate derivative credit risk by entering into transactions with counterparties that are significant and creditworthy financial institutions. We monitor the credit ratings of the counterparties.

For derivatives that qualify as cash flow hedges, we report the effective portion of the change in fair value as a component of “Accumulated other comprehensive income (loss), net of tax” in the Consolidated Balance Sheets and reclassify it into earnings in the same periods in which the hedged item affects earnings, and within the same income statement line item as the impact of the hedged item. The ineffective portion of the change in fair value of a cash flow hedge is recognized into income immediately. No ineffective portion was recorded into earnings during Fiscal 2012, Fiscal 2011, and Fiscal 2010, respectively, and all components of the derivative gain or loss were included in the assessment of hedge effectiveness. For derivative financial instruments which do not qualify as cash flow hedges, any changes in fair value would be recorded in the Consolidated Statements of Operations and Comprehensive Income. We adopted ASC Topic 820, Fair Value Measurements and Disclosures, on February 3, 2008, which required the Company to include credit valuation adjustment risk in the calculation of fair value.

We may at our discretion terminate or change the designation of any such hedging instrument agreements prior to maturity. At that time, any gains or losses previously reported in accumulated other comprehensive income (loss) on termination would amortize into interest expense or interest income to

 

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correspond to the recognition of interest expense or interest income on the hedged debt. If such debt instrument was also terminated, the gain or loss associated with the terminated derivative included in accumulated other comprehensive income (loss) at the time of termination of the debt would be recognized in the Consolidated Statements of Operations and Comprehensive Income at that time.

On September 20, 2012, we terminated the interest rate swap agreement entered into on July 28, 2010 (the “Swap”), settled the contract at fair value of the liability and also extinguished the associated hedged debt instrument. Accordingly, we reclassified $1.8 million of unrealized loss associated with the Swap from “Accumulated other comprehensive income (loss), net of tax” in the Consolidated Balance Sheets into “Interest expense, net” in the Consolidated Statements of Operations and Comprehensive Income.

Contractual Obligations and Off Balance Sheet Arrangements

We finance certain equipment through transactions accounted for as non-cancelable operating leases. As a result, the rental expense for this 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 we, or our landlord, terminate a real property lease prior to its scheduled expiration, we will be required to accrue all future rent payments under any non-cancelable operating lease with respect to leasehold improvements or equipment located thereon. The following table sets forth our contractual obligations requiring the use of cash as of February 2, 2013:

 

     Payments Due by Period  

Contractual Obligations (in millions)

   Total      1 year      2-3
years
    4-5
years
     More
than 5
years
 

Recorded Contractual Obligations:

             

Debt (1)  

   $ 2,357.1       $ —         $ 522.5 (2)    $ 259.6       $ 1,575.0 (3) 

Capital lease obligation

     44.6         2.3         4.7        4.9         32.7   

Unrecorded Contractual Obligations:

             

Operating lease obligations (4)

     1,078.7         214.6         354.1        235.2         274.8   

Interest (5)

     1,180.7         218.1         412.7        324.5         225.4   

Letters of credit

     4.5         4.5         —          —           —     
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 4,665.6       $ 439.5       $ 1,294.0      $ 824.2       $ 2,107.9   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) Represents debt expected to be paid and does not assume any note repurchases or prepayments.
(2) Includes $302.2 million under our Senior Toggle Rate Notes and $220.3 million under our Senior Fixed Rate Notes.
(3) Includes $1,125.0 million (excluding unamortized premium of $16.3 million) under our 9.0% Senior Secured First Lien Notes and $450.0 million under our Senior Secured Second Lien Notes.
(4) Operating lease obligations consists of future minimum lease commitments related to store operating leases, distribution center leases, office leases and equipment leases. Operating lease obligations do not include common area maintenance (“CAM”), contingent rent, insurance, marketing or tax payments for which the Company is also obligated.
(5) Represents interest expected to be paid on our debt and does not assume any note repurchases or prepayments.

We have no material off-balance sheet arrangements (as such term is defined in Item 303(a) (4) (ii) under Regulation S-K of the Securities Exchange Act) other than disclosed herein.

 

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Seasonality and Quarterly Results

Sales of each category of merchandise vary from period to period depending on current 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 Fiscal 2012 were 22%, 23%, 23% and 32%, respectively. See Note 13 – Selected Quarterly Financial Data in the Notes to Consolidated Financial Statements for our quarterly results of operations.

Impact of Inflation

Inflation impacts 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 of our products where competitively practical or by increasing sales volumes.

Recent Accounting Pronouncements

See Note 2 – Summary of Significant Accounting Policies in the Notes to the Consolidated Financial Statements.

There are no recently issued accounting standards that are expected to have a material effect on our financial condition, results of operations or cash flows.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Cash and Cash Equivalents

We have significant amounts of cash and cash equivalents, at financial institutions that are in excess of federally insured limits. With the current financial environment and the instability of financial institutions, we cannot be assured that we will not experience losses on our deposits. We mitigate this risk by investing in money market funds that are invested exclusively in U.S. Treasury securities and maintaining bank accounts with a group of credit worthy financial institutions. As of February 2, 2013, all cash equivalents were maintained in one money market fund that was invested exclusively in U.S. Treasury securities.

Interest Rates

We no longer have exposure to interest rate risk associated with derivative instruments. On September 20, 2012, we terminated the interest rate swap agreement entered into on July 28, 2010 (the “Swap”), settled the contract at fair value of the liability and also extinguished the associated hedged debt instrument. We previously entered into the Swap to manage exposure to fluctuations in interest rates. The Swap had an expiration date of July 30, 2013. The Swap represented a contract to exchange floating rate for fixed interest rates periodically over the life of the Swap without exchange of the underlying notional amount. The Swap covered an aggregate notional amount of $200.0 million of the outstanding principal balance of the Former Term Loan. The fixed rate of the Swap was 1.2235% and was designated and accounted for as a cash flow hedge.

Foreign Currency

We are exposed to market risk from foreign currency exchange rate fluctuations on the United States dollar (“USD” or “dollar”) value of foreign currency denominated transactions and our investments in foreign subsidiaries. We manage this exposure to market risk through our regular operating and financing activities, and may from time to time, use foreign currency options. Exposure to market risk for changes in foreign currency exchange rates relates primarily to our foreign operations’ buying, selling, and financing in currencies other than local currencies and to the carrying value of net investments in foreign subsidiaries. At February 2, 2013, we maintained no foreign currency options. We generally do not hedge the translation exposure related to our net investment in foreign subsidiaries. Included in “Comprehensive income” are $5.5 million, $(4.8) million and $0.8 million, net of tax, reflecting the unrealized (loss) gain on foreign currency translations and intra-entity foreign currency transactions during Fiscal 2012, Fiscal 2011 and Fiscal 2010, respectively.

 

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Certain of our subsidiaries make significant USD purchases from Asian suppliers, particularly in China. Until July 2005, the Chinese government pegged its currency, the yuan renminbi (“RMB”), to the USD, adjusting the relative value only slightly and on infrequent occasion. Many people viewed this practice as leading to a substantial undervaluation of the RMB relative to the USD and other major currencies, providing China with a competitive advantage in international trade. China now allows the RMB to float to a limited degree against a basket of major international currencies, including the USD, the euro and the Japanese yen. The official exchange rate has historically remained stable; however, there are no assurances that this currency exchange rate will continue to be as stable in the future due to the Chinese government’s adoption of a floating rate with respect to the value of the RMB against foreign currencies. While the international reaction to the RMB revaluation has generally been positive, there remains significant international pressure on China to adopt an even more flexible and more market-oriented currency policy that allows a greater fluctuation in the exchange rate between the RMB and the USD. This floating exchange rate, and any appreciation of the RMB that may result from such rate, could have various effects on our business, which include making our purchases of Chinese products more expensive. If we are unable to negotiate commensurate price decreases from our Chinese suppliers, these higher prices would eventually translate into higher costs of sales, which could have a material adverse effect on our results of operations.

The results of operations of foreign subsidiaries, when translated into U.S. dollars, reflect the average foreign currency exchange rates for the months that comprise the periods presented. As a result, if exchange rates fluctuate significantly from one period to the next, results in local currency can vary significantly upon translation into U.S. dollars. Accordingly, fluctuations in foreign currency exchange rates, most notably the strengthening of the dollar against the euro, could have a material impact on our revenue growth in future periods.

General Market Risk

Our competitors include department stores, specialty stores, mass merchandisers, discount stores and other retail and internet channels. Our operations are impacted by consumer spending levels, which are affected by general economic conditions, consumer confidence, employment levels, availability of consumer credit and interest rates on credit, consumer debt levels, consumption of consumer staples including food and energy, consumption of other goods, adverse weather conditions and other factors over which we have little or no control. The increase in costs of such staple items has reduced the amount of discretionary funds that consumers are willing and able to spend for other goods, including our merchandise. Should there be continued volatility in food and energy costs, sustained recession in the United States and Europe, rising unemployment and continued declines in discretionary income, our revenue and margins could be significantly affected in the future. We can not predict whether, when or the manner in which the economic conditions described above will change.

 

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Item 8. Financial Statements and Supplementary Data      Page No.   

Report of Independent Registered Public Accounting Firm

     49   

Consolidated Balance Sheets as of February 2, 2013 and January 28, 2012

     50   

Consolidated Statements of Operations and Comprehensive Income for the fiscal years ended February  2, 2013, January 28, 2012 and January 29, 2011

     51   

Consolidated Statements of Changes in Stockholder’s Deficit for the fiscal years ended February  2, 2013, January 28, 2012 and January 29, 2011

     52   

Consolidated Statements of Cash Flows for the fiscal years ended February 2, 2013, January  28, 2012 and January 29, 2011

     53   

Notes to Consolidated Financial Statements

     54   

 

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Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholder

Claire’s Stores, Inc.:

We have audited the accompanying consolidated balance sheets of Claire’s Stores, Inc. and subsidiaries (the Company) as of February 2, 2013 and January 28, 2012, and the related consolidated statements of operations and comprehensive income, changes in stockholder’s deficit, and cash flows for each of the fiscal years in the three-year period ended February 2, 2013. 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 the standards of the Public Company Accounting Oversight Board (United States). 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 2, 2013 and January 28, 2012, and the results of their operations and their cash flows for each of the fiscal years in the three-year period ended February 2, 2013 in conformity with U.S. generally accepted accounting principles.

/s/ KPMG LLP

April 3, 2013

Miami, Florida

Certified Public Accountants

 

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CLAIRE’S STORES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

 

     February 2, 2013     January 28, 2012  
     (In thousands, except share and per
share amounts)
 

ASSETS

    

Current assets:

    

Cash and cash equivalents and restricted cash of $0 and $4,350, respectively

   $ 166,956      $ 174,374   

Inventories

     157,549        142,104   

Prepaid expenses

     19,701        20,010   

Other current assets

     29,621        25,423   
  

 

 

   

 

 

 

Total current assets

     373,827        361,911   
  

 

 

   

 

 

 

Property and equipment:

    

Furniture, fixtures and equipment

     234,209        207,620   

Leasehold improvements

     312,789        281,774   
  

 

 

   

 

 

 
     546,998        489,394   

Less accumulated depreciation and amortization

     (325,618     (281,874
  

 

 

   

 

 

 
     221,380        207,520   
  

 

 

   

 

 

 

Leased property under capital lease:

    

Land and building

     18,055        18,055   

Less accumulated depreciation and amortization

     (2,708     (1,805
  

 

 

   

 

 

 
     15,347        16,250   
  

 

 

   

 

 

 

Goodwill

     1,550,056        1,550,056   

Intangible assets, net of accumulated amortization of $57,672 and $49,270, respectively

     547,433        549,768   

Deferred financing costs, net of accumulated amortization of $27,156 and $55,818, respectively

     41,381        33,025   

Other assets

     49,848        44,495   
  

 

 

   

 

 

 
     2,188,718        2,177,344   
  

 

 

   

 

 

 

Total assets

   $ 2,799,272      $ 2,763,025   
  

 

 

   

 

 

 

LIABILITIES AND STOCKHOLDER’S DEFICIT

    

Current liabilities:

    

Trade accounts payable

     73,445        60,704   

Income taxes payable

     10,508        10,228   

Accrued interest payable

     68,254        31,859   

Accrued expenses and other current liabilities

     99,529        104,525   
  

 

 

   

 

 

 

Total current liabilities

     251,736        207,316   
  

 

 

   

 

 

 

Long-term debt

     2,373,366        2,386,382   

Obligation under capital lease

     17,232        17,290   

Deferred tax liability

     120,968        120,452   

Deferred rent expense

     29,859        28,861   

Unfavorable lease obligations and other long-term liabilities

     20,551        25,020   
  

 

 

   

 

 

 
     2,561,976        2,578,005   
  

 

 

   

 

 

 

Commitments and contingencies

    

Stockholder’s deficit:

    

Common stock par value $0.001 per share; authorized 1,000 shares; issued and outstanding 100 shares

     —          —     

Additional paid-in capital

     618,403        619,453   

Accumulated other comprehensive income (loss), net of tax

     3,273        (4,351

Accumulated deficit

     (636,116     (637,398
  

 

 

   

 

 

 
     (14,440     (22,296
  

 

 

   

 

 

 

Total liabilities and stockholder’s deficit

   $ 2,799,272      $ 2,763,025   
  

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

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CLAIRE’S STORES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

(in thousands)

 

     Fiscal Year     Fiscal Year     Fiscal Year  
     Ended     Ended     Ended  
     February 2,     January 28,     January 29,  
     2013     2012     2011  

Net sales

   $ 1,557,020      $ 1,495,900      $ 1,426,397   

Cost of sales, occupancy and buying expenses (exclusive of depreciation and amortization shown separately below)

     755,996        724,775        685,111   
  

 

 

   

 

 

   

 

 

 

Gross profit

     801,024        771,125        741,286   
  

 

 

   

 

 

   

 

 

 

Other expenses:

      

Selling, general and administrative

     503,254        504,360        493,081   

Depreciation and amortization

     64,879        68,753        65,198   

Impairment of assets

     —          —          12,262   

Severance and transaction-related costs

     2,828        6,928        741   

Other (income) expense, net

     (6,105     (1,254     5,542   
  

 

 

   

 

 

   

 

 

 
     564,856        578,787        576,824   
  

 

 

   

 

 

   

 

 

 

Operating income

     236,168        192,338        164,462   

Gain (loss) on early debt extinguishment

     (9,707     6,405        13,388   

Impairment of equity investment

     —          —          6,030   

Interest expense, net

     210,797        176,475        157,706   
  

 

 

   

 

 

   

 

 

 

Income before income tax expense

     15,664        22,268        14,114   

Income tax expense

     14,382        10,636        9,791   
  

 

 

   

 

 

   

 

 

 

Net income

   $ 1,282      $ 11,632      $ 4,323   
  

 

 

   

 

 

   

 

 

 

Net income

   $ 1,282      $ 11,632      $ 4,323   

Other comprehensive income (loss), net of tax:

      

Foreign currency translation adjustments

     1,182        (663     10,416   

Net gain (loss) on intra-entity foreign currency transactions, net of tax (benefit) of $142, $(171) and $(149)

     4,283        (4,111     (9,640

Unrealized gain (loss) on interest rate swap, net of tax of $0, $0 and $0

     375        (993     7,587   

Reclassification adjustment of unrealized loss on termination of interest rate swap into net income

     1,784        —          —     

Reclassification of foreign currency translation adjustments into net income

     —          —          (9,572
  

 

 

   

 

 

   

 

 

 

Other comprehensive income (loss)

     7,624        (5,767     (1,209
  

 

 

   

 

 

   

 

 

 

Comprehensive income

   $ 8,906      $ 5,865      $ 3,114   
  

 

 

   

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

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CLAIRE’S STORES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN

STOCKHOLDER’S DEFICIT

(In thousands, except share amounts)

 

     Number of
shares of
common
stock
     Common
stock
     Additional
paid-in
capital
    Accumulated
other
comprehensive
income (loss), net
    Accumulated
deficit
    Total  

Balance: January 30, 2010

     100       $ —         $ 616,086      $ 2,625      $ (653,353   $ (34,642

Net income

     —           —           —          —          4,323        4,323   

Stock option expense

     —           —           4,946        —          —          4,946   

Restricted stock expense, net of unearned compensation

     —           —           67        —          —          67   

Foreign currency translations adjustments

     —           —           —          10,416        —          10,416   

Net gain (loss) on intra-entity foreign currency transactions, net of tax (benefit)

     —           —           —          (9,640     —          (9,640

Unrealized (loss) gain on interest rate swap, net of tax

     —           —           —          7,587        —          7,587   

Reclassification of foreign currency translation adjustments into net income

     —           —           —          (9,572     —          (9,572
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Balance: January 29, 2011

     100         —           621,099        1,416        (649,030     (26,515

Net income

     —           —           —          —          11,632        11,632   

Stock option benefit

     —           —           (1,661     —          —          (1,661

Restricted stock expense, net of unearned compensation

     —           —           15        —          —          15   

Foreign currency translations adjustments

     —           —           —          (663     —          (663

Net gain (loss) on intra-entity foreign currency transactions, net of tax (benefit)

     —           —           —          (4,111     —          (4,111

Unrealized (loss) gain on interest rate swap, net of tax

     —           —           —          (993     —          (993
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Balance: January 28, 2012

     100         —           619,453        (4,351     (637,398     (22,296

Net income

     —           —           —          —          1,282        1,282   

Stock option benefit

     —           —           (1,050     —          —          (1,050

Foreign currency translations adjustments

     —           —           —          1,182        —          1,182   

Net gain (loss) on intra-entity foreign currency transactions, net of tax (benefit)

     —           —           —          4,283        —          4,283   

Unrealized (loss) gain on interest rate swap, net of tax

     —           —           —          375        —          375   

Reclassification adjustment of unrealized loss on termination of interest rate swap into net income

     —           —           —          1,784        —          1,784   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Balance: February 2, 2013

     100       $ —         $ 618,403      $ 3,273      $ (636,116   $ (14,440
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

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CLAIRE’S STORES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

     Fiscal Year     Fiscal Year     Fiscal Year  
     Ended     Ended     Ended  
     February 2,     January 28,     January 29,  
     2013     2012     2011  

Cash flows from operating activities:

      

Net income

   $ 1,282      $ 11,632      $ 4,323   

Adjustments to reconcile net income to net cash provided by operating activities:

      

Depreciation and amortization

     64,879        68,753        65,198   

Impairment

     —          —          18,292   

Amortization of lease rights and other assets

     3,279        3,189        3,204   

Amortization of debt issuance costs

     9,927        13,106        10,005   

Accretion of debt premium

     (831     —          —     

Payment of in kind interest expense

     —          11,831        36,872   

Foreign currency exchange net gain on Euro Loan

     —          (1,953     —     

Net unfavorable accretion of lease obligations

     (826     (657     (1,490

Loss (gain) on sale/retirement of property and equipment, net

     96        42        672   

Loss (gain) on early debt extinguishment

     9,707        (6,405     (13,388

Gain on sale of intangible assets/lease rights

     (493     (90     —     

Stock compensation (benefit) expense

     (1,050     (1,646     5,013   

(Increase) decrease in:

      

Inventories

     (13,418     (8,394     (25,374

Prepaid expenses

     578        1,376        12,658   

Other assets

     (9,833     (5,852     751   

Increase (decrease) in:

      

Trade accounts payable

     10,517        7,311        10,314   

Income taxes payable

     629        (1,991     3,667   

Accrued interest payable

     36,395        15,081        2,139   

Accrued expenses and other liabilities

     (3,750     (3,071     14,575   

Deferred income taxes

     (1,250     (2,022     (595

Deferred rent expense

     857        2,320        4,423   
  

 

 

   

 

 

   

 

 

 

Net cash provided by operating activities

     106,695        102,560        151,259   
  

 

 

   

 

 

   

 

 

 

Cash flows from investing activities:

      

Acquisition of property and equipment

     (68,804     (70,908     (48,711

Proceeds from sale of property and equipment

     —          —          16,765   

Acquisition of intangible assets/lease rights

     (5,049     (5,709     (1,104

Proceeds from sale of intangible assets/lease rights

     1,009        816        —     

Changes in restricted cash

     4,350        18,417        (23,902
  

 

 

   

 

 

   

 

 

 

Net cash used in investing activities

     (68,494     (57,384     (56,952
  

 

 

   

 

 

   

 

 

 

Cash flows from financing activities:

      

Payments of credit facility

     (1,154,310     (438,940     (14,500

Proceeds from notes

     1,142,125        450,000        —     

Proceeds from short-term debt

     —          —          57,494   

Payment of short-term debt

     —          (54,653     —     

Repurchases of notes

     —          (78,343     (79,865

Payment of debt issuance costs

     (27,990     (10,751     (503

Principal payments of capital lease

     (4     —          (765
  

 

 

   

 

 

   

 

 

 

Net cash used in financing activities:

     (40,179     (132,687     (38,139
  

 

 

   

 

 

   

 

 

 

Effect of foreign currency exchange rate changes on cash and cash equivalents

     (1,090     1,633        1,026   
  

 

 

   

 

 

   

 

 

 

Net (decrease) increase in cash and cash equivalents

     (3,068     (85,878     57,194   

Cash and cash equivalents, at beginning of period

     170,024        255,902        198,708   
  

 

 

   

 

 

   

 

 

 

Cash and cash equivalents, at end of period

     166,956        170,024        255,902   

Restricted cash, at end of period

     —          4,350        23,864   
  

 

 

   

 

 

   

 

 

 

Cash and cash equivalents and restricted cash, at end of period

   $ 166,956      $ 174,374      $ 279,766   
  

 

 

   

 

 

   

 

 

 

Supplemental disclosure of cash flow information:

      

Interest paid

   $ 165,495      $ 136,533      $ 108,923   

Income taxes paid

     14,830        14,283        6,332   

Non-cash investing and financing activities:

      

Property acquired under capital lease

     —          —          18,055   

See accompanying notes to consolidated financial statements.

 

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CLAIRE’S STORES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

1. NATURE OF OPERATIONS AND ACQUISITION OF CLAIRE’S STORES, INC.

Nature of Operations - Claire’s Stores, Inc., a Florida corporation, and subsidiaries (collectively the “Company”), is a leading retailer of value-priced fashion accessories targeted towards young women, teens, tweens and kids. The Company is organized into two segments: North America and Europe. The Company operates owned stores throughout the United States, Puerto Rico, Canada, the U.S. Virgin Islands and China (North America segment) and the United Kingdom, Switzerland, Austria, Germany, France, Ireland, Spain, Portugal, Netherlands, Belgium, Poland, Czech Republic, Hungary, Italy and Luxembourg (Europe segment). Until September 2, 2010, the Company operated stores in Japan through a former 50:50 joint venture. Beginning September 2, 2010, these stores began to operate as licensed stores.

Acquisition of Claire’s Stores, Inc. - In May 2007, the Company was acquired by Apollo Management VI, L.P. (“Apollo Management”), together with certain affiliated co-investment partnerships (collectively the “Sponsors”), through a merger (the “Merger”) and Claire’s Stores, Inc. became a wholly-owned subsidiary of Claire’s Inc.

The purchase of the Company and the related fees and expenses were financed through the issuance of the Merger Notes, borrowings under the Former Credit Facility, an equity investment by the Sponsors, and cash on hand at the Company.

The closing of the Merger occurred simultaneously with:

 

   

the closing of the Company’s former senior secured term loan facility (the “Former Term Loan”) and revolving credit facility (the “Former Revolver” and, collectively with the Former Term Loan, the “Former Credit Facility”) of $1.65 billion;

 

   

the closing of the Company’s senior notes offering (the “Merger Notes”) in the aggregate principal amount of $935.0 million; and

 

   

the equity investment by the Sponsors, collectively, of approximately $595.7 million.

The aforementioned transactions, including the Merger and payment of costs related to these transactions, are collectively referred to as the “Transactions.”

Claire’s Inc. is an entity that was formed in connection with the Transactions and prior to the Merger had no assets or liabilities other than the shares of Bauble Acquisition Sub, Inc. and its rights and obligations under and in connection with the merger agreement. As a result of the Merger, all of the Company’s issued and outstanding capital stock is owned by Claire’s Inc.

The acquisition of Claire’s Stores, Inc. was accounted for as a business combination using the purchase method of accounting, whereby the purchase price was allocated to the assets and liabilities based on the estimated fair market values at the date of acquisition.

See Note 5 – Debt for a summary of the terms of the Merger Notes and the Former Credit Facility.

 

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation - The Consolidated Financial Statements include the accounts of the Company and its wholly owned subsidiaries. Until September 2, 2010, the Company accounted for the results of operations of its former 50% ownership interest in Claire’s Nippon under the equity method and included the results within “Other (income) expenses, net” in its Consolidated Statements of Operations and Comprehensive Income. On September 2, 2010, the Company no longer had an ownership interest in Claire’s Nippon. All significant intercompany balances and transactions have been eliminated in consolidation.

 

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Fiscal Year - The Company’s fiscal year ends on the Saturday closest to January 31. The fiscal year ended February 2, 2013 (“Fiscal 2012”) consisted of 53 weeks. The fiscal years ended January 28, 2012 (“Fiscal 2011”) and January 29, 2011 (“Fiscal 2010”) consisted of 52 weeks, respectively.

Use of Estimates - The Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America, which require management to make certain estimates and assumptions about future events. These estimates and the underlying assumptions affect the amounts of assets and liabilities reported, disclosures regarding contingent assets and liabilities and reported amounts of revenues and expenses. Such estimates include, but are not limited to, the value of inventories, goodwill, intangible assets and other long-lived assets, legal contingencies and assumptions used in the calculation of income taxes, retirement and other post-retirement benefits, stock-based compensation, derivative and hedging activities, residual values and other items. These estimates and assumptions are based on management’s best estimates and judgment. Management evaluates its estimates and assumptions on an ongoing basis using historical experience and other factors, including the current economic environment, which management believes to be reasonable under the circumstances. Management adjusts such estimates and assumptions when facts and circumstances dictate. Illiquidity in credit markets, volatility in each of the equity, foreign currency, and energy markets and declines in consumer spending have combined to increase the uncertainty inherent in such estimates and assumptions. As future events and their effects cannot be determined with precision, actual results could differ significantly from these estimates. Changes in those estimates will be reflected in the financial statements in those future periods when the changes occur.

Cash and Cash Equivalents and Restricted Cash - The Company considers all highly liquid instruments purchased with an original maturity of 90 days or less to be cash equivalents. As of February 2, 2013, all cash equivalents were maintained in one money market fund that was invested exclusively in U.S. Treasury securities. Restricted cash was not available to the Company for general corporate purposes. As of January 28, 2012, restricted cash consisted of collateral in the amount of $4.4 million for the interest rate swap. The restricted cash amount was classified as a current asset in the accompanying Consolidated Balance Sheets since the item it secured was classified as a current liability. See Note 5 – Debt and Note 6 – Derivatives and Hedging Activities, respectively, for further details.

Inventories - Merchandise inventories are stated at the lower of cost or market. Cost is determined by the first-in, first-out basis using the retail method in North America and average cost method, at an individual item level for Europe.

Prepaid Expenses - Prepaid expenses as of February 2, 2013 and January 28, 2012 included the following components (in thousands):

 

     February 2,
2013
     January 28,
2012
 

Prepaid rent and occupancy

   $ 17,853       $ 16,739   

Prepaid insurance

     636         1,002   

Other

     1,212         2,269   
  

 

 

    

 

 

 

Total prepaid expenses

   $ 19,701       $ 20,010   
  

 

 

    

 

 

 

 

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Other Current Assets - Other current assets as of February 2, 2013 and January 28, 2012 included the following components (in thousands):

 

     February 2,
2013
     January 28,
2012
 

Credit card receivables

   $ 6,968       $ 6,141   

Franchise receivables

     4,367         2,528   

Store supplies

     7,158         6,862   

Deferred tax assets, net of valuation allowance

     6,606         5,852   

Income taxes receivable

     37         393   

Other

     4,485         3,647   
  

 

 

    

 

 

 

Total other current assets

   $ 29,621       $ 25,423   
  

 

 

    

 

 

 

Property and Equipment - Property and equipment are recorded at historical cost. Depreciation is computed on the straight-line method over the estimated useful lives of the furniture, fixtures, and equipment, which range from five to ten years. Amortization of leasehold improvements is computed on the straight-line method based upon the shorter of the estimated useful lives of the assets or the terms of the respective leases. Maintenance and repair costs are charged to earnings while expenditures for major improvements are capitalized. Upon the disposition of property and equipment, the accumulated depreciation is deducted from the original cost and any gain or loss is reflected in current earnings.

Capital Leases - Leased property meeting certain capital lease criteria is capitalized as an asset and the present value of the related lease payments is recorded as a liability. Amortization of capitalized leased assets is recorded using the straight-line method over the shorter of the estimated useful life of the leased asset or the initial lease term and is included in “Depreciation and amortization” in the Company’s Consolidated Statements of Operations and Comprehensive Income. Interest expense is recognized on the outstanding capital lease obligation using the effective interest method and is recorded in “Interest expense, net” in the Company’s Consolidated Statements of Operations and Comprehensive Income. On February 19, 2010, the Company sold its North America distribution center/office building (the “Property”) to a third party. The Company received net proceeds of $16.8 million from the sale of the Property. Contemporaneously with the sale of the Property, the Company entered into a lease agreement, dated February 19, 2010. The lease agreement provides for (1) an initial expiration date of February 28, 2030 with two (2) five (5) year renewal periods, each at the option of the Company and (2) basic rent of $2.1 million per annum (subject to annual increases). This transaction is accounted for as a capital lease. The Company has a $1.1 million letter of credit to secure lease payments for the Property.

Goodwill - As discussed in Note 1 – Nature of Operations and Acquisition of Claire’s Stores, Inc. above, the Company accounted for the acquisition of Claire’s Stores, Inc. as a business combination using the purchase method of accounting. At the date of acquisition, the Company allocated the purchase price to assets and liabilities based on estimated fair market values and the remaining $1.8 billion excess of cost over amounts assigned to assets acquired and liabilities assumed was recognized as goodwill. The goodwill is not deductible for tax purposes.

The Company performs a goodwill impairment test on an annual basis or more frequently when events or circumstances indicate that the carrying value of a reporting unit more likely than not exceeds its fair value. Recoverability of goodwill is evaluated, at the Company’s option, by first performing a qualitative assessment for any reporting unit for any period or by bypassing the qualitative assessment and proceeding directly to the first step of our two-step goodwill impairment test. If the Company determines, on the basis of qualitative factors, it is not more likely than not that the fair value of a reporting unit is less than the carrying value amount, then performing the two-step impairment test would be unnecessary. The first step of the two-step goodwill impairment test involves a comparison of the fair value of each of our reporting units with its carrying value. If a reporting unit’s carrying value exceeds its fair value, the second step is performed to measure the amount of impairment loss, if any. The second step of the two-step goodwill impairment test involves a comparison of the implied fair value and carrying value of that reporting unit’s goodwill. To the extent that a reporting unit’s carrying value exceeds the implied fair value of its goodwill, an impairment loss is recognized. See Note 3 – Impairment Charges for results of impairment testing and Note 4 – Goodwill and Other Intangible Assets, respectively, for more details.

 

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Intangible Assets - Intangible assets include tradenames, franchise agreements, lease rights, territory rights and leases that existed at the date of acquisition with terms that were favorable to market at that date. The Company makes investments through its Europe subsidiaries in intangible assets upon the opening and acquisition of many of our store locations in Europe. These intangible assets are amortized to residual value on a straight-line basis over the useful lives of the respective leases, not to exceed 25 years. The Company evaluates the residual value of its intangible assets periodically and adjusts the amortization period and/or residual value when the Company believes the residual value of the asset is not recoverable. Indefinite-lived intangible assets are tested for impairment annually or more frequently when events or circumstances indicate that the carrying value more likely than not exceeds its fair value. Definite-lived intangible assets are tested for impairment when events or circumstances indicate that the carrying value may not be recoverable. Any impairment charges resulting from the application of these tests are immediately recorded as a charge to earnings in the Company’s Consolidated Statements of Operations and Comprehensive Income. See Note 3 – Impairment Charges for results of impairment testing and Note 4 – Goodwill and Other Intangible Assets, respectively, for more details.

Deferred Financing Costs - Costs incurred to issue debt are deferred and amortized as a component of interest expense over the estimated term of the related debt using the effective interest rate method. Amortization expense, recognized as a component of “Interest expense, net” in the Company’s Consolidated Statements of Operations and Comprehensive Income, were $9.1 million, $13.1 million and $10.0 million for Fiscal 2012, Fiscal 2011 and Fiscal 2010, respectively.

Other Assets - Other assets as of February 2, 2013 and January 28, 2012 included the following components (in thousands):

 

     February 2,
2013
     January 28,
2012
 

Initial direct costs of leases

   $ 17,811       $ 16,257   

Prepaid lease payments

     8,390         7,366   

Deferred tax assets, non-current

     1,152         1,424   

Other

     22,495         19,448   
  

 

 

    

 

 

 

Total other assets

   $ 49,848       $ 44,495   
  

 

 

    

 

 

 

On September 2, 2010, the Company converted its former 50% ownership interest in the Claire’s Nippon joint venture into the full and exclusive rights to operate Claire’s stores in all of Asia excluding Japan. The former joint venture partner acquired the right to operate Claire’s stores exclusively in Japan. The Company and the former joint venture partner also agreed to operate Claire’s Nippon under a new license agreement, to replace the existing merchandising agreement and to amend the buying agency agreement. In accordance with Accounting Standards Codification (“ASC”) Subtopic 845-10, Nonmonetary Transactions, the Company measured the conversion based on the fair value of the asset surrendered. The Company recorded the exclusive territory rights as an indefinite-lived intangible asset in the amount of $0.6 million. See Note 4 – Goodwill and Other Intangibles.

The Company recorded its 50% ownership interest of Claire’s Nippon’s net loss in the amount of $2.5 million for Fiscal 2010, in “Other (income) expense, net” in the Consolidated Statements of Operations and Comprehensive Income.

The initial direct costs of leases and prepaid lease payments are amortized on a straight-line basis over the respective lease terms, typically ranging from four to 15 years.

Impairment of Long-Lived Assets - The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the net book value of an asset may not be recoverable. Recoverability of long-lived assets to be held and used is measured by a comparison of the net book value of an asset or asset group to the future net undiscounted cash flows expected to be generated by the asset or asset group. If these comparisons indicate that the asset or asset group is not recoverable, an

 

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impairment loss is recognized for the excess of the carrying amount over the fair value of the asset or asset group. The fair value is estimated based on discounted future cash flows expected to result from the use and eventual disposition of the asset or asset group using a rate that reflects the operating segment’s average cost of capital. Long-lived assets to be disposed of are reported at the lower of the carrying amount or fair value less cost to sell and are no longer depreciated. See Note 3 – Impairment Charges for results of impairment testing.

Accrued Expenses and Other Current Liabilities - Accrued expenses and other current liabilities as of February 2, 2013 and January 28, 2012 included the following components (in thousands):

 

     February 2,
2013
     January 28,
2012
 

Compensation and benefits

   $ 40,025       $ 40,532   

Gift cards and certificates

     22,695         22,270   

Sales and local taxes

     15,708         16,493   

Store rent

     3,012         3,776   

Interest rate swap

     —           2,159   

Other

     18,089         19,295   
  

 

 

    

 

 

 

Total accrued expenses and other current liabilities

   $ 99,529       $ 104,525   
  

 

 

    

 

 

 

Revenue Recognition - The Company recognizes sales as the customer takes possession of the merchandise. The estimated liability for sales returns is based on the historical return levels, which is included in “Accrued expenses and other current liabilities.” The Company excludes sales taxes collected from customers from “Net sales” in its Consolidated Statements of Operations and Comprehensive Income.

The Company accounts for the goods it sells to third parties under franchising and licensing agreements within “Net sales” and “Cost of sales, occupancy and buying expenses” in the Company’s Consolidated Statements of Operations and Comprehensive Income. The franchise fees the Company charges under the franchising agreements are reported in “Other (income) expense, net” in the Company’s Consolidated Statements of Operations and Comprehensive Income.

Upon purchase of a gift card or gift certificate, a liability is established for the cash value. The liability is included in “Accrued expenses and other current liabilities.” Revenue from gift card and gift certificate sales is recognized at the time of redemption.

Cost of Sales - Included within the Company’s Consolidated Statements of Operations and Comprehensive Income line item “Cost of sales, occupancy and buying expenses” is the cost of merchandise sold to our customers, inbound and outbound freight charges, purchasing costs, and inspection costs. Also included in this line item are the occupancy costs of the Company’s stores and the Company’s internal costs of facilitating the merchandise procurement process, both of which are treated as period costs. All merchandise purchased by the Company is shipped to one of its two distribution centers. As a result, the Company has no internal transfer costs. The cost of the Company’s distribution centers are included within the financial statement line item “Selling, general and administrative” expenses, and not in “Cost of sales, occupancy and buying expenses.” These distribution center costs were approximately $11.7 million, $12.4 million and $10.0 million, for Fiscal 2012, Fiscal 2011 and Fiscal 2010, respectively. All depreciation and amortization expense is reported on a separate financial statement line item on the Company’s consolidated statement of operations.

Advertising Expenses - The Company expenses advertising costs as incurred, including in-store marketing, mall association dues and digital interactive media. Advertising expenses were $11.9 million, $15.9 million and $12.8 million for Fiscal 2012, Fiscal 2011 and Fiscal 2010, respectively.

Rent Expense - The Company recognizes rent expense for operating leases with periods of free rent (including construction periods), step rent provisions, and escalation clauses on a straight-line basis over the applicable lease term. From time to time, the Company may receive capital improvement funding

 

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from its lessors. These amounts are recorded as a “Deferred rent expense” and amortized over the remaining lease term as a reduction of rent expense. The Company considers lease renewals in the determination of the applicable lease term when such renewals are reasonably assured. The Company takes this factor into account when calculating minimum aggregate rental commitments under non-cancelable operating leases set forth in Note 7 – Commitments and Contingencies.

Stock-Based Compensation - The Company issues stock options and other stock-based awards to executive management, key employees, and directors under its stock-based compensation plans.

Time-vested stock awards, including stock options and restricted stock, are accounted for at fair value at date of grant. The stock-based compensation expense is recorded on a straight-line basis over the requisite service period using the graded-vesting method for the entire award. Performance-based stock awards are accounted for at fair value at date of grant. The stock-based expense was based upon the number of shares expected to be issued when it became probable that performance targets required to receive the awards would be achieved. The stock-based compensation expense is recognized over the requisite service period.

Buy one, get one (“BOGO”) options issued prior to May 2011 were immediately vested, exercisable upon issuance, and accounted for at fair value at date of grant. The compensation expense for these BOGOs was recognized over a four year period due to the terms of the option requiring forfeiture in certain cases including the grantee’s voluntary resignation from the Company’s employ prior to May 2011. BOGOs issued subsequent to May 2011 are accounted for at the fair value at date of grant and the compensation expense is recognized over the requisite service period.

Income Taxes - The Company accounts for income taxes under the provisions of ASC Topic 740, Income Taxes, which generally requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement carrying amounts and tax bases of assets and liabilities, using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect on deferred tax assets and liabilities of a change in tax laws or rates is recognized in income in the period the new legislation is enacted. Valuation allowances are recognized to reduce deferred tax assets to the amount that is more likely than not to be realized. In assessing the likelihood of realization, the Company considers estimates of future taxable income.

The Company is subject to tax audits in numerous jurisdictions, including the United States, individual states and localities, and internationally. Tax audits by their very nature are often complex and can require several years to complete. In the normal course of business, the Company is subject to challenges from the Internal Revenue Service (“IRS”) and other tax authorities regarding amounts of taxes due. These challenges may alter the timing or amount of taxable income or deductions, or the allocation of income among tax jurisdictions. In July 2006, the Financial Accounting Standards Board (“FASB”) issued guidance which clarifies the accounting for income taxes in the financial statements by prescribing a minimum probability recognition threshold and measurement process for recording uncertain tax positions taken or expected to be taken in a tax return. This guidance requires that the Company determine whether a tax position is more likely than not of being sustained upon audit based on the technical merits of the tax position. For tax positions that are at least more likely than not of being sustained upon audit, the Company recognizes the largest amount of the benefit that is more likely than not of being sustained. See Note 11 – Income Taxes for further information.

Foreign Currency Translation - The financial statements of the Company’s foreign operations are translated into U.S. Dollars. Assets and liabilities are translated at fiscal year-end exchange rates while income and expense accounts are translated at the average rates in effect during the year. Equity accounts are translated at historical exchange rates. Resulting translation adjustments are accumulated as a component of “Accumulated other comprehensive income (loss), net of tax” in the Company’s Consolidated Balance Sheets. Foreign currency gains and losses resulting from transactions denominated in foreign currencies, including intercompany transactions, except for intercompany loans of a long-term investment nature, are included in results of operations. These foreign currency transaction losses (gains) were approximately $(1.4) million, $0.9 million and $5.1 million, for Fiscal 2012, Fiscal 2011 and Fiscal 2010, respectively.

 

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Comprehensive Income - Comprehensive income represents a measure of all changes in shareholder’s deficit except for changes resulting from transactions with shareholders in their capacity as shareholders. The Company’s total comprehensive income consists of net income (loss), foreign currency translation adjustments, reclassification of foreign currency translation adjustments into net income and adjustments for derivative instruments accounted for as cash flow hedges. Amounts included in “Comprehensive income” are recorded net of income taxes.

Derivative Financial Instruments - The Company recognizes the fair value of derivative financial instruments in the Consolidated Balance Sheets. Gain and losses related to a hedge that result from changes in the fair value of the hedge are either recognized in income to offset the gain or loss on the hedged item, or deferred and reported as a component of “Accumulated other comprehensive income (loss), net of tax” in the Consolidated Balance Sheets and subsequently recognized in income when the hedged item affects net income. The ineffective portion of the change in fair value of a hedge is recognized in income immediately.

Fair Value Measurements - ASC 820, Fair Value Measurement Disclosures defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. Disclosures of the fair value of certain financial instruments are required, whether or not recognized in the Consolidated Balance Sheets. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date and in the principal or most advantageous market for that asset or liability. There is a three-level valuation hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Observable inputs are inputs market participants would use in valuing the asset or liability and are developed based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’s assumptions about the factors market participants would use in valuing the asset or liability.

Financial Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following table summarizes the Company’s liability measured at fair value on a recurring basis segregated among the appropriate levels within the fair value hierarchy (in thousands):

 

           Fair Value Measurements at
January 28, 2012 Using
 
     Carrying Value     Quoted Prices
in Active
Markets for
Identical Assets
(Liabilities)
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
    Significant
Unobservable
Inputs
(Level 3)
 

Interest rate swap

   $ (2,159   $ —         $ (2,159   $ —     

On September 20, 2012, the Company terminated the interest rate swap entered into on July 28, 2010 (the “Swap”) and settled the contract at the fair value of the liability as of September 20, 2012. At January 28, 2012, the fair value of the Swap represented the estimated amount the Company would receive or pay to terminate this contract at the reporting date based upon pricing or valuation models applied to current market information. The Swap was valued using the market standard methodology of netting the discounted future fixed cash payments and the discounted expected variable cash receipts. The variable cash receipts were based on an expectation of future interest rates derived from observed market interest rate curves. The Swap was collateralized by cash and thus the Company did not make any credit-related valuation adjustments. The Company mitigates derivative credit risk by transacting with highly rated counterparties. The Company does not enter into derivative financial instruments for trading or speculative purposes. See Note 6 – Derivatives and Hedging Activities for further information.

 

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Non-Financial Assets Measured at Fair Value on a Non-Recurring Basis

The Company’s non-financial assets, which include goodwill, intangible assets, and long-lived tangible assets, are not adjusted to fair value on a recurring basis. Fair value measures of non-financial assets are primarily used in the impairment analysis of these assets. Any resulting asset impairment would require that the non-financial asset be recorded at its fair value. The Company reviews goodwill and indefinite-lived intangible assets for impairment annually, during the fourth quarter of each fiscal year, or as circumstances indicate the possibility of impairment. The Company monitors the carrying value of definite-lived intangible assets and long-lived tangible assets for impairment whenever events or changes in circumstances indicate its carrying amount may not be recoverable. There was no impairment of the Company’s non-financial assets during Fiscal 2012 and Fiscal 2011.

Financial Instruments Not Measured at Fair Value

The Company’s financial instruments consist primarily of cash and cash equivalents, restricted cash, accounts receivable, current liabilities, short-term debt, long-term debt, and the revolving credit facility. Cash and cash equivalents, restricted cash, accounts receivable, short-term debt and current liabilities approximate fair market value due to the relatively short maturity of these financial instruments.

The Company considers all investments with a maturity of three months or less when acquired to be cash equivalents. The Company’s cash equivalent instruments are valued using quoted market prices and are primarily U.S. Treasury securities. The estimated fair value of the Company’s long-term debt was approximately $2.41 billion at February 2, 2013, compared to a carrying value of $2.37 billion at that date. The estimated fair value of the Company’s long-term debt was approximately $2.03 billion at January 28, 2012, compared to a carrying value of $2.39 billion at that date. For publicly-traded debt, the fair value (estimated market value) is based on market prices. For other debt, fair value is estimated based on quoted prices for similar instruments.

Recent Accounting Pronouncements - In February 2013, the FASB issued ASU 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income, which requires an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under U.S. generally accepted accounting principles (“GAAP”) to be reclassified in its entirety to net income. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures required under U.S. GAAP that provide additional detail about those amounts. This would be the case when a portion of the amount reclassified out of accumulated other comprehensive income is reclassified to a balance sheet account instead of directly to income or expense in the same reporting period. The amendments are effective prospectively for interim and annual periods beginning after December 15, 2012. The Company does not expect adoption of ASU 2013-02 will have a material impact on the Company’s financial position, results of operations or cash flows.

In July 2012, the FASB issued ASU 2012-02, Intangibles – Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment, which permits an entity to make a qualitative assessment of whether it is more likely than not that a reporting unit’s fair value is less than its carrying amount. If an entity can support the conclusion that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then the entity is not required to take further action. The amendments are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012 and early adoption is permitted. The Company does not expect adoption of ASU 2012-02 will have a material impact on the Company’s financial position, results of operations or cash flows.

In September 2011, the FASB issued ASU 2011-08, Intangibles – Goodwill and Other (Topic 350): Testing Goodwill for Impairment, which permits an entity to make a qualitative assessment of whether it is more likely than not that a reporting unit’s fair value is less than its carrying amount before applying the two-step goodwill impairment test. If an entity can support the conclusion that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, it would not need to

 

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perform the two-step impairment test for that reporting unit. The amendments in this ASU are effective for interim and annual fiscal periods beginning after December 15, 2011 and early adoption is permitted. The Company adopted this guidance in the first quarter of fiscal 2012 and it did not have any impact on the Company’s financial position, results of operations or cash flows.

In June 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income, which requires the presentation of the components of other comprehensive income with the components of net income in either a single continuous statement of comprehensive income or in two separate but consecutive statements and eliminates the option to present the components of other comprehensive income as part of the statement of equity. This guidance was amended in December 2011 when the FASB issued ASU 2011-12, Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05, which defers the presentation on the face of the financial statements of the effects of reclassification adjustments out of accumulated other comprehensive income on the components of net income and other comprehensive income. The Company adopted this guidance in the first quarter of fiscal 2012 and it did not have any impact on the Company’s financial position, results of operations or cash flows.

In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards (“IFRSs”), to provide a consistent definition of fair value and ensure that fair value measurements and disclosure requirements are similar between U.S. GAAP and IFRSs. This guidance changes certain fair value measurement principles and enhances the disclosure requirements for fair value measurements including the categorization by level of the fair value hierarchy for items that are not measured at fair value in the statement of financial position but for which the fair value is required to be disclosed (e.g., a financial instrument that is measured at amortized cost in the statement of financial position but for which fair value is disclosed, such as debt). The Company adopted this guidance in the first quarter of fiscal 2012 and it did not have any impact on the Company’s financial position, results of operations or cash flows.

There are no recently issued accounting standards that are expected to have a material effect on the Company’s financial condition, results of operations or cash flows.

 

3. IMPAIRMENT CHARGES

The Company recorded non-cash impairment charges for the fiscal years ended February 2, 2013, January 28, 2012 and January 29, 2011 as follows (in thousands):

 

     Fiscal 2012      Fiscal 2011      Fiscal 2010  

Franchise agreements

   $ —         $ —         $ 12,262   

Investment in Claire’s Nippon

     —           —           6,030   
  

 

 

    

 

 

    

 

 

 

Total impairment charges

   $ —         $ —         $ 18,292   
  

 

 

    

 

 

    

 

 

 

The Company’s principal indefinite-lived intangible assets, other than goodwill, include tradenames and lease rights which are not subject to amortization. Goodwill and other indefinite-lived intangible assets are tested for impairment annually or more frequently when events or circumstances indicate that the carrying value of a reporting unit more likely than not exceeds its fair value. The Company performs annual impairment tests during the fourth quarter of its fiscal year.

The Company’s principal definite-lived intangible assets include franchise agreements and lease rights which are subject to amortization and leases that existed at date of acquisition with terms that were favorable to market at that date. Definite-lived intangible assets are tested for impairment when events or circumstances indicate that the carrying value of the asset may not be recoverable.

The deterioration in the financial and housing markets and resulting effect on consumer confidence and discretionary spending that occurred during Fiscal 2011 and Fiscal 2010 had a significant impact on the

 

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retail industry. The Company tests assets for impairment annually as of the first day of the fourth quarter of its fiscal year. On the first day of the fourth quarter of Fiscal 2012, Fiscal 2011 and Fiscal 2010, the Company considered the impact the economic conditions had on its business as an indicator under ASC Topic 350, Intangibles – Goodwill and Other, that a reduction in its goodwill fair value may have occurred. In accordance with ASU 2011-08, Intangibles – Goodwill and Other (Topic 350), the Company has the option of performing a qualitative assessment before calculating the fair value of its reporting units or bypassing the qualitative assessment for any reporting unit for any period and proceeding directly to the first step of the two-step goodwill impairment test. The Company opted to proceed directly to the first step of the two-step goodwill impairment testing process defined in ASC Topic 350. The first step in this process compares the fair value of the reporting unit to its carrying value. If the carrying value of the reporting unit exceeds its fair value, the second step of the impairment test is performed to measure the impairment. In the second step, the fair value of the reporting unit is allocated to all of the assets and liabilities of the reporting unit to determine an implied goodwill value. This allocation is similar to a purchase price allocation performed in purchase accounting. If the carrying amount of the reporting unit goodwill exceeds the implied goodwill value, an impairment loss should be recognized in an amount equal to that excess. The Company has two reporting units as defined under ASC Topic 350. These reporting units are its North America segment and its Europe segment.

The fair value of each reporting unit determined under step one of the goodwill impairment test was based on a three-fourths weighting of a discounted cash flow analysis using forward-looking projections of estimated future operating results and a one-fourth weighting of a guideline company methodology under the market approach using revenue and earnings before interest, taxes, depreciation and amortization (“EBITDA”) multiples. Management’s determination of the fair value of each reporting unit incorporates multiple assumptions, including future business growth, earnings projections and the weighted average cost of capital used for purposes of discounting. Decreases in business growth, decreases in earnings projections and increases in the weighted average cost of capital will all cause the fair value of the reporting unit to decrease.

Based on this testing under step one, no impairment charge was recognized during Fiscal 2012, Fiscal 2011 and Fiscal 2010.

The Company also performed similar impairment testing on its other indefinite lived intangible assets during the fourth quarter of Fiscal 2012, Fiscal 2011 and Fiscal 2010. The Company estimates the fair value of these intangible assets primarily utilizing a discounted cash flow model. The forecasted cash flows used in the model contain inherent uncertainties, including significant estimates and assumptions related to growth rates, margins and cost of capital. Changes in any of the assumptions utilized could affect the fair value of the intangible assets and result in an impairment triggering event. No impairment charge was recognized in Fiscal 2012, Fiscal 2011 and Fiscal 2010.

During the fourth quarter of Fiscal 2010, management performed a strategic review of its franchise business. The franchisees’ continued inability to meet store development expectations prompted the Company to reevaluate its franchise development strategy and to perform a valuation of the franchise agreements, which are definite-lived intangible assets. The Company utilized a discounted cash flow model and determined the franchise agreements intangible assets were impaired. This resulted in the Company recording a non-cash impairment charge of $12.3 million in Fiscal 2010, which was included in “Impairment of assets” on the Company’s Consolidated Statements of Operations and Comprehensive Income. No impairment charge was recognized for Fiscal 2012 and Fiscal 2011.

In accordance with ASC Subtopic 323-10, Investments — Equity Method and Joint Ventures, the Company is required to perform an assessment of overall other than temporary decrease in investment value when events or circumstances indicate that the carrying value may not be recoverable. The fair value of Claire’s Nippon is based on a discounted cash flow analysis of estimated future operating results. A decrease in business growth, decrease in earnings projections or increase in the discount factor will cause the fair value to decrease. The 2010 precipitous decline in sales, lower margin rates due to markdowns on slow-moving merchandise, and difficulty in cost reduction efforts, coupled with an inability to generate positive cash flow to pay royalties or dividends since inception, prompted the Company to perform a valuation of Claire’s Nippon. Because the expected future cash flows were less

 

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than the net carrying value of the investment in Claire’s Nippon, during Fiscal 2010, a non-cash impairment charge of $6.0 million was recognized for the excess of the net carrying value of the investment over the estimated fair value of $0.6 million.

The Company accounts for long-lived tangible assets under ASC Topic 360, Property, Plant, and Equipment. Assessment for possible impairment is based on the Company’s ability to recover the carrying value of the long-lived asset from the expected undiscounted future operating cash flows or management’s determination that the long-lived asset has limited future use. If the expected undiscounted future cash flows are less than the carrying value of such assets, an impairment loss is recognized for the difference between estimated fair value and carrying value. Fair value is measured based on a projected discounted cash flow model using a discount rate that is commensurate with the risk inherent in the business. During Fiscal 2012, Fiscal 2011, and Fiscal 2010, no impairment charges were recognized with regards to long-lived assets.

 

4. GOODWILL AND OTHER INTANGIBLE ASSETS

In connection with the Transactions, the Company recorded goodwill and other intangible assets at date of acquisition. The Company’s indefinite-lived intangible assets include tradenames and territory rights which are not subject to amortization. The Company’s principal definite-lived intangible assets include lease rights, franchise agreements and leases that existed at date of acquisition with terms that were favorable to market at that date.

The changes in the carrying amount of goodwill during Fiscal 2012 and Fiscal 2011 by reporting unit are as follows (in thousands):

 

     North America     Europe     Total  

Balance as of February 2, 2013 and January 28, 2012:

      

Goodwill

   $ 1,415,651      $ 431,405      $ 1,847,056   

Accumulated impairment losses

     (180,000     (117,000     (297,000
  

 

 

   

 

 

   

 

 

 
   $ 1,235,651      $ 314,405      $ 1,550,056   
  

 

 

   

 

 

   

 

 

 

The carrying amount and accumulated amortization of identifiable intangible assets at February 2, 2013 and January 28, 2012 were (in thousands):

 

          February 2, 2013     January 28, 2012  
     Estimated    Gross            Gross         
     Life    Carrying      Accumulated     Carrying      Accumulated  
     in Years    Amount      Amortization     Amount      Amortization  

Intangible assets subject to amortization:

             

Lease rights (1)

   Lease
terms
ranging
from 4.5
to 16.5
   $ 85,125       $ (10,758   $ 79,261       $ (8,216

Franchise agreements

   4 to 9      40,738         (19,813     40,738         (16,678

Favorable lease obligations

   10      30,815         (26,690     30,791         (24,079

Other

   5      718         (411     545         (297
     

 

 

    

 

 

   

 

 

    

 

 

 

Total intangible assets subject to amortization

        157,396         (57,672     151,335         (49,270

Indefinite-lived intangible assets:

             

Indefinite-lived tradenames

      $ 447,109       $ —        $ 447,103       $ —     

Indefinite-lived territory rights

        600         —          600         —     
     

 

 

    

 

 

   

 

 

    

 

 

 

Total indefinite-lived intangible assets

        447,709         —          447,703         —     

Total intangible assets

      $ 605,105       $ (57,672   $ 599,038       $ (49,270
     

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) Amounts include lease rights not currently subject to amortization of $53,998 and $50,985 as of February 2, 2013 and January 28, 2012, respectively.

 

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For Fiscal 2012, Fiscal 2011 and Fiscal 2010, amortization expense of $8.4 million, $10.8 million and $10.9 million, respectively, was recognized by the Company. As discussed in Note 3 – Impairment Charges, the Company recognized impairment charges related to intangible assets of $12.3 million in Fiscal 2010. There were no such impairment charges for intangible assets in Fiscal 2012 and Fiscal 2011.

 

Intangible Asset Acquisitions (in 000’s)

   Amortizable      Weighted Average Amortization
Period for Amortizable
Intangible Asset Acquisitions
 

Lease rights:

     

Fiscal 2012

   $ 2,276         9.3   

Fiscal 2011

     1,855         9.9   

Fiscal 2010

     978         9.9   

Other:

     

Fiscal 2012

     173         5.0   

Fiscal 2011

     46         5.0   

Fiscal 2010

     126         5.0   

The weighted average amortization period of amortizable intangible assets acquired in Fiscal 2012 was 9.0 years.

The remaining net amortization as of February 2, 2013 of identifiable intangible assets with finite lives by year is as follows (in thousands):

 

Fiscal Year

   Amortization  

2013

   $ 7,982   

2014

     7,351   

2015

     6,374   

2016

     5,604   

2017

     5,190   

2018 and thereafter

     13,225   
  

 

 

 

Total

   $ 45,726   
  

 

 

 

 

5. DEBT

Debt as of February 2, 2013 and January 28, 2012 included the following components (in thousands):

 

     February 2, 2013      January 28, 2012  

Long-term debt:

     

Senior secured term loan facility due 2014

   $ —         $ 1,154,310   

Senior fixed rate notes due 2015

     220,270         220,270   

Senior toggle notes due 2015

     302,190         302,190   

Senior subordinated notes due 2017

     259,612         259,612   

Senior secured first lien notes due 2019 (1)

     1,141,294         —     

Senior secured second lien notes due 2019

     450,000         450,000   
  

 

 

    

 

 

 

Long-term debt

   $ 2,373,366       $ 2,386,382   
  

 

 

    

 

 

 

Obligation under capital lease

   $ 17,232       $ 17,290   
  

 

 

    

 

 

 

 

(1) Amount includes unamortized premium of $16,294 as of February 2, 2013.

 

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As of February 2, 2013, the Company’s total debt maturities are as follows for each of the following fiscal years (in thousands):

 

     Capital Leases     Debt  

2013

   $ 2,266      $ —     

2014

     2,311        —     

2015

     2,357        522,460   

2016

     2,404        —     

2017

     2,453        —     

Thereafter

     32,774        1,834,612   
  

 

 

   

 

 

 

Total

     44,565      $ 2,357,072   
    

 

 

 

Imputed interest

     (27,279  
  

 

 

   

Present value of minimum capital lease principal payments

     17,286     

Current portion

     54     
  

 

 

   

Long-term capital lease obligation

   $ 17,232     
  

 

 

   

The Company’s interest expense, net for Fiscal 2012, Fiscal 2011 and Fiscal 2010 included the following components (in thousands):

 

     Fiscal 2012     Fiscal 2011     Fiscal 2010  

Term loan facility

   $ 17,644      $ 38,226      $ 53,255   

Revolving credit facility

     935        1,576        6,110   

Senior fixed rate notes

     20,663        20,663        22,605   

Senior toggle notes

     29,493        32,263        36,881   

Senior subordinated notes

     27,642        27,118        27,620   

Senior secured first lien notes

     62,504        —          —     

Senior secured second lien notes

     40,716        36,120        —     

Note payable to bank

     —          5,535        85   

Capital lease obligation

     2,203        2,151        1,232   

Amortization of deferred debt issue costs

     9,927        13,106        10,005   

Accretion of debt premium

     (831     —          —     

Other interest expense

     99        98        57   

Interest income

     (198     (381     (144
  

 

 

   

 

 

   

 

 

 

Interest expense, net

   $ 210,797      $ 176,475      $ 157,706   
  

 

 

   

 

 

   

 

 

 

Accrued interest payable as of February 2, 2013 and January 28, 2012 consisted of the following components (in thousands):

 

     February 2, 2013      January 28, 2012  

Term loan facility

   $ —         $ 4,409   

Revolving credit facility

     75         93   

Senior fixed rate notes

     3,582         3,303   

Senior toggle notes

     5,114         4,714   

Senior subordinated notes

     4,793         4,418   

Senior secured first lien notes

     39,220         —     

Senior secured second lien notes

     15,470         14,922   
  

 

 

    

 

 

 

Total accrued interest payable

   $ 68,254       $ 31,859   
  

 

 

    

 

 

 

LONG-TERM DEBT

Credit Facility

The Former Credit Facility was with a syndication of lenders and consisted of a $1.45 billion senior secured Former Term Loan and a $200.0 million senior secured Former Revolver. The Former Credit Facility contained customary provisions relating to mandatory prepayments, voluntary prepayments, affirmative covenants, negative covenants, and events of default. At the consummation of the Merger, the Company drew the full amount of the Former Term Loan and was issued a $4.5 million letter of credit. The letter of credit was subsequently increased to $6.0 million and later reduced to $4.8 million.

 

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During Fiscal 2012, we issued $1,142.1 million of the 9.0% Senior Secured First Lien Notes that mature on March 15, 2019. We used the net proceeds from the note offerings, together with cash on hand, to repay $1,154.3 million of indebtedness under the Former Term Loan and to terminate the Former Credit Facility.

On September 20, 2012, the Company entered into an Amended and Restated Credit Agreement by and among Claire’s Inc. (“Parent”), the Company, Credit Suisse AG, as Administrative Agent, and the other Lenders named therein (the “Credit Facility”), pursuant to which the Company replaced its existing $200.0 million senior secured Former Revolver maturing May 29, 2013 with a $115.0 million five-year senior secured revolving credit facility.

Borrowings under the Credit Facility will bear interest at a rate equal to, at the Company’s option, either (a) an alternate base rate determined by reference to the higher of (1) the prime rate in effect on such day, (2) the federal funds effective rate plus 0.50% and (3) the one-month LIBOR rate plus 1.00%, or (b) a LIBOR rate with respect to any Eurodollar borrowing, determined by reference to the costs of funds for U.S. dollar deposits in the London Interbank Market for the interest period relevant to such borrowing, adjusted for certain additional costs, in each case plus an applicable margin of 4.50% for LIBOR rate loans and 3.50% for alternate base rate loans. The Company will also pay a facility fee of 0.50% per annum of the committed amount of the Credit Facility whether or not utilized.

All obligations under the Credit Facility are unconditionally guaranteed by (i) Parent, prior to an initial public offering of the Company’s stock, and (ii) the Company’s existing and future direct or indirect wholly-owned domestic subsidiaries, subject to certain exceptions.

All obligations under the Credit Facility, and the guarantees of those obligations, are secured, subject to certain exceptions and permitted liens, by a first priority lien on, (i) all of the Company’s capital stock, prior to an initial public offering of its stock, and (ii) substantially all of the Company’s material owned assets and the material owned assets of subsidiary guarantors, limited in the case of equity interests held by the Company or any subsidiary guarantor in a foreign subsidiary, to 100% of the non-voting equity interests and 65% of the voting equity interests of such foreign subsidiary held directly by the Company or a subsidiary guarantor. The liens securing the Credit Facility rank equally to the liens securing the 9.0% Senior Secured First Lien Notes.

The Credit Facility contains customary provisions relating to mandatory prepayments, voluntary payments, affirmative and negative covenants, and events of default; however, it does not contain any covenants that require the Company to maintain any particular financial ratio or other measure of financial performance except that so long as the revolving loans and letters of credit outstanding exceed $15 million, the Company will be required to comply with a maximum Total Net Secured Leverage Ratio of 5.5 to 1.0 based upon the ratio of its net senior secured debt to adjusted earnings before interest, taxes, depreciation and amortization for the period of four consecutive fiscal quarters most recently ended.

The Company must also pay customary letter of credit fees and agency fees. At February 2, 2013, there was no amount outstanding under the Credit Facility. At January 28, 2012, the weighted average interest rate for borrowings outstanding under the Former Credit Facility was 3.07%.

The Credit Facility does not contain any covenants that require the Company to maintain any particular financial ratio or other measure of financial performance; however, it does contain various covenants that limit our ability to engage in specified types of transactions. These covenants limit the Company’s Parent’s and the Company’s restricted subsidiaries’ ability to, among other things:

 

   

incur additional indebtedness or issue certain preferred shares;

 

   

pay dividends on, repurchase or make distributions in respect of our capital stock or make other restricted payments;

 

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make certain investments;

 

   

sell certain assets;

 

   

create liens;

 

   

consolidate, merge, sell or otherwise dispose of all or substantially all of our assets; and

 

   

enter into certain transactions with our affiliates.

A breach of any of these covenants could result in an event of default. Upon the occurrence of an event of default, the lenders could elect to declare all amounts outstanding under the Credit Facility to be immediately due and payable and terminate all commitments to extend further credit. Such actions by those lenders could cause cross defaults under the Company’s other indebtedness. If the Company were unable to repay those amounts, the lenders under the Credit Facility could proceed against the collateral granted to them to secure that indebtedness.

Senior Notes

In connection with the Transactions, the Company issued $600 million of senior notes in two series:

 

  1) $250.0 million of 9.25% Senior Notes due 2015 (the “Senior Fixed Rate Notes”), and

 

  2) $350.0 million of 9.625%/10.375% Senior Toggle Notes due 2015 (the “Senior Toggle Notes” and together with the Senior Fixed Rate Notes, the “Senior Notes”)

The Senior Fixed Rate Notes are unsecured obligations of the Company and mature on June 1, 2015. Interest is payable semi-annually at 9.25% per annum, which commenced on December 1, 2007.

The Senior Toggle Notes are unsecured obligations of the Company and mature on June 1, 2015. Interest is payable semi-annually commencing on December 1, 2007. For any interest period through June 1, 2011, the Company may, at its option, elect to pay interest on the Senior Toggle Notes (i) entirely in cash (“Cash Interest”), (ii) entirely by increasing the principal amount of the outstanding Senior Toggle Notes or by issuing PIK Notes (“PIK Interest”) or (iii) 50% as Cash Interest and 50% of PIK Interest.

Cash Interest on the Senior Toggle Notes accrues at 9.625% per annum and is payable in cash. PIK Interest on the Senior Toggle Notes accrues at the Cash Interest Rate per annum plus 0.75% and increases the amount outstanding of the Senior Toggle Notes.

The Company elected to pay interest in kind on its Senior Toggle Notes for the interest periods beginning June 2, 2008 through June 1, 2011. This election, net of reductions for note repurchases, increased the principal amount on the Senior Toggle Notes by $109.5 million as of February 2, 2013 and January 28, 2012, respectively. The accrued payment in kind interest is included in “Long-term debt” in the Consolidated Balance Sheets. Effective June 2, 2011, the Company began accruing cash interest.

Each of the Company’s wholly-owned domestic subsidiaries that guarantee indebtedness under the Credit Facility jointly and severally irrevocably and unconditionally guarantee on a senior basis the performance and punctual payment when due, whether at stated maturity, by acceleration or otherwise, of all obligations of the Company under the Senior Notes, expenses, indemnification or otherwise.

The Company may redeem the Senior Notes at its option, subject to certain notice provisions at the following redemption prices (expressed as percentage of principal amount), plus accrued and unpaid interest to the redemption date (subject to the right of holders of record on the relevant record date to receive interest due on the relevant interest payment date), if redeemed during the twelve-month period commencing on June 1 of the years set forth below:

 

Period

   Senior Fixed Rate Notes     Senior Toggle Notes  

2012

     102.313     102.406

2013 and thereafter

     100.000     100.000

 

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Upon the occurrence of a change of control, each holder of the Senior Notes has the right to require the Company to repurchase all or any part of such holder’s Senior Notes, at a price in cash equal to 101% of the principal amount of the Senior Notes redeemed plus accrued and unpaid interest, if any.

Senior Subordinated Notes

In connection with the Transactions, the Company issued $335.0 million of Senior Subordinated Notes. The Senior Subordinated Notes are senior subordinated obligations of the Company and will mature on June 1, 2017. Interest is payable semi-annually at 10.50% per annum, which commenced on December 1, 2007.

Each of the Company’s wholly-owned domestic subsidiaries that guarantee indebtedness under the Credit Facility jointly and severally irrevocably and unconditionally guarantee on a senior subordinated basis the performance and punctual payment when due, whether at stated maturity, by acceleration or otherwise, of all obligations of the Company under the Senior Subordinated Notes, expenses, indemnification or otherwise.

The Company may redeem the Senior Subordinated Notes at its option, subject to certain notice provisions, at the following redemption prices (expressed as a percentage of principal amount), plus accrued and unpaid interest to the redemption date (subject to the right of holders of record on the relevant record date to receive interest due on the relevant interest payment date), if redeemed during the twelve-month period commencing on June 1 of the years set forth below:

 

Period

   Redemption Price  

2012

     105.25

2013

     103.50

2014

     101.75

2015 and thereafter

     100.00

Upon the occurrence of a change of control, each holder of the Senior Subordinated Notes has the right to require the Company to repurchase all or any part of such holder’s Senior Subordinated Notes, at a price in cash equal to 101% of the principal amount of the Senior Subordinated Notes redeemed plus accrued and unpaid interest, if any.

Senior Secured Second Lien Notes

On March 4, 2011, the Company issued $450.0 million aggregate principal amount of 8.875% senior secured second lien notes that mature on March 15, 2019 (the “Senior Secured Second Lien Notes”). Interest on the Senior Secured Second Lien Notes is payable semi-annually to holders of record at the close of business on March 1 or September 1 immediately preceding the interest payment date on March 15 and September 15 of each year, commencing on September 15, 2011.

The Senior Secured Second Lien Notes are guaranteed on a second-priority senior secured basis by all of the Company’s existing and future direct or indirect wholly-owned domestic subsidiaries that guarantee the Credit Facility. The Senior Secured Second Lien Notes and related guarantees are secured by a second-priority lien on substantially all of the assets that secure the Company’s and its subsidiary guarantors’ obligations under the Credit Facility. The Company used the net proceeds of the offering of the Senior Secured Second Lien Notes to reduce the entire $194.0 million outstanding under the Former Revolver (without terminating the commitment) and $241.0 million indebtedness under the Former Term Loan.

On or after March 15, 2015, the Company may redeem the Senior Secured Second Lien Notes at its option, subject to certain notice provisions, at the following redemption prices (expressed as a percentage of principal amount), plus accrued and unpaid interest to the redemption date (subject to the right of holders of record on the relevant record date to receive interest due on the relevant interest payment date), if redeemed during the twelve-month period commencing on March 15 of the years set forth below:

 

Period

   Redemption Price  

2015

     104.438

2016

     102.219

2017 and thereafter

     100.000

 

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In addition, prior to March 15, 2014, the Company may redeem in the aggregate up to 35% of the original aggregate principal amount of the Senior Secured Second Lien Notes with the net cash proceeds of certain equity offerings at a redemption price of 108.875%, plus accrued unpaid interest. The Company may also redeem Senior Secured Second Lien Notes prior to March 15, 2015, subject to certain notice periods, at a price equal to 100% of the principal amount of the Senior Secured Second Lien Notes redeemed plus an applicable premium and accrued and unpaid interest, if any.

9.0% Senior Secured First Lien Notes

On February 28, 2012, the Company issued $400.0 million aggregate principal amount of 9.00% senior secured first lien notes that mature on March 15, 2019 (the “9.0% Senior Secured First Lien Notes”). The notes were issued at a price equal to 100.00% of the principal amount. On March 12, 2012, the Company issued an additional $100.0 million aggregate principal amount of the same series of 9.0% Senior Secured First Lien Notes at a price equal to 101.50% of the principal amount. On September 20, 2012, the Company issued an additional $625.0 million aggregate principal amount of the same series of 9.0% Senior Secured First Lien Notes at a price equal to 102.50% of the principal amount. Interest on the 9.0% Senior Secured First Lien Notes is payable semi-annually to holders of record at the close of business on March 1 or September 1 immediately preceding the interest payment date on March 15 and September 15 of each year, commencing on September 15, 2012.

The 9.0% Senior Secured First Lien Notes are guaranteed on a first-priority senior secured basis by all of the Company’s existing and future direct or indirect wholly-owned domestic subsidiaries. The 9.0% Senior Secured First Lien Notes and related guarantees are secured, subject to certain exceptions and permitted liens, by a first priority lien on substantially all of the Company’s material owned assets and the material owned assets of subsidiary guarantors, limited in the case of equity interests held by the Company or any subsidiary guarantor in a foreign subsidiary, to 100% of the non-voting equity interests and 65% of the voting equity interests of such foreign subsidiary held directly by the Company or a subsidiary guarantor. The liens securing the 9.0% Senior Secured First Lien Notes rank equally to the liens securing the Credit Facility. The 9.0% Senior Secured First Lien Notes are subject to customary covenants, (described below), and events of default. The Company used the proceeds of the offerings of the 9.0% Senior Secured First Lien Notes to reduce $1,154.3 million of indebtedness under the Former Term Loan, and to pay $28.0 million in financing costs which have been recorded as Deferred Financing Costs, Net in the accompanying Consolidated Balance Sheets.

On or after March 15, 2015, the Company may redeem the 9.0% Senior Secured First Lien Notes at its option, subject to certain notice provisions, at the following redemption prices (expressed as a percentage of principal amount), plus accrued and unpaid interest to the redemption date (subject to the right of holders of record on the relevant record date to receive interest due on the relevant interest payment date), if redeemed during the twelve-month period commencing on March 15 of the years set forth below:

 

Period

   Redemption Price  

2015

     106.750

2016

     104.500

2017

     102.250

2018 and thereafter

     100.000

In addition, prior to March 15, 2015, the Company may redeem in the aggregate up to 35% of the original aggregate principal amount of the 9.0% Senior Secured First Lien Notes with the net cash proceeds of certain equity offerings at a redemption price of 109.000%, plus accrued unpaid interest. The Company may also redeem 9.0% Senior Secured First Lien Notes prior to March 15, 2015, subject to certain notice periods, at a price equal to 100% of the principal amount of the 9.0% Senior Secured First Lien Notes redeemed plus an applicable premium and accrued and unpaid interest, if any.

 

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Covenants

The Senior Fixed Rate Notes, Senior Toggle Notes, Senior Subordinated Notes, Senior Secured Second Lien Notes and 9.0% Senior Secured First Lien Notes (collectively, the “Notes”) and Credit Facility contain certain covenants that, among other things, and subject to certain exceptions and other basket amounts, restrict the ability of the Company and its subsidiaries to:

 

   

incur additional indebtedness;

 

   

pay dividends or distributions on its capital stock, repurchase or retire its capital stock and redeem, repurchase or defease any subordinated indebtedness;

 

   

make certain investments;

 

   

create or incur certain liens;

 

   

create restrictions on the payment of dividends or other distributions to us from the Company’s subsidiaries;

 

   

transfer or sell assets;

 

   

engage in certain transactions with its affiliates; and

 

   

merge or consolidate with other companies or transfer all or substantially all of its assets.

Certain of these covenants, such as limitations on the Company’s ability to make certain payments such as dividends, or incur debt, will no longer apply if the Notes have investment grade ratings from both of the rating agencies of Moody’s Investor Services, Inc. (“Moody’s”) and Standard & Poor’s Ratings Group (“S&P”) and no event of default has occurred. Since the date of issuance of the Notes, the Notes have not received investment grade ratings from Moody’s or S&P. Accordingly, all of the covenants under the Notes currently apply to the Company. None of these covenants, however, require the Company to maintain any particular financial ratio or other measure of financial performance except as previously disclosed herein for the Credit Facility. As of February 2, 2013, the Company is in compliance with the covenants under its Notes.

Europe Credit Facilities

The Company’s non-U.S. subsidiaries have bank credit facilities totaling approximately $2.5 million. 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 the respective country of operation. As of February 2, 2013, the entire amount of $2.5 million was available for borrowing by the Company, subject to a reduction of $2.2 million for outstanding bank guarantees.

Note Repurchases and Gain (Loss) in Early Debt Extinguishment

During Fiscal 2012, the Company recognized a $9.7 million loss on early debt extinguishment attributed to the write-off of unamortized debt issuance costs associated with the early repayment of $1,154.3 million of indebtedness under the Former Term Loan and replacement of the Former Revolver with the Credit Facility.

The following is a summary of the Company’s note repurchase activity during Fiscal 2011 and Fiscal 2010 (in thousands): There was no debt repurchase activity during Fiscal 2012.

 

     Fiscal 2011  
     Principal      Repurchase      Recognized  

Notes Repurchased

   Amount      Price      Gain (1)  

Senior Fixed Rate Notes

   $ 15,730       $ 15,213       $ 260   

Senior Toggle Notes

     69,617         63,130         6,145   
  

 

 

    

 

 

    

 

 

 
   $ 85,347       $ 78,343       $ 6,405   
  

 

 

    

 

 

    

 

 

 

 

(1) Net of deferred issuance cost write-offs of $257 for the Senior Fixed Rate Notes and $796 for the Senior Toggle Notes, and accrued interest write-off of $455 for the Senior Toggle Notes.

 

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     Fiscal 2010  
     Principal      Repurchase      Recognized  

Notes Repurchased

   Amount      Price      Gain (1)  

Senior Fixed Rate Notes

   $ 14,000       $ 12,268       $ 1,467   

Senior Toggle Notes

     57,173         49,798         7,612   

Senior Subordinated Notes

     22,625         17,799         4,309   
  

 

 

    

 

 

    

 

 

 
   $ 93,798       $ 79,865       $ 13,388   
  

 

 

    

 

 

    

 

 

 

 

(1) Net of deferred issuance cost write-offs of $265 for the Senior Fixed Rate Notes, $922 for the Senior Toggle Notes and $517 for the Senior Subordinated Notes, and accrued interest write-off of $1,159 for the Senior Toggle Notes.

 

6. DERIVATIVES AND HEDGING ACTIVITIES

The Company formally designates and documents the financial instrument as a hedge of a specific underlying exposure, as well as the risk management objectives and strategies for undertaking the hedge transaction. The Company formally assesses both at inception and at least quarterly thereafter, whether the financial instruments that are used in hedging transactions are effective at offsetting changes in cash flows of the related underlying exposure. The Company measures the effectiveness of its cash flow hedges by evaluating the following criteria: (i) the re-pricing dates of the derivative instrument match those of the debt obligation; (ii) the interest rates of the derivative instrument and the debt obligation are based on the same interest rate index and tenor; (iii) the variable interest rate of the derivative instrument does not contain a floor or cap, or other provisions that cause a basis difference with the debt obligation; and (iv) the likelihood of the counterparty not defaulting is assessed as being probable.

The Company primarily employs derivative financial instruments to manage its exposure to interest rate changes and to limit the volatility and impact of interest rate changes on earnings and cash flows. The Company does not enter into derivative financial instruments for trading or speculative purposes. The Company faces credit risk if the counterparties to the financial instruments are unable to perform their obligations. However, the Company seeks to mitigate derivative credit risk by entering into transactions with counterparties that are significant and creditworthy financial institutions. The Company monitors the credit ratings of the counterparties.

For derivatives that qualify as cash flow hedges, the Company reports the effective portion of the change in fair value as a component of “Accumulated other comprehensive income (loss), net of tax” in the Consolidated Balance Sheets and reclassifies it into earnings in the same periods in which the hedged item affects earnings, and within the same income statement line item as the impact of the hedged item. The ineffective portion of the change in fair value of a cash flow hedge is recognized in income immediately. No ineffective portion was recorded to earnings during Fiscal 2012, Fiscal 2011 and Fiscal 2010, respectively, and all components of the derivative gain or loss were included in the assessment of hedge effectiveness. For