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Executives

Eugene S. Kahn – Chief Executive Officer

J. Per Brodin – Senior Vice President and Chief Financial Officer

Analysts

Grant Jordan – Wachovia

Carla Casella – J.P. Morgan

Mary Gilbert – Imperial Capital

Jason Trujillo – Lehman Brothers

Karen Altrace – Goldman Sachs

Colleen Burns – Oppenheimer

Jeffrey Takacs – Babson Capital

Jeff Kobylarz – Stone Harbor Investments

Adam Plissner – Credit Suisse

Claire’s Stores, Inc. (CLE) F1Q08 Earnings Call June 11, 2008 10:00 AM ET

Operator

Good morning and welcome to Claire’s Stores First Quarter Conference Call. On the call today are Eugene Kahn, Chief Executive Officer, and Per Brodin, Senior Vice President and Chief Financial Officer. Yesterday, Claire’s issued its first quarter earnings press release. A copy can be found on Claire’s corporate website www.clairestores.com. This call is being taped, and a reply will be available until June 20, 2008. The playback number is 203-369-0512 and the password is 25247. This call is also being simultaneously webcast and archived. It can be accessed at www.clairestores.com and replayed or downloaded as an MP3 file. I would now look to introduce Per Brodin, Senior Vice President and Chief Financial Officer. Sir, you may begin.

Per Brodin

Thank you, Leslie. Good morning everyone, and welcome to Claire’s Stores conference call reviewing the company’s unaudited first quarter results for fiscal 2008. The following discussion may contain forward-looking statements, and our actual results may differ materially from those expectations. Information concerning factors that could cause such differences can be found in the form 10-K as filed with the SEC on April 25, 2008. The content of this conference call contains time-sensitive information that is only accurate as of the date of this live broadcast, June 11, 2008. We do not assume any obligations to update our forwarding information. Any redistribution, retransmission, or broadcast of this call in any form without the expressed written consent of Claire’s Stores is prohibited.

I would like to point out that the press release we issued yesterday contains EBITDA and adjusted EBITDA numbers to provide you with additional information we believe is meaningful in evaluating our operating performance and our ability to service our debt. Because these are not calculated in accordance with generally accepted accounting principles, these measures should not be considered in isolation from our financial statements prepared in accordance with GAAP. It should also be noted that our computation of EBITDA and adjusted EBITDA may differ from similarly titled computations used by other companies. Since our last conference call, we changed the naming convention of our fiscal year. As we refer to our fiscal year, it will now correspond to the calendar year in which the fiscal year begins. For example, on this call, we will review our first quarter fiscal 2008 results because this fiscal year began on February 3, 2008. At this time, I’m going to turn the call over to Eugene Kahn, CEO of Claire’s Stores.

Eugene S. Kahn

Thank you, Per. Good morning everyone, and thank you for joining us today. First I’d like to provide you with an overview of our business during the first quarter followed by an update and key changes related to our five priorities for fiscal 2008 that I highlighted on our April 4th conference call. Then, I’ll turn the call back over to Per for a financial review. We will close with your questions.

In terms of topline performance, our consolidated sales for the quarter were $327 million, a decrease of 4%. On a constant currency basis, same-store sales decreased 8.4%. This decline in same-store sales was driven by an increase of 3.7% in average sale per transaction which was more than offset by a 12.5% decrease in average transactions per store. The increase in sales per transaction reflects a higher average ticket as our focus on good, better, best price tiering has began to take hold. The decrease in average transaction per store primarily reflects a decrease in overall mall traffic; however, we are continuing to focus on rectifying the merchandising and in-store execution challenges that are within our control.

In North America, same-store sales decreased 12.3% where Icing unperformed Claire’s as the concept continued its poor performance from fourth quarter. Beginning in April, same-store sales at both Claire’s and Icing in North America while still negative have shown slight sequential improvement that has continued into the second quarter. We are encouraged to see improved results in select accessory categories including sunglasses, handbags, and cosmetics as well as younger jewelry which has benefited from a number of relevant merchandising trends.

Our European business performed reasonably well in a difficult retail environment with same-store sales decreasing only 0.2%. In Europe, the growth categories are similar to those in North America but also included younger novelty accessories and in general demonstrated greater overall growth.

We believe our results are reflective of a tough retail environment globally coupled with areas for improvement in our execution. We are addressing these opportunities through improvement in our team as well as improving our blocking and tackling as it relates to the merchandise cycle and store execution. While I’m genuinely disappointed with the results, I continue to be optimistic that the initiatives we have implemented and the organizational changes we have made over the last 12 months including several recently named replacements will help drive our future business and should become more evident in our second-half results.

There are a number of positive metrics I want to highlight as they attest to the discipline with which we are running the business. While we are experiencing a deleveraging of our fixed expenses which impacts our gross margin, our consolidated merchandise margin remains strong only decreasing 30 basis points compared to last year’s first quarter due largely to a shift in merchandise mix with a decline in higher margin jewelry and hair accessories and an increase in the slightly lower margin accessory business. We are pleased that we have been able to drive growth in many of our accessory categories and continue to sustain an attractive merchandise margin rate. We continue to press accessories and cosmetics growth in North America to reach similar penetration levels that we have achieved across our European business. Simultaneously, we are applying a disciplined approach to inventory management and markdowns while keeping inventories in line which has translated into a strong IMU and merchandise margin.

As we look to the second half of the spring season and onto the rest of fiscal 2008, we continue to focus on our topline performance and to build the foundation for future growth across our global business. As I highlighted on our yearend Q4 2007 call, we have five business strategies which remain unchanged as we believe these will help deliver our topline and EBITDA gross goals for the future. Those five strategies are the following: 1) Build an effective organization model. 2) Strengthen our merchandise offense. 3) Execute on our pan-European transformation. 4) Improve the importance our North American business. 5) Intensify our expense discipline.

Our fiscal 2008 priorities have been developed in support of these business strategies. We made progress against a number of our priorities particularly as it relates to building the capabilities of our team. We have recently revamped our merchandising organization with the addition of several new executives who have joined the management team predominantly filling existing positions. I would like to highlight a few of them for you. First, Joan Munnelly was named chief merchandise officer. Second, Denise Vujovich assuming the responsibility of Executive Vice President and GMM for the North American business, and third Laura Dank became Vice President and DMM with responsibility for Icing.

As you might have read in the recent press release, Joan Munnelly was appointed to the newly created position of Chief Merchandise Officer. Joan will oversee the entire assortment strategy and merchandise process for our worldwide business working in concert with both of the EVP GMMs as well as the buying team in North America and Europe. She will have direct responsibility for our fashion trend and product innovation function, our product design and development team, and our Asian-based sourcing organization. Joan’s responsibilities will also include overseeing assortment planning, selection, and the buying process from concept development through merchandise commitment. In addition, Joan will be a member of the corporate senior management team charged with establishing and implementing the company’s current and future global direction. During the last 8 years, Joan was with Tween Brands, where for the last 5 years, she was Execute Vice President and GMM of merchandising, design, and fashion for all areas of that company’s strong growth vehicle just as previously she held a similar position at Limited too.

Denise Vujovich has joined us from Macy’s where she was Senior Vice President and GMM of accessories, cosmetics, footwear, and intimate apparel. Denise brings 28 years of successful retailing experience in categories that are highly relevant to our business. Denise and I have previously worked together, and I’m very excited to have her join the team. I believe she is well suited to drive our topline performance in Claire’s North America for both Claire’s and the Icing brand.

Laura Dank has joined as VP as DMM for the Icing brand. Laura has a successful working history with Denise having recently served as VP and DMM for fashion accessories at Macy’s. Consistent with the real alignment of the buying organization by brand in North America, Laura will lead, and for the first time an executive will have sole responsibility from the merchandise offense of the Icing business. We believe this is a critical step in turning around same-store sales and creating the brand strategy.

All three of these merchant leaders come with a wealth of merchandising, product development, and supervisory experience and will bolster our capabilities greatly. Additionally, we have appointed Connie Day Adams as VP and DMM of jewelry for Claire’s North America. Connie has been with Claire’s for nearly 9 years and will lead a team of five buyers in driving the growth of our jewelry business. In order to realize the caliber of organization we believe is required, we continue to pursue new talent. We have upgraded a number of buyers with a broad range of relevant retail experience to complement the existing talent that Claire’s has globally. This is consistent with the North American and European buying and planning organization redesign which is head count neutral. The new structure will allow us for the first time to have three separate dedicated merchandise teams focused on Claire’s North America, on Icing, and on Claire’s Europe. We are still actively recruiting several key positions including DMM of accessories for Claire’s North America and a DMM of jewelry for Claire’s Europe. We have identified candidates for both positions and hope to fill these positions in the near future. Our focus on enhancing our organization and upgrading our talent level aligns well with three of the fiscal ‘08 priorities namely focusing on merchandise offense, recruiting people to business with strong industry, management, and leadership experience, and differentiating and transforming the Icing concept. I believe these upgrades combined with our new simplified buying and planning organization focused on our three distinct segments, Claire’s North America, Icing, and Claire’s Europe, should help us deliver strong and consistent topline performance globally.

The next priority is the pan-European transformation or PET project as we outlined on our last call. This initiative is a multiprong project that focuses on the following objectives. First, institute a centralized pan-European buying and planning team which would generate revenue growth and additional merchandise offense from the dedicated organizations. Two, create a pan-European merchandising system that will allow Europe to operate a single fully integrated system that includes the best functionality of both Europe and North America. This will serve as the basis for improving future North American and global capabilities. Third, consolidate into a single distribution center model for all of Europe based in our existing Birmingham UK facility. This will generate economies of scale for buying logistics and inventory management. Fourth, implement a European operating structure separated into three geographic zones. This will provide a platform for significant new store growth and reinforce the management of the existing store base. We will be able to create zone-specific strategies based on geography, market, and cultural similarities. As part of this effort, we appointed David Rostron as managing director of zone one which includes the United Kingdom and Ireland reporting to Paul Mildenstein, COO of stores and real estate for Europe. David brings with him a wealth of operational experience gained from an extensive career across a broad portfolio of retailers including Marks & Spencer, GAP, and Primark. Fifth, centralize support function in the Birmingham central office. Real estate, property administration, and construction are now centralized and functioning well. The remaining support functions are being reviewed for opportunities to simply and refine their overall approach. We are confident that we will complete phase one of this important initiative by the original target date of July 7, and look forward to realizing the benefits of a more focused merchandise approach, stronger and more meaningful planning and reporting system support, lower distribution costs, a more traditional operating model across Europe and more focused support functions resulting faster response times and operating efficiency. Phase two is scheduled to be complete by early November and further refinements will be delivered in the spring ‘09 season. The fifth and final priority relates to our cost reduction efforts intended to counteract the impact of the soft retailing and economic environment.

We have carefully reviewed our cost structure and have identified a number of areas for savings including freight, shrink, procurement of nonmerchandise business services, store labor optimization, and other payroll. We estimate that we can save $40 million annually by working across a number of functional areas. We have began to execute against a number of these identified opportunities and expect that we can realize $15 million of the savings in the current fiscal year to further support our EBITDA performance. In addition, we intent to achieve the full annualized savings in fiscal 2009.

I’d like to take a couple of minutes highlighting the first quarter merchandise performance, our customer’s response to our offering, and the lessons learned. As in the fourth quarter, the accessory business, with the exception of hair goods, continues to strengthen with customers showing less interest in jewelry generally. On a global basis, comparable accessory sales increased 1.1% excluding hair goods. In Europe, the accessory penetration grew to 55% of the business. In North America, accessories represented 39% of the business.

By emphasizing key classifications and seasonal items, we were able to impact sales results. Handbag performance was driven by double handle bags, licensed styles, and small leather goods. Cosmetics grew in all categories with the strongest performance coming in nails, gift sets, and cases. Items with peace symbol motifs were consistently successful across all categories. Fashion accessories’ performance was strengthened by sunglasses growth which had better styling, tiered pricing, and improved in-store presentation.

Jewelry growth targeted to the younger customer, ages 7 to 11, was driven by bracelets and necklaces. Licensed merchandise in both accessories and jewelry continued to perform well. Holiday theme merchandise for Valentine’s Day, St. Patrick’s Day, and Easter continued the strong performance demonstrated by holiday motif merchandise in the fourth quarter.

While the accessory business continues to grow in importance as jewelry trends continue to be soft, once exception within accessories is the poor-performing hair goods business. The slowing trend in this category we saw in the fall season has continued into the first quarter. We took prompt and decisive action by reevaluating our assortments and adjusting our merchandise investments as a result of this trend. Overall, we have an opportunity to continue to distort our assortments with greater authority by target age group, young customers ages 12 to 17; younger customers, ages 7 to 11; and our youngest customers, ages 3 to 5. Where we had done so in the first quarter for example in handbags and cosmetics, we have seen good success.

Our focus by customer segment, fashion sensibility of basics, core fashion, or trend merchandise and a faster response to best selling categories, ideas, or items should improve our sales performance in the future. I will now turn the call back to Per for the first quarter financial review.

J. Per Brodin

Thank you, Gene. I would like to begin by first recapping changes in our store base that occurred in the first quarter of fiscal 2008 and then outline our plans with respect to the store base for the full year of 2008. In the first quarter, we opened 13 stores net, reflecting our decision to exit older, less productive locations. This reflects 10 and 19 new stores in Europe and North America respectively. In the quarter, we closed 4 and 12 stores in Europe and North America respectively. We ended the first quarter with 3053 company-operated stores in North America and Europe which compares to 3040 stores at the end of fiscal 2007. In our Japanese joint venture, the number of total stores operated increased from 198 to 201, and the total number of franchise stores increased from 166 to 169 at the end of the first quarter. Collectively, our global store count increased by 19 in the first quarter.

In terms of planned store openings for fiscal 2008, we anticipate more net addition than last year, although we are still being conservative given the state of the economy and our desire to complete the PET initiative before launching a more aggressive store opening plans. We expect a net increase of approximately 65 to 75 company-owned stores. The joint venture is expected to open approximately 15 stores, and the franchise store count is expected to grow by 20.

In terms of the capital expenditures associated with planned company owned store openings and remodels, we anticipate that our fiscal 2008 CapEx will be approximately $85 million. Of the $85 million, approximately 40% is for new stores including lease right or key money, and the reminder of that amount relates to remodels and maintenance, and approximately $14 million for POS upgrades.

Now, let me turn to our financials and review some of the specific line items starting with the statement of operation. Sales for the 13-week period ended May 3, 2008, decreased 4% to $327 million compared to sales of $340.6 million for the 13-week period ended May 5, 2007. This decrease was primarily attributable to the $28.7 million decrease in same-store sales partially offsets by foreign currency exchange effect of $11.8 million. Our same-store sales decreased 8.4% for the quarter, which was comprised of a -12.3% and -0.2% drop in North America and Europe respectively. Similar to what we have experienced during the fourth quarter of 2007, the decline at Icing was more pronounced than at Claire’s and pulled down the consolidated North American same-store sales.

I also want to reiterate that we conservatively compute same-store sales on a constant currency basis. Accordingly, our same-store sales do not reflect the benefit from the weakening of the US dollar relative to the British pound sterling, Euro, Swiss Franc, or Canadian dollar. As Eugene noted earlier, we began to see improvement in same-store sales at both Icing and Claire’s in North America beginning in April that has continued thus far in the second quarter. Europe is continuing to grow in importance relative to our overall business. Our revenues from Europe grew to 36% of our total compared to our 30.8% during last year’s first fiscal quarter. Gross margin for the first quarter of fiscal 2008 was 47.4% versus 52.6% for the prior year’s first fiscal quarter. We report gross margin after buying and occupancy costs. Excluding foreign exchange impacts and nonrecurring costs associated with the PET project, gross margin was 48.9%.

Merchandise margin decreased 30 basis points primarily as a result of the change in our sales mix. Year over year, the mix between jewelry and accessories was largely unchanged but as Gene previously indicated, the decline in the relatively high-margin hair good category was largely offset by growth in handbags, cosmetics, and sunglasses. Most of our gross margin percentage decline relates to an increase in the amount of occupancy and buying costs and the deleveraging effect of our negative same-store sales. Of the increase in buying and occupancy costs, buying expenses were impacted by nonrecurring costs of $1.2 million associated with the PET project. In addition, occupancy costs increased because of a $1.5 million increase in the book to cash rent adjustment and $2.2 million due to the decline in the dollar. Notwithstanding those impacts, we believe we have opportunity to reduce occupancy costs, particularly in rent support, where we have experienced increases partly due to the rise in energy costs. While we are increasing our focus in this area, none of this has been included in the $40 million cost production program Gene described.

SG&A expenses increased $7.7 million, or 6.2% compared to last year’s first fiscal quarter. Adjusting this balance for the effect of foreign exchange of $5 million, sponsor management fees of $0.8 million, and one-time PET costs of $1.4 million, SG&A increased approximately $0.5 million, or 0.5% on a comparable constant currency basis year over year. Adjusted EBITDA for the first quarter which as referenced in our press release excludes the impact of transaction expenses from the May 2, 2007, acquisition of the company, rent-related adjustments, and other non-recurring or non-cash expenses as $34.3 million, compared with adjusted EBITDA of $60.6 million in the first quarter of fiscal 2007. The $26.3 million decline in adjusted EBITDA is primarily the result of a decrease in merchandise profit dollars associated with the decline in same-store sales in the face of higher occupancy and buying costs and SG&A, slightly offset by the contribution of new stores and the impact of foreign exchange.

Now, let me turn to a discussion of selected balance sheet items. We ended the first quarter of fiscal 2008 with $68 million in cash. At the end of the quarter, our $200 million revolver was available and undrawn aside from a $5.9 million letter of credit. Given the seasonality of our business, particularly as it relates to inventory, we will draw the revolver for working capital needs during the fiscal year, but we plan to have a zero revolver balance at year end. During the first fiscal quarter, $11.7 million of $16 million of capital expenditure is related namely to store openings and remodeling projects with the balance primarily attributable to technology. During the first quarter of fiscal 2008, net cash used in operating activities totaled approximately $1.4 million. This represents adjusted EBITDA of $34 million, less $24 million of cash of interest and $12 million of cash taxes. As we discussed on the year-end call, we expect our ongoing cash taxes to be less than $10 million annually. In the first quarter of 2008, we paid a nonrecurrent cash tax payment related to the period prior to the acquisition of the company in May 2007. Excluding the nonrecurring tax payment, our cash taxes would have been approximately $2 million, which primarily relates to local taxes paid in our European Division.

Our disciplined approach to merchandise assortment planning and inventory management led to an inventory decrease despite an operating additional 50 net stores and operating in a difficult retail environment. Those improvements resulted in $117.8 million of inventory at the end of first quarter 2008, compared to $127.3 million at the end of the first quarter of 2007.

With that, let me turn the call back to Gene.

Eugene S. Kahn

Thank you, Per. We’ll now be glad to open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of [__________]. You may ask your question.

Unknown Analyst

I was wondering if you could if you could please touch on your comfort with the liquidity and the cash burn here. You’re saying that you’ll end the year with an undrawn revolver. If you see, again, cash costs with this annualized savings program and what’s the view there?

Per Brodin

I’ll start with the latter part of that question. While there will be some costs incurred to implement the cost savings initiatives, we don’t see those as being significant relative to the overall program, and relative to liquidity, we typically do not give forward EBITDA guidance, but if you’re to use our last 12 months’ adjusted EBITDA of $273 million, we would generate positive free cash flow. Our uses of cash would include approximately $152 million of cash interest, which anticipates picking the notes as we had announced previously, the CapEx I described of approximately $85 million, and cash taxes of $10 million.

Unknown Analyst

In terms of all the new hires, and my apologies, I didn’t catch everybody’s name, should we expect a material shift in SG&A, or is this going to be offset or included in the numbers?

Per Brodin

I think as Gene mentioned, that was relatively headcount neutral, so on a dollar-per-dollar basis, that should also be the case.

Eugene Kahn

In looking at the work that we did in creating the reorganization for both the North American and European teams, that total census in totality remained virtually the same, and mostly all the people that I discussed with you today, just so you understand the breadth of the changes that we’ve made in order to improve our performance, are most replacements.

Unknown Analyst

And lastly from a really big picture perspective, in terms of the trends with accessories versus jewelries, how do you see that playing out in terms of the fashion cycle? What’s the lead time for new product and where do we see ourselves going there?

Eugene Kahn

We operate basically on quarterly deliveries, so we’re working starting 180 days out, but we’re placing goods on basically 160- to 120-day out cycle dependent on the classification. Accessories themselves work on a slightly longer lead time. For instance, woven fabrics dealing with things like handbags or scarves require a longer lead time than jewelry, but it’s basically similar lead times to what we’ve always been working with. We’ll be placing goods in the next 30 days for the middle to the end of fall season receipts.

Unknown Analyst

Just one more. You had said that your expectations were for a better second half, that you had a lot of temporary issues last quarter. Do you still see the year unfolding that way?

Eugene Kahn

I think that obviously we’re all experiencing a touch retain environment right now, and that would be true globally. On the other hand, when you look at our performance in the second half of the year as compared to the first half of the year or last year, I think that we’ll be operating from a weaker base. So I think putting that, plus the team that we’ve put in place, plus the changes that we’ve made in place, we do have the expectation to perform in the second half of the year than we currently are performing.

Operator

Your next question comes from the line of Grant Jordan from Wachovia.

Grant Jordan – Wachovia

My first question is certainly I understand the deleveraging of the same-store sales versus the rent costs. Within that cost of goods sold, the way I understand it, you've got the purchasing costs, the rent costs, and then the merchandise costs. I’m really just trying to get a magnitude of the purchasing costs to understand how much deleveraging is going on.

Per Brodin

I think, as we discussed, or as I discussed in my remarks, there were a couple of pieces in the buying line of our income statement that portion of the cost included nonrecurring PET cots of approximately $1.2 million, and then there was some foreign exchange effect in that line as well as some other miscellaneous changes.

Grant Jordan – Wachovia

So, stripping out those one-time items, was there an increase in the buying costs year over year?

Per Brodin

There was a small increase year over year stripping off those costs.

Grant Jordan – Wachovia

Okay, so are you still expecting that should be roughly flat for the year?

Per Brodin

I think we should expect that to be consistent sequentially for the rest of the year.

Grant Jordan – Wachovia

My next question is on inventory. Clearly, we’d like to see inventory levels down, improve working capital usage, but I was just trying to get a sense, do you feel like you missed any sales through stock-outs or just not having the right inventory or enough inventory of certain items?

Eugene Kahn

I would say, Grant, that I’m very comfortable that we did not miss any business. We’re very focused on the things that are driving the business, and although we’re operating with less weeks of supply, we also have significant reduced the number of SKUs that we’re operating with. So, we’re making the same or better investments, by SKU, by door than we had last year at this time.

Grant Jordan – Wachovia

Just looking forward a little bit, the second quarter of last year is the way I calculated year over year, so second quarter of ’07 versus second quarter of ’06, your inventory per store was down about 10%. Do we feel like we’ve already seen a lot of what you can do in terms of reducing inventory in the stores or do you think there’s further room to take more inventory out?

Eugene Kahn

I would say that there’s further room to take inventory out to improve our agility, and we’ll continue to see that trend until we get to the middle of the fourth quarter where some of what we’ve put in place last year when we arrived in the business start to take hold. So, our goal is to operate with 20 weeks of supply or less, and we are functioning to that and cutting receipts as appropriate to the decline in the business on an ongoing basis.

Grant Jordan – Wachovia

My last question would just be if you can give us any sort of update on Icing. I know that you’ve got the new merchandising team there, but have you seen any changes there, any changes in the business trends?

Eugene Kahn

As I stated in my remarks, business is slightly better and clearly demonstrating itself in both the Claire’s and the Icing franchise in North America. I’d say that we’re really counting on the new team to impact the business by the end of the fourth quarter and as we move forward. I think that we need to remember that looking at this somewhat strategically, our focus is to really understand the targeted customer, decide how we can best respond to her, and pursue that actively with the new team that we’ve put in place. That would include Joan, as the chief merchandise officer, as well as the North American team. At the same time, I would tell you that our sell through on new receipts and merchandise targeted right in the heart of the customer that we are targeting continue to perform well, and we differentiate the assortments from Claire’s, we are seeing some success. We need to have a larger nucleus in order to shout that to the customer, which I think is the ultimate event we need to sort of get over the highest hurdle and start seeing some fruits of our labor.

Operator

Your next question comes from the line of Carla Casella from J.P. Morgan.

Carla Casella – J.P. Morgan

I’m wondering if you can comment on market share. From what we’ve been hearing we thought mall traffic for retail in general was down in the mid to high single digits. Does yours being down more imply that you’ve lost market share, or do you think that it’s that age group of customer that might have had weaker mall traffic?

Eugene Kahn

I would say obviously we concur that the mall traffic is down, but I wouldn’t say that we are really losing share here. I think that as everybody is pulling back and people are making discretionary visits to malls, we see a lot of difference in levels of purchase by the different customer targets, but I would say in general that transactions from our point of view do not equal market share and that we definitely see some improvement in our average unit sales which we think is a good indicator of receptivity by the consumer.

Carla Casella – J.P. Morgan

Great! With your new, actually I guess specifically with Joan, since she has been there, have you see anything or learned anything about things they were doing at Tween that you may be able to employ or anything they were doing better, lessons learned, etc.?

Eugene Kahn

Well, I think that obviously her experience is right on target to the younger customer, ages 7 to 11. Obviously I got to know over Joan over a period of months, and I had spent more time with her before that than I’ve spent in the last week since she has arrived. I think that there’s great application from what knowledge that she has for the last 8 years, and that’s a certainly a part of the value that she brings. At the same time, she has a good understanding of the young or teen customer and has re-emerged herself in that market quite as well, since as we shared with you before, it’s important for us to pursue all three of our targeted customers.

Operator

Your next question comes from the line of Mary Gilbert from Imperial Capital.

Mary Gilbert – Imperial Capital

Going back to Icing, I wondered could you tell us where you are in the process in terms of effectuating the merchandise. Are you happy with the assortment in the stores and it’s just a matter of getting the message out to the consumer?

Eugene Kahn

Mary, I would say, as I said on the last call, I would expect that with our merchandise strategy that we are working on and doing research on about the customer, the landscape, etc., etc., we’ll begin to see the fruits of the labor, as I said, at the end of this year, but I would say that we’re going to be happy to have a reconstituted assortment hopefully by the beginning of the spring season and hopefully begin marketing efforts sometime during mid fiscal ’09.

Mary Gilbert – Imperial Capital

Okay. This year, we’re still working on it. Can you talk about how the performance differs from Claire’s? We know that it was weaker than Claire’s, but can you give us the magnitude of the difference?

Eugene Kahn

We really don’t disclose the difference between the two operating divisions, but needless to say Claire’s is focused on its three targeted customers. Icing has gone through a change that began before Apollo purchased the company and continues to evolve. At this time last year, the assortment in Icing was about 80% the same as Claire’s, and this year, I’d say it’s approaching 85% different than Claire’s, so you can draw your conclusion from that.

Mary Gilbert – Imperial Capital

The other thing is how much do you expect to go into the revolver, like what do you think borrowings could be?

Per Brodin

We really don’t provide intra-period guidance on what our borrowings may be. We have indicated that we expect to draw on the revolver for seasonal needs, but to at zero at the end of the year.

Mary Gilbert – Imperial Capital

I understand that. We’re just trying to get the magnitude of the borrowings. Okay, from a working capital perspective, you do expect to generate cash from working capital, it sounds like, in terms of what you’re planning for inventories. Does that sound right?

Per Brodin

Our working capital tends to relatively flat. As we grow the store base, we have investments in inventory offset by increases in our merchandise payables. It’s something that overall remains relatively flat on an overall year basis.

Operator

Your next question comes from the line of Emily Shanks from Lehman Brothers.

Jason Trujillo – Lehman Brothers

This is actually Jason Trujillo with Lehman Brothers, calling in place of Emily. My first question relates to strength and weakness by region, starting with America. Can you give us some color on what you saw regarding that?

Eugene Kahn

Jason, we basically in the first quarter saw the business pretty much the same across the entire US. In Europe, the continental European continues to perform better than the UK business, but that’s generally how we’re looking at it. As we go forward, we’ll be looking at the business in three zones in Europe and trying to not look at it by country, but look at it by geography or culture and the size of the market so that we have three zones that we’ll operate the business by.

Jason Trujillo – Lehman Brothers

That’s very helpful, and then along those same lines, can you give us traffic and ticket trends of North America and Europe?

Eugene Kahn

We really don't disclose the information by division, if you will, but obviously the dynamics of the North American business, we pretty well have that one in here. I’d say that we are seeing different types of economic conditions impacting the business, so I’d say that the devaluation of the Pound Sterling obviously has some impact against the Euro in purchasing power in the UK, and I’d say obviously the strength of the Euro continues to influence the traffic and transactions associated with the countries whose currencies are Euro.

Jason Trujillo – Lehman Brothers

Great! That helps a lot. Regarding the new store plans, I believe last quarter you said it was weighted about 75% towards Europe. Is that ratio still correct, and can you share with us how many of those new stores are going to Icing stores?

Per Brodin

In terms of a North America versus Europe, that split still remain relatively consistent with what we said in the fourth quarter call, and Icing stores in North America, the large preponderance of stores that we open in the current year will be Claire’s Stores.

Eugene Kahn

Adding to what Per said, I’d say that the vast majority in North America will be Claire’s Stores, and that we are on target in Europe to open the number of stores that we want to open and reach our European expansion goals, but that’s still a work in progress and we still have a period here of 60 to 75 days where we could still open a store before the holiday season.

Jason Trujillo – Lehman Brothers

Then, just lastly, concerning the continued weaker performance of Icing relative to Claire’s, what do you see as the primary issue you’re facing in that business? Is it really a merchandising issue or is it possibly something to do with marketing or targeting the right customer?

Eugene Kahn

Well, we’ve done some preliminary research, as I think I related at the last call, but I’ll reinforce that, that says that there’s a definitely a young college student and young working woman consumer that the data would indicate is a prime candidate for an accessory business. It would indicate that the accessory classifications continue to grow in importance to this customer rather than jewelry which peaks earlier and then peaks again later on. So we’re very comfortable with the target that we’ve selected. When the customer reaches this age, their buying habits, let’s call them, or their lifestyles are maybe even more lifestyle in nature and not so age specific like the targets that are at Claire’s, so the research that we’re doing and the studying that we’ll be working on will be to look at whether we’re going to look at each targeted customers similarly or whether we’re going to take a more lifestyle approach to the business. Saying anything more than that would be very premature. At the same time, I’d say that with the team in place and being able to have them participate in the research and the project, we’ll get good buy in. I’d say that we think the customer is good. We understand the classifications within accessories and jewelry that we need to focus on, and we believe that we need to decide how to think about the business and they buy to those thoughts. So this is an evolution, not a revolution, but from where we were a year ago, this is a hard right turn. We believe that we’re on the right track, but we think that we need to be organizationally supported. We need differentiated merchandize, and capturing a new customer really requires time to build on the strength of the new concept, and we have seen preliminary signs of acceptance of products that will go along with that, but as I said to a caller earlier, we want to get the merchandise properly positioned, which we think we will reach by this first quarter of fiscal ’09 and then in the interim period, we’ll decide what marketing effort is required to tell the customer who and what we are as compared to always being in a transitory state.

Operator

Your next question comes from the line of Karen Altrace from Goldman Sachs.

Karen Altrace – Goldman Sachs

The first question I have to ask is an obligatory question. On sourcing from China, with the inflationary pressures, how are you managing that?

Eugene Kahn

I think that we’re managing it well. Remember that at this time last year we really weren’t making any purchases globally. In our most recent buying trip to Hong Kong, we had both teams operating together within the merchandising cycle project that we talked to you about, and the two buyers for each department, where the hierarchy is similar and the structure is very similar, worked hand in hand, and our goal is to have on average 50% of the styles being common, 25% be divisional if you will but they might be the same style in a color palette or a different finish, and the last 25% would be zone or locally specific. That’s 75% of the merchandise that can be worked on in common. We’re working diligently to accomplish that. From the inception of the trend and formalizing the assortment planning to the development process to the purchasing, and in doing that we have more common buying which is allowing us to resist price increases, and when necessary, we’ve found that we are able to pass along those price increases. We had a vendor conference Hong Kong when the buying teams were there, met with our top 200 vendors, and I think that we forged a partnership that will make them understand that we’ll be narrowing our vendors and depending on the people who want to do business with us on a mutually profitable basis.

Karen Altrace – Goldman Sachs

You did mention that business conditions are getting tougher in Europe. Can you elaborate on what you’re seeing there because obviously that business had had some momentum and what the challenges will be to keep comps positive there?

Eugene Kahn

I think as I said to you the continent continues to show good strength. Across the board, meaning generally, there are peaks and valleys, but I think it’s not so much country specific. I think the economy across the continent is very similar, and so what we’re finding is I think previously, and I hope you can understand this with due respect Karen, too much was put into how a country performed rather than whether there was a good regional sales manager or divisional manager that drove sales. So, in Spain, we had had a good increase, but the average was the average. We had RSMs and DSMs that had performed 5 to 10 points below and we had ones that had performed 5 to 8 points over, so this is a very people business, and in standardizing our practices and approaches to a centralized Europe, we think, will leverage the strength and capabilities that have made us successful, and we have a dominant position in the UK and France and bring them to all of Europe. So I think, as I have said before and we’re all aware of the fact that the UK is struggling. The Republic of Ireland on the other hand seems to be doing quite well, and the rest of the continent is very similar, so those dynamics impact our business, but I think that we put a team in place much earlier to do the former UK group, and so Mark Smith and Melanie Berry both got a great headstart starting last June, and I think that we’ll see the benefit of that in the fall season in the UK to help blunt some of the economic circumstances, but we’ll also see the benefit of the pan-European buying and merchandising team in place since the end of March to impact the second half of the year throughout Europe so that we’re going to have merchandise broad buys, people who live in Europe for Europeans and move forward.

Karen Altrace – Goldman Sachs

Great! You guys are obviously doing as much as you can for the factors that you can control. There is, as you mentioned, higher gas pricing and negative mall traffic factors that are beyond your control. Would you be willing to scale back new store development in order to stay cash flow positive, if it came to that?

Per Brodin

I think we discussed somewhat on the fourth quarter call that we think one of the nice things about our operating model is we do have a flexible capital structure, and part of that includes the fact that part of our strategy is predicated on store growth and to the extent that we need to, we’ll slow down store growth if that’s what we need to do.

Operator

Your next question comes from the line of Colleen Burns from Oppenheimer.

Colleen Burns – Oppenheimer

Just a followup on that previous question regarding Europe. Basically does that mean that you haven’t seen a sequential improvement in Europe sales, like you saw in North America more recently?

Eugene Kahn

As we said, sales were 0.3% down in Europe, and basically sales are off slightly to that, but that’s a 5-week trend and not anything that I think we can draw our conclusion on.

Colleen Burns – Oppenheimer

Okay, and then just with regard to advertising, I think Tween brand did a bunch of advertising recently. Are you guys exploring any advertising opportunities in order to drive traffic given the current environment?

Eugene Kahn

We are always looking at opportunities to help drive traffic, but I think right now, getting our merchandise in order is the number one way to drive traffic. I think that Tween brand and other retailers that we compete with all have very strong direct mail and marketing programs to attract customers. A dedicated CRM program is part of initiatives that we will intend to roll out in fiscal ’09, but could not be attempted in fiscal ’08. The rollout of the POS that continues will allow us to facilitate that at point of sale and will all work together as we approach 2009.

Colleen Burns – Oppenheimer

That’s helpful, and then just lastly on the cost savings expected this year, the $15 million. Is most of that coming from freight savings, store labor…can you just broadly talk about what we should see this year?

Per Brodin

I think we discussed it comes from a variety factors as we looked at the broad spectrum of costs throughout the organization, but it comes from the areas of freight, shrink, and what we call indirect, which are nonpayroll, and there are some payroll costs involved as well.

Colleen Burns – Oppenheimer

And you expect to see benefits from all of those to hit this year or would some of them take longer?

Per Brodin

We expect to see benefits from all those areas in the current year and then obviously hitting the full year of benefit next year. I guess I will clarify. Some do take longer than others, some are harder than others to implement, but we expect to see savings in all those areas.

Colleen Burns – Oppenheimer

On the new stores, I think you said you closed 12 in North America in the first quarter, if I heard you correctly. Were those mostly Icing stores or…?

Per Brodin

No, those were mostly Claire’s Stores.

Operator

Your next question comes from the line of Jeffrey Takacs from Babson Capital.

Jeffrey Takacs – Babson Capital

I’m new to the credits, so I apologize if this question seems a little remedial. I’m trying to get behind operating leverage. Can you kind of break out with ballpark figures what component of either first quarter or full year 2007 was fixed cost in both COGS and SG&A?

Per Brodin

You said fiscal ’07 versus fiscal ’08?

Jeffrey Takacs – Babson Capital

The year ended February 2, 2008. If you have that, that’d be great. I’ll have a full year.

Per Brodin

Maybe it would be better to this offline. I’d be happy to take this call and walk you through some of the cost structure and get you up to speed on the credit?

Jeffrey Takacs – Babson Capital

Okay, what’s the best way to get touch with you? Go through the agent and…?

Per Brodin

The number is listed on the press release from the morning.

Jeffrey Takacs – Babson Capital

Okay, I’ll do that. Then my second question, just trying to get behind the mechanics. I know you guys have no maintenance covenants, but you do have an incurrence covenant. Does your incurrence covenant at 5 times net any secured leverage allow you to draw down on the revolver? If I just kind of do a ballpark net senior secured leverage, I’ve got you at just above 5 times. Are you still able to access the revolver?

Per Brodin

We have full access to our revolver at this time.

Operator

Your next question comes from the line of Jeff Kobylarz from Stone Harbor Investments.

Jeff Kobylarz – Stone Harbor Investments

Can you comment how much of your same-store sales decline do you think was due to wrong merchandise, bad merchandise, or execution?

Eugene Kahn

I was waiting for this question. It’s been asked in every call. I’d say that 50% of our downturn in business is reflective of the tough retail environment, and the 50% majority, I’d say the majority of it is a more spirited approach to the merchandise being required, but there is improvement in our in-store execution going forward as well.

Jeff Kobylarz – Stone Harbor Investments

Okay, so when do you think you will have the appropriate merchandise and execution?

Eugene Kahn

Obviously, we’ve worked on this for beginning a year ago. I’ve been the CEO for a little over a year right now, so I think that as we get into the fall season, we’re going to see improvement, but I think that it’s taken a while to find and put in place a merchandising organization that really will be capable of dealing with the diversity of three targeted customers at Claire’s and a totally different concept at Icing. Remember please that the organization up to and including the months of July in North America, the buying and planning organization was responsible for Claire’s North America, Icing, and Continental Europe, and in fact the merchandise that’s doing well in Continental Europe was purchased by buyers based in [__________]. Going forward, we think we’ll get benefit from the new organization, but as I said in my remarks, we really won’t see the benefit of dedicated organizations for each of those three entities until well into the fall season. So, this is an evolution, and we will see steady improvement, but if you’re really asking when we’ll turn the corner, I’d say that you’re looking at a 4- to 6-month period before we see the product that Joan, Denise, and the reconstituted team in Europe will really have in-store impact.

Jeff Kobylarz – Stone Harbor Investments

Your merchandise margin, it held up decently given the mix shift that seems in the first quarter, and is that reasonable to see it continuing at that kind of trend going forward?

Eugene Kahn

We think our disciplined approach to inventory management and inventory investment will allow us to sustain the merchandise margins, and in an upturn environment, we will look forward to improving them.

Jeff Kobylarz – Stone Harbor Investments

Good. In Europe, can you comment why your comps were relatively flat there given it’s also a weak environment there and just contrast the performance of Europe same-store sales being flat versus US down so much?

Eugene Kahn

To reiterate some of what I’ve said but sort of answer your question directly, if you think about it, Continental Europe, the economy is okay, and we’re seeing benefit of that. In the UK, where the economy is toughening, we’re still seeing improvement compared to other retailers that we track because I think that the buying team and the leadership that Mark Smith and Melanie Berry brought to the business last June is having an impact on our business. It’s a great case for what we’re trying to explain what will occur in the future. I think that adding those two together, you get the number that we reported.

Jeff Kobylarz – Stone Harbor Investments

Fine. Just given the difficult retail environment, are you considering purchasing into the Claire’s system and Icing system lower average unit retail merchandise if the consumer is balking at buying because of price at all?

Eugene Kahn

When we came to the business, we brought a strategy of price steering, good, better, best. We have attributes in place to be able to discipline our approach to that, and in fact, we’re finding that the better and best price points which still are great values have as good or if not better rates of sale, so we continue to be dedicated to looking at our business and establishing a tiered approach to pricing that always conveys value to the customer, but at stepped prices. So we are not intending nor do we see any reason lower our average unit retail to drive traffic.

Operator

Our last question comes from the line of Adam Plissner from Credit Suisse.

Adam Plissner – Credit Suisse

I was wondering if you could just go back. You keep mentioning your intention to keep the revolver balance at zero by the end of the year. Are you implying that you’re not going to draw down on your cash of $68.9 million, or is this just a preference to use cash to support free cash flow burn, or are you trying to say that you’re going to be free cash flow positive?

Per Brodin

No. We anticipate that over time cash balance will come down and we will likely maintain a minimum cash balance, and that coupled with season’s working capital needs, as I mentioned, we’ll need to at times draw on the revolver.

Eugene Kahn

Adam, I must say we’ve been saying since the morning of the purchase of the company that we put the revolver in place to meet our seasonal needs and we draw it when we need to, but we don’t intend to abuse it. It’s just part of our strategy.

Adam Plissner – Credit Suisse

Is there a minimum amount of cash that you want to keep on balance?

Per Brodin

From a minimum standpoint, we spoke to on the last call as well, we’d say $15 million. That would be cash on hand. There are some areas we’re looking at that we need to improve. The efficiency of our treasury operation particularly in Europe such that we could operate at that level, but generally our goal is to operate at cash in that neighborhood.

Adam Plissner – Credit Suisse

Okay. The Q4 conference call, I guess we were talking last early April, and I guess we didn't see the weaker trends in February or March as significantly as they were coming. Apparently, they are certainly trending better in April and May. Is there anything that you could talk to that would attribute the significantly weaker trends that you saw on those two months and potentially why we’re seeing the improvement? Is there something to pinpoint in maybe that 2-month period that is now trending better?

Eugene Kahn

I think that due to multiple units per transactions of two to three at Claire’s, mall traffic being down equates to traffic being down, our 12.5%, and I think that jewelry being 55% of the business and that’s weaker than the general overall trend of the total accessories business added to that. When you think about some of the weather conditions and other things that we faced earlier in the year, I think that each period the business showed different trends, and the casualization of our society is impacting this age customers well, and I think that the response to the business as we move into the summer season definitely embraces the importance of casual. The peace motif trend that I spoke to in my remarks is demonstrative of some of the merchandise that’s more applicable when you’re not wearing heavy layered garments.

Adam Plissner – Credit Suisse

The last thing I had, just in terms of the evolution of Icing here, you gave some sort of milestone events that we should be looking out for 4 to 6 months from now, is there an ultimate judgment day that you guys have in mind, 15 months or 18 months down the road, that if things don’t meet your planned expectations that you would then move to transition out of the concept, and hypothetically if that were the case, what would it mean? Would it be a process similar to your typical closed stores as you go through it or would it be something obviously more impactful?

Per Brodin

I speak to at least part of that. This is another thing that we touched on the Q4 conference call. While Icing is underperforming and we’re trying to improve that, overall Icing is cash flow positive, so as we look for improvements in that brand, we certainly that improving. Whether there’s an ultimate day of reckoning, I don’t believe we have a day circled in red with an ultimate day of reckoning, but Gene spoke to some of the milestones we’re looking at, and we’ll reevaluate and see how the business is doing at the time relative to other opportunities.

Eugene Kahn

We really have to remember what Icing serves. It really serves two parts. It is our second brand here in North America, and the research that we’ve done indicates that it has every reason for us to go forward and be patient and spend the time, effort, and energy, and not to mention make the financial commitment to it, but we also have to remember that it can provide us with a global growth platform when we get it right, and so we could easily open hundreds of stores in the UK and France instantaneously with the penetration that we have with Claire’s business and our understanding of that marketplace. Our desire is to go as fast as you want us to go in order to really have that growth platform. At the same time, we want to get it right, so that it has that capability.

Adam Plissner – Credit Suisse

Thanks.

Eugene Kahn

Thank you, and thank you all for your time today. We look forward to speaking to you at the Q2 call in September.

Operator

That concludes today’s conference call, and you may disconnect at this time.

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Source: Claire’s Stores, Inc. F1Q08 (Qtr End 5/3/08) Earnings Call Transcript
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