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CLAIRES STORES INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) 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 Unaudited Condensed Consolidated Financial Statements and related notes thereto contained elsewhere in this document. We include a store in the calculation of same store sales once it has been in operation sixty weeks after its initial opening and, 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 one week or more. The removal is effective prospectively upon the completion of the first fiscal 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 rates. 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. 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. 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. As of August 2, 2014, we operated a total of 3,052 owned stores, of which 1,880 were located in all 50 states of the United States, Puerto Rico, Canada, and the U.S. Virgin Islands (North America segment) and 1,172 stores were located in the United Kingdom, Ireland, France, Spain, Portugal, Belgium, Switzerland, Austria, Netherlands, Germany, Poland, Czech Republic, Hungary, Italy and Luxembourg (Europe segment). We operate our stores under two brand names: Claire's® and Icing®. In January 2014, we made a decision to close our China stores and closed all of our 17 company-operated stores by May 4, 2014. As of August 2, 2014 we also franchised or licensed 436 stores in Japan, the Middle East, Turkey, Greece, Guatemala, Malta, Ukraine, Mexico, India, Dominican Republic, El Salvador, Venezuela, Panama, Honduras, Indonesia, Philippines, Costa Rica, Colombia, Serbia, Sweden, Romania and Bulgaria. 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 Unaudited Condensed Consolidated Statements of Operations and Comprehensive Loss. The franchise fees we charge under the franchising agreements are reported in "Other (income) expense, net" in our Unaudited Condensed Consolidated Statements of Operations and Comprehensive Loss. Claire's® is our primary global brand that we operate through company-operated 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. 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. Icing® is our other brand which we currently operate in North America through company-operated stores. Icing® offers an inspiring merchandise assortment of fashionable products that helps a young woman to say something about herself, whatever the occasion. 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. 19 -------------------------------------------------------------------------------- Table of Contents We provide our target customer groups with a significant selection of fashionable merchandise across a wide range of categories, all with a compelling value proposition. Our major categories of business are: • Jewelry: Includes earrings as well as our ear piercing service, necklaces, bracelets, body jewelry and rings; and • Accessories: Includes hairgoods; beauty products; personal, fashion, and seasonal accessories, including tech accessories, holders, phone cases, stationery, key rings, DIY kits, attitude glasses, headwear, legwear, armwear, and sunglasses; and handbags and small leather goods. In North America, our stores are located primarily in shopping malls. 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. Financial activity for the three and six months ended August 2, 2014 includes the following: • Net sales increase of 3.0% and 1.5%, respectively. • Same store sales percentages: Three Months Six Months Ended Ended August 2, 2014 August 2, 2014 Consolidated (0.6 )% (2.5 )% North America (2.9 )% (4.3 )% Europe 2.5 % 0.2 % • Operating income margin of 10.1% and 7.5%, respectively. Operational activity for the three and six months ended August 2, 2014 includes the following: • Opened 11 and 26, respectively, new company-operated stores. • Closed 30 and 88, respectively, company-operated stores due to underperformance or lease renewal terms that did not meet our criteria, including 3 and 17 stores, respectively, in China. A summary of our consolidated results of operations for the three and six months ended August 2, 2014 and August 3, 2013 are as follows (dollars in thousands): Three Months Three Months Ended Ended August 2, 2014 August 3, 2013 Net sales $ 377,829 $ 366,703 Decrease in same store sales (0.6 )% (0.1 )% Gross profit percentage 49.8 % 50.6 % Selling, general and administrative expenses as a percentage of net sales 34.2 % 34.5 % Depreciation and amortization as a percentage of net sales 4.7 % 4.4 % Operating income $ 38,227 $ 44,322 Loss on early debt extinguishment $ - $ 3,121 Net loss $ (20,574 ) $ (20,672 ) Number of stores at the end of the period (1) 3,052 3,094 (1) Number of stores excludes stores operated under franchise agreements. 20 -------------------------------------------------------------------------------- Table of Contents Six Months Six Months Ended Ended August 2, 2014 August 3, 2013 Net sales $ 731,172 $ 720,709 (Decrease) increase in same store sales (2.5 )% 1.3 % Gross profit percentage 48.5 % 50.1 % Selling, general and administrative expenses as a percentage of net sales 34.9 % 34.9 % Depreciation and amortization as a percentage of net sales 5.6 % 4.4 % Operating income $ 54,982 $ 76,911 Loss on early debt extinguishment $ - $ 4,795 Net loss $ (58,711 ) $ (47,256 ) Number of stores at the end of the period (1) 3,052 3,094 (1) Number of stores excludes stores operated under franchise agreements. Net sales Net sales for the three months ended August 2, 2014 increased $11.1 million, or 3.0%, from the three months ended August 3, 2013. The increase was attributable to new store sales of $15.9 million, a favorable foreign currency translation effect of our non-U.S. net sales of $8.1 million and an increase in shipments to franchisees of $1.0 million, partially offset by the effect of store closures of $11.7 million and a decrease in same store sales of $2.2 million. Net sales would have increased 0.8% excluding the impact from foreign currency exchange rate changes. Net sales for the six months ended August 2, 2014 increased $10.5 million, or 1.5%, from the six months ended August 3, 2013. The increase was attributable to new store sales of $32.6 million, a favorable foreign currency translation effect of our non-U.S. net sales of $14.7 million and an increase in shipments to franchisees of $1.7 million, partially offset by the effect of store closures of $21.2 million and a decrease in same store sales of $17.3 million. Net sales would have decreased 0.6% excluding the impact from foreign currency exchange rate changes. For the three months ended August 2, 2014, the decrease in same store sales was primarily attributable to a decrease in average number of transactions per store of 0.6%, partially offset by an increase in average transaction value of 1.4%. For the six months ended August 2, 2014, the decrease in same store sales was primarily attributable to a decrease in average number of transactions per store of 2.0%, partially offset by an increase in average transaction value of 0.6%. The following table compares our sales of each product category for each of the periods presented: Percentage of Total Percentage of Total Three Months Three Months Six Months Six Months Ended Ended Ended Ended Product Category August 2, 2014 August 3, 2013 August 2, 2014 August 3, 2013 Jewelry 50.3 51.8 50.3 51.5 Accessories 49.7 48.2 49.7 48.5 100.0 100.0 100.0 100.0 21 -------------------------------------------------------------------------------- Table of Contents Gross profit In calculating gross profit and gross profit percentages, we exclude the costs related to our distribution center and depreciation and amortization expense. These costs are included instead in "Selling, general and administrative" expenses in our Unaudited Condensed Consolidated Statements of Operations and Comprehensive Loss. Other retail companies may include these costs in cost of sales, so our gross profit percentages may not be comparable to those retailers. During the three months ended August 2, 2014, gross profit percentage decreased 80 basis points to 49.8% compared to 50.6% during the three months ended August 3, 2013. The decrease in gross profit percentage consisted of a 40 basis point decrease in merchandise margin, a 30 basis point increase in occupancy costs and a 10 basis point increase in buying and buying-related costs. The decrease in merchandise margin resulted primarily from an increase in markdowns. Markdowns fluctuate based upon many factors including the amount of inventory purchased versus the rate of sale and promotional activity. We do not anticipate a significant change in the level of markdowns that would materially affect our merchandise margin. The increase in occupancy costs, as a percentage of net sales, was primarily caused by the deleveraging effect of a decrease in same store sales. During the six months ended August 2, 2014, gross profit percentage decreased 160 basis points to 48.5% compared to 50.1% during the six months ended August 3, 2013. The decrease in gross profit percentage consisted of a 120 basis point increase in occupancy costs and a 40 basis point decrease in merchandise margin. The increase in occupancy costs, as a percentage of net sales, was primarily caused by the deleveraging effect of a decrease in same store sales. The decrease in merchandise margin resulted primarily from an increase in markdowns. Markdowns fluctuate based upon many factors including the amount of inventory purchased versus the rate of sale and promotional activity. We do not anticipate a significant change in the level of markdowns that would materially affect our merchandise margin. Selling, general and administrative expenses During the three months ended August 2, 2014, selling, general and administrative expenses increased $2.8 million, or 2.2%, compared to the three months ended August 3, 2013. As a percentage of net sales, selling, general and administrative expenses decreased 30 basis points compared to the three months ended August 3, 2013. Excluding an unfavorable $2.9 million foreign currency translation effect, selling, general and administrative expenses would have decreased $0.1 million. During the six months ended August 2, 2014, selling, general and administrative expenses increased $3.3 million, or 1.3%, compared to the six months ended August 3, 2013. As a percentage of net sales, selling, general and administrative expenses remained unchanged compared to the six months ended August 3, 2013. Excluding an unfavorable $5.6 million foreign currency translation effect, selling, general and administrative expenses would have decreased $2.3 million. This decrease primarily resulted from reductions in compensation-related expenses, such as store payroll and bonus and previously recorded non-cash stock-based compensation expense. Depreciation and amortization expense During the three months ended August 2, 2014, depreciation and amortization expense increased $1.6 million to $17.8 million compared to $16.2 million for the three months ended August 3, 2013. Excluding an unfavorable $0.3 million foreign currency translation effect, the increase in depreciation and amortization expense would have been $1.3 million. During the six months ended August 2, 2014, depreciation and amortization expense increased $9.5 million to $41.3 million compared to $31.8 million for the six months ended August 3, 2013. Excluding an unfavorable $0.6 million foreign currency translation effect, the increase in depreciation and amortization would have been $8.9 million. 22-------------------------------------------------------------------------------- Table of Contents Other (income) expense, net The following is a summary of other (income) expense activity for the three and six months ended August 2, 2014 and August 3, 2013 (in thousands): Three Months Three Months Six Months Six Months Ended Ended Ended Ended August 2, 2014 August 3, 2013 August 2, 2014 August 3, 2013Foreign currency exchange (gain) loss, net $ 2,026 $ (755 ) $ 1,769 $ 1,274 Royalty income (1,355 ) (1,327 ) (2,541 ) (2,432 ) Other income - - (43 ) - $ 671 $ (2,082 ) $ (815 ) $ (1,158 ) Loss on early debt extinguishment There was no debt repurchase activity for the three and six months ended August 2, 2014. The following is a summary of the Company's debt repurchase activity for the three and six months ended August 3, 2013 (in thousands). All debt repurchases in the three and six months ended August 3, 2013, were pursuant to the tender offer and note redemptions. Three Months Ended August 3, 2013 Six Months Ended August 3, 2013 Principal Repurchase Recognized Principal Repurchase Recognized Notes Repurchased Amount Price Loss (1) Amount Price Loss (2) 9.25% Senior Fixed Rate Notes due 2015 (the "Senior Fixed Rate Notes") $ 181,259 $ 181,259 $ 1,494 $ 220,270 $ 219,802 $ 2,597 9.625%/10.375% Senior Toggle Notes due 2015 (the "Senior Toggle Notes") 280,667 280,667 1,627 302,190 301,947 2,198 $ 461,926 $ 461,926 $ 3,121 $ 522,460 $ 521,749 $ 4,795 (1) Net of deferred issuance cost write-offs of $1,476 for the Senior Fixed Rate Notes and $1,625 for the Senior Toggle Notes and tender premiums and fees of $18 for the Senior Fixed Rate Notes and $2 for the Senior Toggle Notes. (2) Net of deferred issuance cost write-offs of $1,829 for the Senior Fixed Rate Notes and $1,766 for the Senior Toggle Notes and tender premiums and fees of $1,236 for the Senior Fixed Rate Notes and $675 for the Senior Toggle Notes. Interest expense, net During the three months ended August 2, 2014, net interest expense aggregated $54.6 million compared to $57.8 million for the three months ended August 3, 2013. The decrease of $3.2 million is primarily due to a lower rate of interest on the indebtedness used to refinance our former Senior Fixed Rate Notes and Senior Toggle Notes. During the six months ended August 2, 2014, net interest expense aggregated $109.3 million compared to $116.0 million for the six months ended August 3, 2013. The decrease of $6.7 million is primarily due to a lower rate of interest on the indebtedness used to refinance our former Senior Fixed Rate Notes and Senior Toggle Notes. Income taxes The effective income tax rate for the three and six months ended August 2, 2014 was (26.0)% and (8.1)% compared to (24.9)% and (7.7)% for the three and six months ended August 3, 2013. These effective income tax rates differed from the statutory federal income tax rate of 35% primarily from increases in the valuation allowance recorded for additional deferred tax assets generated primarily from operating losses in the three and six months ended August 2, 2014 and August 3, 2013, respectively, by our U.S. operations. Segment Operations We have two reportable segments - North America and Europe. The following is a discussion of results of operations by reportable segment. 23-------------------------------------------------------------------------------- Table of Contents North America Key statistics and results of operations for our North America segment are as follows (dollars in thousands): Three Months Three Months Six Months Six Months Ended Ended Ended Ended August 2, 2014 August 3, 2013 August 2, 2014 August 3, 2013 Net sales $ 212,458 $ 219,317 $ 426,656 $ 445,274 (Decrease) increase in same store sales (2.9 )% 1.1 % (4.3 )% 1.7 % Gross profit percentage 49.1 % 51.7 % 48.0 % 51.7 % Number of stores at the end of the period (1) 1,880 1,925 1,880 1,925 (1) Number of stores excludes stores operated under franchise agreements and includes 11 China stores as of August 3, 2013. During the three months ended August 2, 2014, net sales in North America decreased $6.9 million, or 3.1%, from the three months ended August 3, 2013. The decrease was attributable to the effect of store closures of $6.5 million, a decrease in same store sales of $5.9 million and an unfavorable foreign currency translation effect of our non-U.S. net sales of $0.8 million, partially offset by new store sales of $5.3 million and an increase in shipments to franchisees of $1.0 million. Sales would have decreased 2.8% excluding the impact from foreign currency exchange rate changes. During the six months ended August 2, 2014, net sales in North America decreased $18.6 million, or 4.2%, from the six months ended August 3, 2013. The decrease was attributable to a decrease in same store sales of $17.9 million, the effect of store closures of $12.0 million and an unfavorable foreign currency translation effect of our non-U.S. net sales of $2.2 million, partially offset by new store sales of $11.8 million and increased shipments to franchisees of $1.7 million. Sales would have decreased 3.7% excluding the impact from foreign currency exchange rate changes. For the three months ended August 2, 2014, the decrease in same store sales was primarily attributable to a decrease in average number of transactions per store of 0.9% and a decrease in average transaction value of 0.8%. For the six months ended August 2, 2014, the decrease in same store sales was primarily attributable to a decrease in average number of transactions per store of 2.8% and a decrease in average transaction value of 0.6%. During the three months ended August 2, 2014, gross profit percentage decreased 260 basis points to 49.1% compared to 51.7% during the three months ended August 3, 2013. The decrease in gross profit percentage consisted of a 150 basis point decrease in merchandise margin and a 110 basis point increase in occupancy costs. The decrease in merchandise margin resulted primarily from an increase in markdowns and lower initial markups. Markdowns fluctuate based upon many factors including the amount of inventory purchased versus the rate of sale and promotional activity. We do not anticipate a significant change in the level of markdowns that would materially affect our merchandise margin. The increase in occupancy costs, as a percentage of net sales, was primarily caused by the deleveraging effect of a decrease in same store sales. During the six months ended August 2, 2014, gross profit percentage decreased 370 basis points to 48.0% compared to 51.7% during the six months ended August 3, 2013. The gross profit percentage consisted of a 200 basis point increase in occupancy costs and a 170 basis point decrease in merchandise margin. The increase in occupancy costs, as a percentage of net sales, was primarily caused by the deleveraging effect of a decrease in same store sales. The decrease in merchandise margin resulted primarily from an increase in markdowns. Markdowns fluctuate based upon many factors including the amount of inventory purchased versus the rate of sale and promotional activity. We do not anticipate a significant change in the level of markdowns that would materially affect our merchandise margin. 24-------------------------------------------------------------------------------- Table of Contents The following table compares our sales of each product category in North America for each of the periods presented: Percentage of Total Percentage of Total Three Months Three Months Six Months Six Months Ended Ended Ended Ended Product Category August 2, 2014 August 3, 2013 August 2, 2014 August 3, 2013 Jewelry 55.4 57.5 55.5 56.5 Accessories 44.6 42.5 44.5 43.5 100.0 100.0 100.0 100.0 Europe Key statistics and results of operations for our Europe segment are as follows (dollars in thousands): Three Months Three Months Six Months Six Months Ended Ended Ended Ended August 2, 2014 August 3, 2013 August 2, 2014 August 3, 2013 Net sales $ 165,371 $ 147,386 $ 304,516 $ 275,435 Increase (decrease) in same store sales 2.5 % (2.0 )% 0.2 % 0.7 % Gross profit percentage 50.6 % 49.1 % 49.1 % 47.6 % Number of stores at the end of the period (1) 1,172 1,169 1,172 1,169 (1) Number of stores excludes stores operated under franchise agreements. During the three months ended August 2, 2014, net sales in Europe increased $18.0 million, or 12.2%, from the three months ended August 3, 2013. The increase was attributable to new store sales of $10.6 million, a favorable foreign currency translation effect of our non-U.S. net sales of $8.9 million and an increase of same store sales of $3.7 million, partially offset by the effect of store closures of $5.2. Sales would have increased 5.8% excluding the impact from foreign currency exchange rate changes. During the six months ended August 2, 2014, net sales in Europe increased $29.1 million, or 10.6%, from the six months ended August 3, 2013. The increase was attributable to new store sales of $20.8 million, a favorable foreign currency translation effect of our non-U.S. net sales of $16.9 million and an increase in same store sales of $0.6 million, partially offset by the effect of store closures of $9.2 million. Sales would have increased 4.2% excluding the impact from foreign currency exchange rate changes. For the three months ended August 2, 2014, the increase in same store sales was primarily attributable to an increase in average transaction value of 4.7%, partially offset by a decrease in average number of transactions per store of 1.0%. For the six months ended August 2, 2014, the increase in same store sales was primarily attributable to an increase in average transaction value of 3.1%, partially offset by a decrease in average number of transactions per store of 1.8%. During the three months ended August 2, 2014, gross profit percentage increased 150 basis points to 50.6% compared to 49.1% during the three months ended August 3, 2013. The increase in gross profit percentage consisted of a 90 basis point increase in merchandise margin and a decrease of 80 basis points in occupancy costs, partially offset by a 20 basis point increase in buying and buying-related costs. The increase in merchandise margin resulted primarily from a decrease in markdowns partially offset by higher inventory shrink. Markdowns fluctuate based upon many factors including the amount of inventory purchased versus the rate of sale and promotional activity. We do not anticipate a significant change in the level of markdowns or shrink that would materially affect our merchandise margin. The decrease increase in occupancy costs, as a percentage of net sales, was primarily caused by the leveraging effect of an increase in same store sales. During the six months ended August 2, 2014, gross profit percentage increased 150 basis points to 49.1% compared to 47.6% during the six months ended August 3, 2013. The increase in gross profit percentage consisted of a 140 basis point increase in merchandise margin and a 20 basis point decrease in occupancy costs, partially offset by a 10 basis point increase in buying and buying-related costs. The increase in merchandise margin resulted primarily from a decrease in markdowns and higher initial markups. 25-------------------------------------------------------------------------------- Table of Contents Markdowns fluctuate based upon many factors including the amount of inventory purchased versus the rate of sale and promotional activity. We do not anticipate a significant change in the level of markdowns that would materially affect our merchandise margin. The decrease increase in occupancy costs, as a percentage of net sales, was primarily caused by the leveraging effect of an increase in same store sales. The following table compares our sales of each product category in Europe for each of the periods presented: Percentage of Total Percentage of Total Three Months Three Months Six Months Six Months Ended Ended Ended Ended Product Category August 2, 2014 August 3, 2013 August 2, 2014 August 3, 2013 Jewelry 43.8 43.6 43.2 43.7 Accessories 56.2 56.4 56.8 56.3 100.0 100.0 100.0 100.0 Liquidity and Capital Resources We anticipate that cash generated from operations, borrowings under our $115.0 million Credit Facility (as described below) and future refinancings of our indebtedness will be sufficient to allow us to satisfy payments of interest and principal on our indebtedness as they become due, to fund new store expenditures, and future working capital requirements in both the next twelve months and over the longer term. Interest on the outstanding Notes (as described below) will be approximately $206.1 million in Fiscal 2014, and we expect to fund these interest payments through a combination of cash from operations and borrowings under our Credit Facility. No principal is due on the Notes until Fiscal 2017, when our Senior Subordinated Notes will mature. We expect to pay the outstanding principal amount of these Notes at maturity through a combination of new indebtedness, cash from operations and other available sources. In addition, we anticipate the cash generated from operations and borrowings under the Credit Facility will be sufficient to allow us to fund new store expenditures and future working capital requirements in both the next twelve months and over the longer term. However, our ability to make interest payments and meet operational liquidity needs, as well as our ability to refinance the Senior Subordinated Notes when they mature in Fiscal 2017, will depend, in part, on our future operating performance. Our future operating performance and liquidity, as well as our ability to refinance our indebtedness, may also be adversely affected by general economic, financial, and other factors beyond our control, including those disclosed in "Risk Factors" in our Annual Report on Form 10-K for the fiscal year ended February 1, 2014. A summary of cash flows provided by (used in) operating, investing and financing activities for the six months ended August 2, 2014 and August 3, 2013 is outlined in the table below (in thousands): Six Months Six Months Ended Ended August 2, 2014 August 3, 2013 Operating activities $ (19,739 ) $ (46,423 ) Investing activities (31,437 ) (42,335 ) Financing activities 19,285 (3,529 ) Cash flows from operating activities For the six months ended August 2, 2014, cash used in operations decreased $26.7 million compared to the prior year period. The primary reason for the decrease was a decrease in working capital, excluding cash and cash equivalents, of $28.4 million, a decrease in tax payments and other items of $6.5 million, and a decrease in interest payments of $4.6 million, partially offset by a net decrease in operating income, of $12.8 million. 26-------------------------------------------------------------------------------- Table of Contents Cash flows from investing activities For the six months ended August 2, 2014, cash used in investing activities was $31.4 million and primarily consisted of $31.4 million for capital expenditures. For the six months ended August 3, 2013, cash used in investing activities was $42.3 million and primarily consisted of $42.3 million for capital expenditures. During the remainder of Fiscal 2014, we expect to fund approximately $10.0 million of capital expenditures. Cash flows from financing activities For the six months ended August 2, 2014, cash provided by financing activities was $19.3 million, which consisted primarily of net borrowings of $19.5 million under the revolving Credit Facility, partially offset by payment of $0.2 million in financing costs. For the six months ended August 3, 2013, cash used in financing activities was $3.5 million, which consisted primarily of proceeds of $530.0 million from the issuance of $210.0 million aggregate principal amount of 6.125% Senior Secured First Lien Notes and $320.0 million aggregate principal amount of 7.75% Senior Notes, note repurchases of $521.7 million to retire $220.3 million aggregate principal amount of Senior Fixed Rate Notes and $302.2 million aggregate principal amount of Senior Toggle Notes pursuant to a tender offer and note redemptions, to pay $1.9 million in tender premiums and fees, and to pay $9.8 million in financing costs. We or our affiliates have purchased and may, from time to time, purchase portions of our indebtedness in privately-negotiated, open market transactions. Cash Position As of August 2, 2014, we had cash and cash equivalents of $27.1 million and all cash equivalents were maintained in one money market fund invested exclusively in U.S. Treasury Securities. As of August 2, 2014, our foreign subsidiaries held cash and cash equivalents of $19.3 million. During the six months ended August 2, 2014, we repatriated cash held by foreign subsidiaries but did not accrue U.S. income taxes since the amount of our remaining U.S. net operating loss carry forwards was sufficient to offset the associated income tax liability. During the remainder of Fiscal 2014, 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 as of August 2, 2014, we do not expect to pay U.S. income tax on future Fiscal 2014 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, net of any foreign tax credit benefit, on any such repatriation. We anticipate that cash generated from operations, borrowings under our Credit Facility (as described below), and future refinancings of our indebtedness will be sufficient to allow us to satisfy payments of interest and principal on our indebtedness as they become due, to fund new store expenditures, and future working capital requirements in both the next twelve months and over the longer term. However, this will depend, in part, on our future operating performance. Our future operating performance and liquidity, as well as our ability to refinance our indebtedness, may be adversely affected by general economic, financial, and other factors beyond our control, including those disclosed in "Risk Factors" in our Annual Report on Form 10-K for the fiscal year ended February 1, 2014. Credit Facility On September 20, 2012, we 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 (as amended, the "Credit Facility"), pursuant to which we replaced our existing $200.0 million senior secured former revolver maturing May 29, 2013 with a $115.0 million five-year senior secured revolving credit facility, maturing September 20, 2017. On April 30, 2014, the Company entered into Amendment No. 1 to its Credit Facility (the "Amendment"). The Amendment increased the maximum permitted Total Net Secured Leverage Ratio from 5.50:1.00 to 6.00:1.00 for purposes of the covenant described below. 27 -------------------------------------------------------------------------------- Table of Contents Borrowings under the Credit Facility bear interest at a rate equal to, at our 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. We 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 our stock, and (ii) our 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 our capital stock, prior to an initial public offering of our stock, and (ii) substantially all of our material owned assets and the material owned assets of subsidiary guarantors, limited in the case of equity interests held by us 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 us or a subsidiary guarantor. The liens securing the Credit Facility rank equally to the liens securing the 6.125% Senior Secured First Lien Notes and the 9.0% Senior Secured First Lien Notes due 2019 (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 us 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, we are required to maintain, at each borrowing date measured at the end of the prior fiscal quarter (but reflecting borrowings and repayments under the Credit Facility through the measurement date) and at the end of each fiscal quarter, a maximum Total Net Secured Leverage Ratio of 6.0:1.0 based upon the ratio of our net senior secured first lien debt to adjusted earnings before interest, taxes, depreciation and amortization for the period of four consecutive fiscal quarters most recently ended. As of August 2, 2014, our revolving loans and letters of credit outstanding exceeded $15.0 million, and our Total Net Secured Leverage Ratio was 5.1:1.0. The Credit Facility also contains various covenants that limit our ability to engage in specified types of transactions. These covenants, subject to certain exceptions and other basket amounts, limit our and our 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 our other indebtedness. If we were unable to repay those amounts, the Lenders under the Credit Facility could proceed against the collateral granted to them to secure that indebtedness. As of August 2, 2014, we were in compliance with the covenants. 28-------------------------------------------------------------------------------- Table of Contents As of August 2, 2014, we had $19.5 million of borrowings and $3.3 million of letters of credit outstanding, which reduces the borrowing availability under the Credit Facility to $92.2 million as of that date. Note Covenants Our Senior Subordinated Notes, Senior Secured Second Lien Notes, 9.0% Senior Secured First Lien Notes, 6.125% Senior Secured First Lien Notes, and 7.75% Senior Notes (collectively, the "Notes") also contain various covenants that limit our ability to engage in specified types of transactions. These covenants, subject to certain exceptions and other basket amounts, limit our and our subsidiaries' ability to, among other things: • incur additional indebtedness; • 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 our 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 us. None of these Note covenants, however, require us to maintain any particular financial ratio or other measure of financial performance. As of August 2, 2014, we were in compliance with the covenants under the Notes. 29-------------------------------------------------------------------------------- Table of Contents 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. As of August 2, 2014, we had a reduction of $2.4 million of outstanding bank guarantees under this facility, which reduces the borrowing availability to $0.1 million as of that date. Parent Company Registration Statement Filing On May 3, 2013, Claire's Inc., our Parent, filed a registration statement with the Securities and Exchange Commission for an initial public offering of Claire's Inc.'s common stock. Critical Accounting Policies and Estimates Our Unaudited Condensed Consolidated Financial Statements have been prepared in accordance with U.S. generally accepted accounting principles. Preparation of these statements requires management to make judgments and estimates. Some accounting policies have a significant impact on amounts reported in these financial statements. A summary of significant accounting policies and a description of accounting policies that are considered critical may be found in our Fiscal 2013 Annual Report on Form 10-K, filed on April 2, 2014, in the Notes to Consolidated Financial Statements, Note 2 - Summary of Significant Accounting Policies, and the Critical Accounting Policies and Estimates section contained in the Management's Discussion and Analysis of Financial Condition and Results of Operations therein. Recent Accounting Pronouncements See Note 2 - Recent Accounting Pronouncements, in the Notes to Unaudited Condensed Consolidated Financial Statements. Cautionary Note Regarding Forward-Looking Statements and Risk Factors 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 we issue publicly. 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 periods, 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. 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. The forward-looking statements may use the words "expect," "anticipate," "plan," "intend," "project," "may," "believe," "forecasts" and similar expressions. 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; unwillingness of vendors and service providers to supply goods or services pursuant to historical customary credit arrangements; 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 other channels, such as e-commerce; uncertainties generally associated with the specialty retailing business, such as decreases in mall traffic; 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; increase in our cost of merchandise; significant increases in our merchandise markdowns; inability to grow our Company operated store base in North America and Europe, or expand 30-------------------------------------------------------------------------------- Table of Contents 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; results from any future asset impairment analysis; changes in applicable laws, rules and regulations, including changes in North America and Europe, 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 anti-bribery laws; changes in employment laws, including 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; 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. The Company undertakes no obligation to update or revise any forward-looking statements to reflect subsequent events or circumstances. 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. Additional discussion of these and other risks and uncertainties is contained elsewhere in this Item 2, in Item 3, "Quantitative and Qualitative Disclosures About Market Risk" and in our Form 10-K for Fiscal 2013 under "Statement Regarding Forward-Looking Disclosures" and "Risk Factors." |