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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 For the Quarterly Period Ended October 28, 2006
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from  to
 Commission file number 001-08899
 Claires Stores, Inc.
  Florida
    
    59-0940416(State or other jurisdiction of incorporation or organization)
    
    (I.R.S. Employer Identification No.)
 3 S.W. 129th Avenue, Pembroke Pines, Florida
    
    33027(Address of principal executive offices)
    
    (Zip Code)
 Registrants telephone number, including area code: (954) 433-3900
 þ o
 o
 Large accelerated filer þ           Accelerated filer o            Non-accelerated filer o
 o þ




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CLAIRES STORES, INC. AND SUBSIDIARIES
INDEX
 PAGE NO.PART I. FINANCIAL INFORMATIONItem 1. Financial StatementsUnaudited Condensed Consolidated Balance Sheets at October 28, 2006 and
January 28, 2006
    
    
    3Unaudited Condensed Consolidated Statements of Operations and
Comprehensive Income for the Three and Nine Months Ended
October 28, 2006 and October 29, 2005
    
    
    4Unaudited Condensed Consolidated Statements of Cash Flows for the
Nine Months Ended October 28, 2006 and October 29, 2005
    
    
    5Notes to Unaudited Condensed Consolidated Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of
Financial Condition and Results of
Operations
    
    
    13Item 3. Quantitative and Qualitative Disclosures
About Market Risk
    
    
    23Item 4. Controls and Procedures
    
    
    23PART II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    24Item 1A. Risk Factors
    
    
    24Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    24Item 5. Other Information
    
    
    24Item 6. Exhibits
    
    
    25SIGNATURE PAGE
    
    
    26Ex-3.1 Amended and Restated BylawsEx-31.1 Section 302 Certification of Co-CEOEx-31.2 Section 302 Certification of Co-CEOEx-31.3 Section 302 Certification of CFOEx-32.1 Section 906 Certification of Co-CEOEx-32.2 Section 906 Certification of Co-CEOEx-32.3 Section 906 Certification of CFO
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PART I. FINANCIAL INFORMATION
 CLAIRES STORES, INC. AND SUBSIDIARIES
 
 UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
 Oct. 28, 2006
    
    
    Jan. 28, 2006(In thousands, except share and per share amounts)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    244,551
    
    
    $
    431,122Inventories
    
    
    158,853
    
    
    
    113,405Prepaid expenses
    
    
    24,457
    
    
    
    17,738Other current assets
    
    
    44,680
    
    
    
    35,742Total current assets
    
    
    472,541
    
    
    
    598,007Property and equipment:Land and building
    
    
    17,350
    
    
    
    18,151Furniture, fixtures and equipment
    
    
    274,278
    
    
    
    252,346Leasehold improvements
    
    
    284,032
    
    
    
    238,817575,660
    
    
    
    509,314Less accumulated depreciation and amortization
    
    
    (314,745
    )
    
    
    (286,595
    )260,915
    
    
    
    222,719Intangible assets, net of accumulated amortization of $11,435
and $10,550, respectively
    
    
    61,461
    
    
    
    56,175Other assets
    
    
    17,725
    
    
    
    15,162Goodwill
    
    
    200,227
    
    
    
    198,638279,413
    
    
    
    269,975Total assets
    
    $
    1,012,869
    
    
    $
    1,090,701LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Trade accounts payable
    
    $
    77,880
    
    
    $
    50,242Income taxes payable
    
    
    20,892
    
    
    
    36,708Accrued expenses and other liabilities
    
    
    101,374
    
    
    
    92,495Total current liabilities
    
    
    200,146
    
    
    
    179,445Long-term liabilities:Deferred tax liability
    
    
    19,896
    
    
    
    20,979Deferred rent expense
    
    
    24,411
    
    
    
    21,959Other liabilities
    
    
    2,274
    
    
    
    46,581
    
    
    
    42,938Commitments and contingencies
    
    
    
    
    
    
    Stockholders equity:Preferred stock par value $1.00 per share; authorized
1,000,000 shares, issued and outstanding 0 shares
    
    
    
    
    
    
    Class A common stock par value $0.05 per share;
authorized 40,000,000 shares, issued and outstanding
4,880,120
shares and 4,895,746 shares, respectively
    
    
    244
    
    
    
    245Common stock par value $0.05 per share; authorized
300,000,000 shares, issued and outstanding 88,166,654
shares and 94,580,977 shares, respectively
    
    
    4,408
    
    
    
    4,729Additional paid-in capital
    
    
    74,373
    
    
    
    63,321Unearned compensation
    
    
    
    
    
    
    (2,690
    )Accumulated other comprehensive income, net of tax
    
    
    30,961
    
    
    
    21,036Retained earnings
    
    
    656,156
    
    
    
    781,677766,142
    
    
    
    868,318Total liabilities and stockholders equity
    
    $
    1,012,869
    
    
    $
    1,090,701
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CLAIRES STORES, INC. AND SUBSIDIARIES
 
 UNAUDITED CONDENSED CONSOLIDATED STATEMENTS
 OF OPERATIONS AND COMPREHENSIVE INCOME
 Three Months Ended
    
    
    Nine Months EndedOct. 28,
    
    
    Oct. 29,
    
    
    Oct. 28,
    
    
    Oct. 29,2006
    
    
    2005
    
    
    2006
    
    
    2005(In thousands, except per share amounts)Net sales
    
    $
    347,593
    
    
    $
    327,259
    
    
    $
    1,008,680
    
    
    $
    955,009Cost of sales, occupancy and buying expenses
    
    
    165,487
    
    
    
    151,541
    
    
    
    480,540
    
    
    
    442,084Gross profit
    
    
    182,106
    
    
    
    175,718
    
    
    
    528,140
    
    
    
    512,925Other expenses (income):Selling, general and administrative
    
    
    118,860
    
    
    
    112,631
    
    
    
    348,645
    
    
    
    334,722Depreciation and amortization
    
    
    14,249
    
    
    
    12,318
    
    
    
    41,319
    
    
    
    36,442Interest and other income
    
    
    (3,933
    )
    
    
    (3,761
    )
    
    
    (13,181
    )
    
    
    (8,805
    )129,176
    
    
    
    121,188
    
    
    
    376,783
    
    
    
    362,359Income before income taxes
    
    
    52,930
    
    
    
    54,530
    
    
    
    151,357
    
    
    
    150,566Income taxes
    
    
    16,303
    
    
    
    16,403
    
    
    
    49,067
    
    
    
    47,279Net income
    
    
    36,627
    
    
    
    38,127
    
    
    
    102,290
    
    
    
    103,287Foreign currency translation adjustments
    
    
    924
    
    
    
    638
    
    
    
    9,925
    
    
    
    (8,631
    )Comprehensive income
    
    $
    37,551
    
    
    $
    38,765
    
    
    $
    112,215
    
    
    $
    94,656Net income per share:Basic
    
    $
    0.39
    
    
    $
    0.38
    
    
    $
    1.05
    
    
    $
    1.04Diluted
    
    $
    0.39
    
    
    $
    0.38
    
    
    $
    1.05
    
    
    $
    1.04Basic weighted average number of common
shares outstanding
    
    
    94,414
    
    
    
    99,140
    
    
    
    97,045
    
    
    
    99,063Diluted weighted average number of common
and common equivalent shares outstanding
    
    
    94,605
    
    
    
    99,534
    
    
    
    97,324
    
    
    
    99,448Dividends declared per share:Common stock
    
    $
    0.10
    
    
    $
    0.10
    
    
    $
    0.30
    
    
    $
    0.30Class A common stock
    
    $
    0.05
    
    
    $
    0.05
    
    
    $
    0.15
    
    
    $
    0.15
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CLAIRES STORES, INC. AND SUBSIDIARIES
 
 UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 Nine Months EndedOct. 28, 2006
    
    
    Oct. 29, 2005(In thousands)Cash flows from operating activities:Net income
    
    $
    102,290
    
    
    $
    103,287Adjustments to reconcile net income to net cash
provided by operating activities:Depreciation and amortization
    
    
    41,319
    
    
    
    36,442Amortization of intangible assets
    
    
    1,142
    
    
    
    829Loss on sale/retirement of property and equipment, net
    
    
    1,141
    
    
    
    2,523Gain on sale of intangible assets
    
    
    (47
    )
    
    
    Excess tax benefit from stock-based compensation
    
    
    (3,442
    )
    
    
    Stock-based compensation expense
    
    
    5,981
    
    
    
    2,504(Increase) decrease in -Inventories
    
    
    (43,601
    )
    
    
    (38,843
    )Prepaid expenses
    
    
    (5,665
    )
    
    
    5,389Other assets
    
    
    (7,541
    )
    
    
    (5,770
    )Increase (decrease) in -Trade accounts payable
    
    
    25,685
    
    
    
    34,348Income taxes payable
    
    
    (12,197
    )
    
    
    (14,961
    )Accrued expenses and other liabilities
    
    
    5,275
    
    
    
    (4,789
    )Deferred income taxes
    
    
    (4,564
    )
    
    
    (2,264
    )Deferred rent expense
    
    
    2,134
    
    
    
    1,914Net cash provided by operating activities
    
    
    107,910
    
    
    
    120,609Cash flows from investing activities:Acquisition of property and equipment
    
    
    (76,755
    )
    
    
    (55,314
    )Proceeds from sale of land and building
    
    
    881
    
    
    
    Acquisition of intangible assets
    
    
    (3,604
    )
    
    
    (6,968
    )Purchase of short-term investments
    
    
    
    
    
    
    (82,334
    )Sale of short-term investments
    
    
    
    
    
    
    216,947Net cash provided by (used in) investing activities
    
    
    (79,478
    )
    
    
    72,331Cash flows from financing activities:Proceeds from stock options exercised
    
    
    8,565
    
    
    
    3,141Purchase and retirement of common stock
    
    
    (199,675
    )
    
    
    Excess tax benefit from stock-based compensation
    
    
    3,442
    
    
    
    Dividends paid
    
    
    (28,491
    )
    
    
    (28,992
    )Net cash used in financing activities
    
    
    (216,159
    )
    
    
    (25,851
    )Effect of foreign currency exchange rate changes on cash
and cash equivalents
    
    
    1,156
    
    
    
    1,662Net increase (decrease) in cash and cash equivalents
    
    
    (186,571
    )
    
    
    168,751Cash and cash equivalents at beginning of period
    
    
    431,122
    
    
    
    191,006Cash and cash equivalents at end of period
    
    $
    244,551
    
    
    $
    359,757
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CLAIRES STORES, INC. AND SUBSIDIARIES
 
 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 1.
    
    Basis of Presentation and Significant Accounting PoliciesThe accompanying unaudited condensed consolidated financial statements have been prepared in
accordance with the instructions to Form 10-Q, and do not include all of the information and
footnotes required by generally accepted accounting principles for complete financial
statements. In the opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair statement have been included. These statements should
be read in conjunction with the consolidated financial statements and notes thereto included in
the Annual Report on Form 10-K for the year ended January 28, 2006 filed with the Securities and
Exchange Commission, including Note 1 to the consolidated financial statements included therein
which discusses principles of consolidation and a summary of significant accounting policies.
These statements have been prepared in accordance with U.S. generally accepted accounting
principles, which require management to make certain estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts of revenues and expenses during
the reporting period. The most significant estimates include valuation of inventories,
valuation of goodwill and intangible assets, provisions for income taxes, stock-based
compensation, and contingencies and litigation. Actual results could differ from these
estimates. Due to the seasonal nature of the Companys business, the results of operations for
interim periods of the year are not necessarily indicative of the results of operations on an
annualized basis. Certain prior period amounts have been reclassified to conform to the current
period presentation.Stock-Based CompensationThe Company adopted Statement of Financial Accounting Standard No. 123 (revised 2004),
Share-Based Payment (SFAS No. 123R) on January 29, 2006.Time-vested stock awards are accounted for at fair value at date of grant. The compensation
expense is recorded over the requisite service period.Other stock awards, such as long-term incentive plan awards, which qualify as equity plans under
SFAS No. 123R, are accounted for based on fair value at date of grant. The compensation expense
is based on the number of shares expected to be issued when it becomes probable that performance
targets required to receive the award will be achieved. The expense is recorded over the
requisite service period.Other long-term incentive plans accounted for as liabilities under SFAS No. 123R are recorded at
fair value at each reporting date until settlement. The compensation expense is based on the
number of performance units expected to be issued when it becomes probable that performance
targets required to receive the award will be achieved. The expense is recorded over the
requisite service period.Recent Accounting PronouncementsIn July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No.
48, Accounting for Uncertainty in Income Taxes  an interpretation of FASB Statement No. 109
(FIN 48). FIN 48 clarifies the accounting and reporting for uncertainties in income tax law.
The interpretation prescribes a comprehensive model for the financial statement recognition,
measurement, presentation and disclosure of uncertain tax positions taken or expected to be
taken in income tax returns. FIN 48 is effective for fiscal years beginning after December 15,
2006. The Company is currently assessing the impact, if any, of FIN 48 which it will adopt at
the beginning of Fiscal 2008.In June 2006, the FASB ratified Emerging Issues Task Force (EITF) Issue No. 06-3, How Taxes
Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the
Income Statement (that is, Gross versus Net Presentation), which allows companies to adopt a
policy of presenting taxes in the income statement on either a gross or net basis. Taxes within
the scope of this EITF would include taxes that are imposed on a revenue transaction between a
seller and a customer. If such taxes are significant, the accounting policy should be disclosed
as well as the amount of taxes included in the financial statements if presented on a gross
basis. EITF 06-3 is effective for interim and
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annual reporting periods beginning after December 15, 2006. EITF 06-3 will not impact the method for recording and
reporting these sales or value added taxes in the consolidated financial statements as the
Company does not record such taxes on a gross basis.In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. The Statement
defines fair value, establishes a framework for measuring fair value in generally accepted
accounting principles, and expands disclosure about fair value measurements. This Statement
does not require any new fair value measurement and applies to financial statements issued for
fiscal years beginning after November 15, 2007 with early application encouraged. The Company
is required to implement this Statement on February 3, 2008. The Company does not expect this
Statement will have a material impact on its financial position, results of operations or cash
flows.The FASB recently ratified EITF 06-5, Accounting for Purchases of Life Insurance-Determining
the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4 (EITF
06-5). EITF 06-5 requires that a policyholder should consider any additional amounts included
in the contractual terms of the policy in determining the amount that could be realized under
the insurance contract. EITF 06-5 is effective for fiscal years beginning after December 15,
2006 and it requires that recognition of the effects of adoption should be either by (a) a
change in accounting principle through a cumulative-effect adjustment to retained earnings as of
the beginning of the year of adoption or (b) a change in accounting principle through
retrospective application to all prior periods. The Company does not expect EITF 06-5 will have
a material impact on its financial position, results of operations or cash flows.In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No.
108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in
Current Year Financial Statements (SAB 108). SAB 108 requires that registrants quantify
errors using both a balance sheet and income statement approach and evaluate whether either
approach results in a misstated amount that, when all relevant quantitative and qualitative
factors are considered, is material. SAB 108 is effective for the first fiscal year ending
after November 15, 2006 and is not expected to have a material impact on the Companys
consolidated financial statements.2.
    
    Earnings Per ShareThe information required to compute basic and diluted earnings per share is as follows (in
thousands, except per share data):
 Three Months Ended
    
    
    Nine Months EndedOct. 28,
    
    
    Oct. 29,
    
    
    Oct. 28,
    
    
    Oct. 29,2006
    
    
    2005
    
    
    2006
    
    
    2005Numerator:Net income
    
    $
    36,627
    
    
    $
    38,127
    
    
    $
    102,290
    
    
    $
    103,287Denominator:Weighted average number of shares outstandingBasic
    
    
    94,414
    
    
    
    99,140
    
    
    
    97,045
    
    
    
    99,063Effect of dilutive stock options
    
    
    155
    
    
    
    359
    
    
    
    222
    
    
    
    364Effect of dilutive time-vested stock awards
    
    
    36
    
    
    
    35
    
    
    
    57
    
    
    
    21Diluted
    
    
    94,605
    
    
    
    99,534
    
    
    
    97,324
    
    
    
    99,448Net income per share:Basic
    
    $
    0.39
    
    
    $
    0.38
    
    
    $
    1.05
    
    
    $
    1.04Diluted
    
    $
    0.39
    
    
    $
    0.38
    
    
    $
    1.05
    
    
    $
    1.04
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All outstanding time-vested stock awards and options for the three and nine months ended
October 28, 2006 were included in the computation of diluted earnings per share. All
outstanding options and time-vested stock awards for the three months ended October 29, 2005
were included in the computation of diluted earnings per share. Time-vested stock awards of
5,476 shares of common stock for the nine months ended October 29, 2005 were not included in the
computation of diluted earnings per share because their effect would be anti-dilutive. All
outstanding options for the nine months ended October 29, 2005 were included in the computation
of diluted earnings per share.3.
    
    Stock-Based CompensationThe Company issues stock options and other stock-based awards to executive management, key
employees and directors under its stock-based compensation plans.Through January 28, 2006, the Company accounted for stock-based compensation using the intrinsic
value method under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees (APB 25). For grants of restricted stock, other than those awarded under long-term
incentive agreements, the fair value of the shares at the date of grant was amortized to
compensation expense over the awards vesting period. For awards of stock granted under
long-term incentive agreements, the fair value at the end of each reporting period was amortized
to compensation expense over the awards vesting period. The Company has historically reported
pro forma results under the disclosure-only provisions of Statement of Financial Accounting
Standards No. 123, Accounting for Stock-Based Compensation (SFAS No. 123), as amended by
Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based
Compensation-Transition and Disclosure.
 Three Months Ended
    
    
    Nine Months EndedOct. 29,
    
    
    Oct. 29,2005
    
    
    2005Net income  as reported
    
    $
    38,127
    
    
    $
    103,287Stock-based employee compensation
expense determined under the fair
value based method, net of income tax
    
    
    (948
    )
    
    
    (2,691
    )Stock-based employee compensation
expense included in reported net
income, net of income tax
    
    
    584
    
    
    
    1,628Net income  pro forma
    
    $
    37,763
    
    
    $
    102,224Basic net income per share  as reported
    
    $
    0.38
    
    
    $
    1.04Basic net income per share  pro forma
    
    $
    0.38
    
    
    $
    1.03Diluted net income per share  as reported
    
    $
    0.38
    
    
    $
    1.04Diluted net income per share  pro forma
    
    $
    0.38
    
    
    $
    1.03
 Effective January 29, 2006, the Company adopted SFAS No. 123R using the modified
prospective transition method. Under the modified prospective transition method, fair value
accounting and recognition provisions of SFAS No. 123R are applied to share-based awards granted
or modified subsequent to the date of adoption and prior periods presented are not restated. In
addition, for awards granted prior to the effective date, the unvested portion of the awards is
recognized in periods subsequent to the effective date based on the grant date fair value
determined for pro forma disclosure purposes under SFAS No. 123.Prior to adopting SFAS No. 123R, the Company presented tax benefits resulting from the exercise
of stock options as operating cash flows in the statements of cash flows. SFAS No. 123R
requires cash flows resulting from excess tax benefits to be classified as a part of cash flows
from financing activities. Excess tax benefits are realized tax benefits from tax deductions
for stock-based compensation in excess of the deferred tax asset attributable to stock
compensation costs.
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During the three months ended October 28, 2006 and October 29, 2005, the Company recognized $2.2
million and $0.9 million, respectively, of stock-based compensation cost and related tax
benefits of approximately $0.7 million and $0.3 million, respectively. In the nine months ended
October 28, 2006 and October 29, 2005, the Company recognized total stock-based compensation
cost of $6.0 million and $2.5 million, respectively, and related tax benefits of approximately
$2.0 million and $0.8 million, respectively. As a result of the adoption of SFAS No. 123R, the
Companys income before income taxes, net income and basic and diluted earnings per share for
the three and nine months ended October 28, 2006 are not materially different than if the
Company had continued to account for the share-based compensation programs under APB 25. For
the nine months ended October 28, 2006, cash flow from operating activities decreased $3.4
million and cash flow from financing activities increased $3.4 million as a result of adoption
of SFAS No. 123R and the requirement relating to classification of cash flows of tax benefits
from share-based compensation.The Company issues new shares to satisfy share-based awards and exercise of stock options.
During the three and nine month periods ended October 28, 2006 and October 29, 2005, no cash was
used to settle equity instruments granted under share-based payment arrangements.Under the Claires Stores, Inc. Amended and Restated 1996 Incentive Plan (the 1996 Plan), the
Company may grant either incentive stock options or non-qualified stock options to purchase up
to 8,000,000 shares of Common stock, plus any shares unused or recaptured from previous plans.
Incentive stock options granted under the 1996 Plan are exercisable at prices equal to the fair
market value of shares at the date of grant, except that incentive stock options granted to any
person holding 10% or more of the total combined voting power or value of all classes of capital
stock of the Company, or any subsidiary of the Company, carry an exercise price equal to 110% of
the fair market value at the date of grant. The aggregate number of shares granted to any one
person may not exceed 1,000,000. Each incentive stock option or non-qualified stock option will
terminate ten years after the date of grant (or such shorter period as specified in the grant)
and may not be exercised thereafter.The Claires Stores, Inc. Amended and Restated 2005 Incentive Plan (the 2005 Plan) was
approved by the Companys Board of Directors in March 2005 and by stockholders in June 2005.
Under the 2005 Plan, the Company may grant incentive stock options, non-qualified stock options,
restricted and deferred stock awards, dividend equivalents, stock appreciation rights, bonus
stock awards, performance awards and other stock based awards to purchase up to 2,000,000 shares
of Common stock, plus any shares unused or recaptured from previous plans. Incentive stock
options available for grant under the 2005 Plan are exercisable at prices equal to the fair
market value of shares at the date of the grant, except that incentive stock options available
to any person holding 10% or more of the total combined voting power or value of all classes of
capital stock of the Company, or any subsidiary of the Company, carry an exercise price equal to
110% of the fair market value at the date of the grant. The aggregate number of shares granted
to any one person may not exceed 500,000 shares. Each incentive stock option or non-qualified
stock option will terminate ten years after the date of grant (or such shorter period as
specified in the grant) and may not be exercised thereafter. The terms and conditions related
to restricted and deferred stock awards, dividend equivalents, stock appreciation rights, bonus
stock awards, performance awards and other stock based awards will be determined by the
Compensation Committee of the Companys Board of Directors.Incentive stock options currently outstanding are exercisable at a price equal to the fair
market value of the shares at date of grant and expire ten years after the date of grant.
Non-qualified stock options currently outstanding are exercisable at prices equal to the fair
market value of the shares at date of grant and expire ten years after the date of grant.There were 9,192,709 shares of Common stock available for future grants under the 2005 Plan at
October 28, 2006 (which includes shares recaptured from the previous plans). There will be no
future grants under the 1996 Plan.On January 23, 2006, the Company accelerated the vesting of approximately 659,000 incentive and
non-qualified stock options held by employees, representing substantially all unvested options
outstanding at the time of acceleration. These accelerated options had a weighted average
exercise price of $16.29, which was less than the market price of the Companys Common stock of
$29.34 at the time of
 9




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##### Table of Contents



acceleration. This action resulted in non-cash, stock-based compensation expense of $314,000 in Fiscal 2006. The decision
to accelerate vesting of these options was made primarily to avoid recognizing the related
aggregate compensation cost of approximately $4.2 million in the Companys consolidated
financial statements primarily during Fiscal 2007 and 2008 under SFAS No. 123R.A summary of the activity in the Companys stock option plans is presented below:
 Nine Months Ended October 28, 2006WeightedWeighted
    
    
    AverageAverage
    
    
    Remaining
    
    
    AggregateNumber
    
    
    Exercise
    
    
    Contractual
    
    
    Intrinsicof Shares
    
    
    Price
    
    
    Life (Years)
    
    
    ValueOutstanding at beginning of
period
    
    
    1,113,436
    
    
    $
    15.33Options granted
    
    
    
    
    
    
    Options exercised
    
    
    (594,436
    )
    
    $
    14.42Options canceled
    
    
    (10,000
    )
    
    $
    16.93Outstanding at end of period
    
    
    509,000
    
    
    $
    16.36
    
    
    
    6.33
    
    
    $
    5,925,230Exercisable at end of period
    
    
    509,000
    
    
    $
    16.36
    
    
    
    6.33
    
    
    $
    5,925,230
 On January 29, 2006, substantially all of the Companys outstanding stock options were vested
and exercisable. During the three and nine month periods ended October 28, 2006 and October 29,
2005, no compensation expense relating to stock options was recorded. The aggregate intrinsic
value of stock options exercised during the three month periods ended October 28, 2006 and
October 29, 2005 was approximately $47,000 and $0.8 million, respectively. The aggregate
intrinsic value of stock options exercised during the nine month periods ended October 28, 2006
and October 29, 2005 was approximately $11.1 million and $2.1 million, respectively.Time-Vested Stock Awards  During the fiscal year ended January 28, 2006, the Company
issued approximately 170,000 shares of restricted common stock to non-management directors and
executive management. The shares were issued under the 1996 Plan and 2005 Plan. The recipients
are entitled to vote and receive dividends on the shares, which are subject to certain transfer
restrictions and forfeiture if a recipient leaves the Company for various reasons, other than
disability, death, or certain other events. The weighted average grant date fair value was
$22.48 per share. The stock, which had an aggregate fair value at date of grant of
approximately $3.8 million, is subject to vesting provisions of one to three years based on
continued employment or service to the Company.During June, 2006, the Company issued an additional 18,400 shares of restricted common stock to
non-management directors under the 2005 Plan. The weighted average grant date fair value was
$24.38 per share. The stock, which had an aggregate fair value at date of grant of
approximately $449,000, is subject to vesting provisions of one year based on continued service
to the Company. There were no other grants of restricted stock during the nine months ended
October 28, 2006.
 10




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##### Table of Contents



Compensation expense relating to all outstanding time-vested shares during the three months
ended October 28, 2006 and October 29, 2005 approximated $337,000 and $378,000, respectively.
Compensation expense relating to all outstanding time-vested shares recorded during the nine
months ended October 28, 2006 and October 29, 2005 was approximately $1,006,000 and $794,000,
respectively. At October 28, 2006, unearned compensation related to these shares was $2.1
million. That cost is expected to be recognized over a weighted-average period of approximately
1.2 years. At the date of vesting, the total fair value of time-vested shares which vested
during the nine months ended October 28, 2006 approximated $1.7 million.A summary of the activity during the nine months ended October 28, 2006 in the Companys
time-vested stock is presented below:
 Weighted-AverageTime-Vested Shares
    
    Shares
    
    
    Grant Date Fair ValueNonvested at beginning of period
    
    
    169,933
    
    
    $
    22.48Granted
    
    
    18,400
    
    
    $
    24.38Vested
    
    
    (57,433
    )
    
    $
    23.02Forfeited
    
    
    
    
    
    
    Nonvested at end of period
    
    
    130,900
    
    
    $
    22.52
 Long-Term Incentive Stock Plan  In Fiscal 2006, the Compensation Committee of the Board
of Directors (the Compensation Committee) began granting performance stock awards, generally
referred to as the long-term incentive plan (the LTIP). Under the LTIP, common stock will be
awarded to certain officers and employees upon the Companys achievement of specific measurable
performance criteria determined by the Compensation Committee, as may be adjusted by the
Compensation Committee under the 1996 Plan and 2005 Plan. The performance grants for Fiscal
2006 were made under the 1996 Plan. During the three months ended October 28, 2006 and October
29, 2005, compensation expense and additional paid-in capital of approximately $251,000 and
$521,000, respectively, was recorded in conjunction with the LTIP. During the nine months ended
October 28, 2006 and October 29, 2005, compensation expense and additional paid-in capital of
approximately $762,000 and $1.7 million, respectively, was recorded in conjunction with the
LTIP. Compensation expense during the three and nine months ended October 28, 2006 was based on
the fair value of the common stock at date of grant in Fiscal 2006. Compensation expense for
the three and nine months ended October 29, 2005 was based on the fair value of the common stock
on October 29, 2005. Shares awarded under the LTIP vest over a three year period subject to the
Company achieving specified performance targets in each of the three years. During Fiscal 2006,
officers and employees earned approximately 54,000 shares of common stock representing shares
earned through achievement of performance targets for Fiscal 2006. These shares were issued
during May 2006. A maximum of approximately 609,000 additional shares may be issued under the
LTIP for Fiscal 2006 grants.During April 2006, the Compensation Committee approved the Fiscal 2007 Long-Term Incentive
Program (Fiscal 2007 LTIP). Under the Fiscal 2007 LTIP, Performance Units will be issued to
certain officers and employees upon the Companys achievement during the fiscal year ended
February 3, 2007 of specific measurable performance criteria determined by the Compensation
Committee, as may be adjusted by the Compensation Committee. An aggregate maximum of
approximately 1,030,000 Performance Units may be earned under the Fiscal 2007 LTIP. The
Performance Units will be paid in cash, based on the closing price of the Companys common stock
at the end of each of the three fiscal years in the vesting period. Performance Units earned
vest over a three year period at the rate of 25%, 25% and 50% during the years ended February 3,
2007, February 2, 2008 and January 31, 2009, respectively. The Fiscal 2007 LTIP is accounted
for as a liability under SFAS 123R. During the three and nine months ended October 28, 2006,
the Company recorded compensation expense of approximately
 11




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##### Table of Contents



$1.6 million and $4.2 million,
respectively, in conjunction with the Fiscal 2007 LTIP. The compensation expense was based on the common stock closing price
on October 28, 2006 of $28.00.4.
    
    Segment InformationThe Company is organized based on the geographic markets in which it operates. Under this
structure, the Company currently has two reportable segments: North America and International.
The Company accounts for the goods it sells to third parties who license our brand under the
merchandising agreements within Net sales and Cost of sales, occupancy and buying expenses
in its North American division and the license fees it charges under the licensing agreements
within Interest and other income within its International division in the Companys
Consolidated Statements of Operations and Comprehensive Income. The Company accounts for the
results of operations of Claires Nippon under the equity method and includes the results within
Interest and other income in the Companys Unaudited Condensed Consolidated Statements of
Operations and Comprehensive Income within the Companys North American division. Substantially
all of the stock-based compensation expense is recorded in the Companys North American
division. Net sales and Income before income taxes for the periods presented were as follows
(dollars in thousands):
 Income Before
    
    
    
    
    
    
    
    
    
    
    Income BeforeNet Sales
    
    
    Income Taxes
    
    
    Net Sales
    
    
    Income TaxesThree Months Ended
    
    
    Three Months Ended
    
    
    Nine Months Ended
    
    
    Nine Months EndedOct. 28,
    
    
    Oct. 29,
    
    
    Oct. 28,
    
    
    Oct. 29,
    
    
    Oct. 28,
    
    
    Oct. 29,
    
    
    Oct. 28,
    
    
    Oct. 29,2006
    
    
    2005
    
    
    2006
    
    
    2005
    
    
    2006
    
    
    2005
    
    
    2006
    
    
    2005North America
    
    $
    236,337
    
    
    $
    228,668
    
    
    $
    40,505
    
    
    $
    41,732
    
    
    $
    699,200
    
    
    $
    667,936
    
    
    $
    122,324
    
    
    $
    119,615International
    
    
    111,256
    
    
    
    98,591
    
    
    
    12,425
    
    
    
    12,798
    
    
    
    309,480
    
    
    
    287,073
    
    
    
    29,033
    
    
    
    30,951Total
    
    $
    347,593
    
    
    $
    327,259
    
    
    $
    52,930
    
    
    $
    54,530
    
    
    $
    1,008,680
    
    
    $
    955,009
    
    
    $
    151,357
    
    
    $
    150,566
 5.
    
    Income TaxesThe Companys effective income tax rate during the three and nine months ended October 28, 2006
was 30.8% and 32.4%, respectively, as compared to 30.1% and 31.4% during the three and nine
months ended October 29, 2005, respectively. The Companys higher effective income tax rate for
the three and nine months ended October 28, 2006 was due to a change in the overall geographic
mix of earnings and non-recurring items. For the three months ended October 28, 2006, the
Companys effective income tax rate was lower than its expected rate primarily due to a foreign
tax examination that was settled more favorably than anticipated. For the three months ended
October 29, 2005, the Companys effective income tax rate was lower than its expected rate
primarily as a result of a reconciliation between the prior year end tax provision and the tax
return relating to U.S. taxation of the Companys foreign operations.6.
    
    Statements of Cash FlowsPayments of income taxes were $67.3 million and $63.5 million for the nine months ended October
28, 2006 and October 29, 2005, respectively.During the nine months ended October 28, 2006 and October 29, 2005, Property and equipment with
an original cost of $19.2 million and $13.1 million, respectively, was retired. The loss on
retirement approximated $1.9 million and $2.5 million for the nine months ended October 28, 2006
and October 29, 2005, respectively.
 12




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##### Table of Contents



7.
    
    Stockholders EquityDuring the three and nine months ended October 28, 2006, the Company repurchased and retired
approximately 3,214,000 and 7,097,000 shares of common stock, respectively.See Note 3 for shares issued during May 2006 in conjunction with the Companys long-term
incentive stock plan.8.
    
    Commitments and ContingenciesThe Company is, from time to time, involved in litigation incidental to the
conduct of its business, including personal injury litigation, litigation
regarding merchandise sold, including product and safety concerns regarding
metal content in merchandise, litigation with respect to various employment
matters, including wage and hour litigation, litigation with present and former
employees and litigation regarding intellectual property rights. The Company
believes that current pending litigation will not have a material adverse
effect on its financial position, earnings or cash flows.
 
 Item 2. Managements Discussion and Analysis of Financial
Condition and Results of Operations
    Overview
  13




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##### Table of Contents




    
    maximizing the effectiveness of our retail product pricing through promotional activity
    
    minimizing our product costs through economies of scale as the worlds leading
mall-based retailer of value-priced accessories and jewelry
    
    reinvesting operating cash flows into opening new stores, remodeling existing stores and
infrastructure in order to create future revenues and build brand name loyalty
  
    
    successfully identifying merchandise appealing to our customers and managing our
inventory levels
    
    displaying our merchandise at convenient, accessible locations staffed with personnel
that provide courteous and professional customer service
    
    sourcing our merchandise to achieve a positive price/value relationship
    
    increasing sales at existing store locations
    
    expanding our sales, especially in our International division, through additional store locations
  Critical Accounting Policies and Estimates
  14




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##### Table of Contents



Stock-Based Compensation
       Results of Operations
 Consolidated Operations
  Three Months Ended
    
    Nine Months EndedOct. 28,
    
    Oct. 29,
    
    Oct. 28,
    
    Oct. 29,2006
    
    2005
    
    2006
    
    2005Net sales
    
    $
    347,593
    
    
    $
    327,259
    
    
    $
    1,008,680
    
    
    $
    955,009Increase in comparable store sales
    
    
    0.0
    %
    
    
    9.0
    %
    
    
    2.0
    %
    
    
    6.0
    %Gross profit percentage
    
    
    52.4
    %
    
    
    53.7
    %
    
    
    52.4
    %
    
    
    53.7
    %Selling, general and administrative expenses
as a percentage of Net sales
    
    
    34.2
    %
    
    
    34.4
    %
    
    
    34.6
    %
    
    
    35.0
    %Net income
    
    $
    36,627
    
    
    $
    38,127
    
    
    $
    102,290
    
    
    $
    103,287Net income per diluted share
    
    $
    0.39
    
    
    $
    0.38
    
    
    $
    1.05
    
    
    $
    1.04Number of stores at the end of the period (1)
    
    
    2,987
    
    
    
    2,881
    
    
    
    2,987
    
    
    
    2,881
 
 (1)
    
    Number of stores excludes Claires Nippon and stores operated under licensing agreements outside of North America 15




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##### Table of Contents



Three Months Ended
    
    Nine Months EndedOct. 28,
    
    Oct. 29,
    
    Oct. 28,
    
    Oct. 29,2006
    
    2005
    
    2006
    
    2005Jewelry
    
    
    59.0
    %
    
    
    59.0
    %
    
    
    60.0
    %
    
    
    59.0
    %Accessories
    
    
    41.0
    %
    
    
    41.0
    %
    
    
    40.0
    %
    
    
    41.0
    %100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    16




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##### Table of Contents



Segment Operations
  North America
  Three Months Ended
    
    Nine Months EndedOct. 28,
    
    Oct. 29,
    
    Oct. 28,
    
    Oct. 29,2006
    
    2005
    
    2006
    
    2005Net sales
    
    $
    236,337
    
    
    $
    228,668
    
    
    $
    699,200
    
    
    $
    667,936Increase in comparable store sales
    
    
    1.0
    %
    
    
    9.0
    %
    
    
    3.0
    %
    
    
    5.0
    %Gross profit percentage
    
    
    52.7
    %
    
    
    53.5
    %
    
    
    52.9
    %
    
    
    53.9
    %Number of stores at the end of the period (1)
    
    
    2,145
    
    
    
    2,131
    
    
    
    2,145
    
    
    
    2,131
 
 (1)
    
    Number of stores excludes Claires Nippon and stores operated under licensing agreements outside of North America  17




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##### Table of Contents



Three Months Ended
    
    Nine Months EndedOct. 28,
    
    Oct. 29,
    
    Oct. 28,
    
    Oct. 29,2006
    
    2005
    
    2006
    
    2005Jewelry
    
    
    63.0
    %
    
    
    65.0
    %
    
    
    65.0
    %
    
    
    66.0
    %Accessories
    
    
    37.0
    %
    
    
    35.0
    %
    
    
    35.0
    %
    
    
    34.0
    %100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
  International
  Three Months Ended
    
    Nine Months EndedOct. 28,
    
    Oct. 29,
    
    Oct. 28,
    
    Oct. 29,2006
    
    2005
    
    2006
    
    2005Net sales
    
    $
    111,256
    
    
    $
    98,591
    
    
    $
    309,480
    
    
    $
    287,073Increase (decrease) in comparable store sales
    
    
    (1.0
    %)
    
    
    8.0
    %
    
    
    (1.0
    %)
    
    
    9.0
    %Gross profit percentage
    
    
    51.7
    %
    
    
    54.1
    %
    
    
    51.2
    %
    
    
    53.3
    %Number of stores at the end of the period (1)
    
    
    842
    
    
    
    750
    
    
    
    842
    
    
    
    750
 
 (1)
    
    Number of stores excludes Claires Nippon and stores operated under licensing agreements 18




---



##### Table of Contents



Three Months Ended
    
    Nine Months EndedOct. 28,
    
    Oct. 29,
    
    Oct. 28,
    
    Oct. 29,2006
    
    2005
    
    2006
    
    2005Jewelry
    
    
    49.0
    %
    
    
    46.0
    %
    
    
    49.0
    %
    
    
    45.0
    %Accessories
    
    
    51.0
    %
    
    
    54.0
    %
    
    
    51.0
    %
    
    
    55.0
    %100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
 19




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##### Table of Contents



Analysis of Consolidated Financial Condition
  Nine Months EndedOct. 28,
    
    Oct. 29,2006
    
    2005Operating activities
    
    $
    107,910
    
    
    $
    120,609Investing activities
    
    $
    (79,478
    )
    
    $
    72,331Financing activities
    
    $
    (216,159
    )
    
    $
    (25,851
    )
       20




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##### Table of Contents



Credit Arrangements
    Recent Accounting Pronouncements
   21




---



##### Table of Contents



Cautionary Note Regarding Forward-Looking Statements and Risk Factors
  22




---



##### Table of Contents



Item 3. Quantitative and Qualitative Disclosures About Market Risk
 Foreign Currency
    Interest Rates
  
 Item 4. Controls and Procedures
   23




---



##### Table of Contents



PART II. OTHER INFORMATION
 
 Item 1. Legal Proceedings
  
 Item 1A. Risk Factors
  
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
   Total Number of
    
    
    Approximate DollarTotal
    
    
    
    
    
    
    Shares Purchased
    
    
    Value of Shares thatNumber
    
    
    Average
    
    
    as Part of Publicly
    
    
    May Yet beof Shares
    
    
    Price Paid
    
    
    Announced
    
    
    Purchased UnderPeriod
    
    Purchased
    
    
    per Share
    
    
    Programs
    
    
    the ProgramsJuly 30, 2006  August 26, 2006
    
    
    857
    
    
    $
    25.56
    
    
    
    857
    
    
    $
    66,390August 27, 2006  September 30, 2006
    
    
    1,668
    
    
    
    27.74
    
    
    
    1,668
    
    
    
    20,113October 1, 2006  October 28, 2006
    
    
    689
    
    
    
    28.71
    
    
    
    689
    
    
    
    325Total Third Quarter
    
    
    3,214
    
    
    $
    27.37
    
    
    
    3,214
    
    
    $
    0
 
 Item 5. Other Information
  24




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##### Table of Contents



Item 6. Exhibits
 3.1
    
    Amended and Restated Bylaws31.1
    
    Certification of Co-Chief Executive Officer pursuant to Rule
13a-14(a) and 15d-14(a).31.2
    
    Certification of Co-Chief Executive Officer pursuant to Rule
13a-14(a) and 15d-14(a).31.3
    
    Certification of Chief Financial Officer pursuant to Rule
13a-14(a) and 15d-14(a).32.1
    
    Certification of Co-Chief Executive Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.32.2
    
    Certification of Co-Chief Executive Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.32.3
    
    Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
 Items 3 and 4 are not applicable and have been omitted.
 25




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##### Table of Contents



SIGNATURE
  CLAIRES STORES, INC.
(Registrant)December 6, 2006
    
    /s/ Marla L. SchaeferMarla L. SchaeferCo-Chairman of the Board of Directors
(principal co-executive officer and
director)December 6, 2006
    
    /s/ E. Bonnie SchaeferE. Bonnie SchaeferCo-Chairman of the Board of Directors
(principal co-executive officer and
director)December 6, 2006
    
    /s/ Ira D. KaplanIra D. Kaplan, Senior Vice President,
Chief Financial Officer and Director
(principal financial and accounting
officer and director)
 26




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##### Table of Contents



INDEX TO EXHIBITS
 EXHIBIT NO.
    
    DESCRIPTION3.1
    
    

Amended
and Restated Bylaws.31.1
    
    
    Certification of Co-Chief Executive Officer pursuant to Rule 13a-14(a) and
15d-14(a).31.2
    
    
    Certification of Co-Chief Executive Officer pursuant to Rule 13a-14(a) and
15d-14(a).31.3
    
    
    Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and
15d-14(a).32.1
    
    
    Certification of Co-Chief Executive Officer pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    
    Certification of Co-Chief Executive Officer pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.3
    
    
    Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 27