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Tilly’s SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 _________ FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended January 29, 2000 Commission File Number 333-42427 --------- J. CREW GROUP, INC. (Exact name of registrant as specified in its charter) New York 22-2894486 -------- ---------- (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) 770 Broadway, New York, New York 10003 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (212) 209-2500 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: NoneIndicate by check mark whether the registrant (1) has filed all reports requiredto be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.Yes X No -Indicate by check mark if disclosure of delinquent filers pursuant to Item 405of Regulation S-K is not contained herein, and will not be contained, to thebest of registrant's knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or any amendment to thisForm 10-K. [X]The common stock of the registrant is not publicly traded. Therefore, theaggregate market value is not readily determinable.As of April 1, 2000, there were 11,726,865 shares of Common Stock, par value$.01 per share, outstanding.Documents incorporated by reference: None Certain statements in this Annual Report on Form 10K under the captions"Business", "Selected Financial Data", "Management's Discussion and Analysis ofFinancial Condition and Results of Operations", "Financial Statements andSupplementary Data" and elsewhere constitute "forward-looking statements" withinthe meaning of the Private Securities Litigation Reform Act of 1995. We may alsomake written or oral forward looking statements in our periodic reports to theSecurities and Exchange Commission on Form 10Q, 8K, etc., in press releases andother written materials and in oral statements made by our officers, directorsor employees to third parties. Statements that are not historical facts,including statements about our beliefs and expectations, are forward-lookingstatements. Such forward-looking statements involve known and unknown risks,uncertainties and other important factors that could cause the actual results, performance or achievements of the Company, or industry results, to differmaterially from historical results, any future results, performance orachievements expressed or implied by such forward-looking statements. Such risksand uncertainties include, but are not limited to, competitive pressures in theapparel industry, changes in levels of consumer spending or preferences inapparel and acceptance by customers of the Company's products, overall economicconditions, governmental regulations and trade restrictions, political orfinancial instability in the countries where the Company's goods aremanufactured, postal rate increases, paper and printing costs, the level of theCompany's indebtedness and exposure to interest rate fluctuations, and otherrisks and uncertainties described in this report and the Company's other reportsand documents filed or which may be filed, from time to time, with theSecurities and Exchange Commission. These statements are based on current plans,estimates and projections, and therefore you should not place undue reliance onthem. Forward looking statements speak only as of the date they are made and weundertake no obligation to update publicly any of them in light of newinformation or future events.References herein to fiscal years are to the fiscal years of J. Crew Group,Inc., which end on the Friday closest to January 31 in the following calendaryear for fiscal years 1995 and 1996 and on the Saturday closest to January 31 inthe following calendar year for fiscal years 1997, 1998 and 1999. Accordingly,fiscal years 1995, 1996, 1997, 1998 and 1999 ended on February 2, 1996, January31, 1997, January 31, 1998, January 30, 1999 and January 29, 2000. All fiscalyears for which financial information is included had 52 weeks.References in this Report to the "Company" and "J. Crew" mean J. Crew Group,Inc. and its subsidiaries, unless the context requires otherwise. Part IITEM 1. BUSINESSGeneralThe Company is a leading retailer of women's and men's apparel, shoes andaccessories operating under the J. Crew (R) brand name. The Company has built astrong and widely recognized brand name known for its timeless styles at pricepoints that the Company believes represent exceptional product value. The J.Crew image has been built and reinforced over its 17-year history through thecirculation of more than 700 million catalogs that use magazine-qualityphotography to portray a classic American perspective and aspirationallifestyle. Many of the original items introduced by the Company in the early1980s (such as the rollneck sweater, weathered chino, barn jacket and pockettee) were instrumental in establishing the J. Crew brand and continue to be coreproduct offerings. The Company has capitalized on the strength of the J. Crewbrand to provide customers with clothing to meet more of their lifestyle needs,including casual, career and sport.The J. Crew merchandising strategy emphasizes timeless styles and a broadassortment of high-quality products designed to provide customers with one-stopshopping opportunities at attractive prices. J. Crew retail stores, catalogs andits Internet site offer a full line of men's and women's basic durables (casualweekend wear), sport, swimwear, accessories and shoes, as well as the moretailored men's and women's "Classics" lines. Approximately 60% of the Company'sJ. Crew brand sales are derived from its core offerings of classics, durablesand sport clothing, the demand for which the Company believes is stable andresistant to changing fashion trends. The Company believes that the J. Crewimage and merchandising strategy appeal to college-educated, professional andaffluent customers who, in the Company's experience, have demonstrated strongbrand loyalty and a tendency to make repeat purchases. 1 J. Crew products are distributed exclusively through the Company's retail andfactory outlet stores, catalogs and the Company's Internet site, jcrew.com. TheCompany currently circulates over 75 million J. Crew catalogs per annum and operates 81 J. Crew retail stores and 42 J. Crew factory outlet stores. Inaddition, J. Crew products are distributed through 70 free-standing and shop-in-shop stores in Japan under a licensing agreement with Itochu Corporation.The Company has three major operating divisions: J. Crew Direct, J. Crew Retail,and J. Crew Factory Outlets, each of which operate under the J. Crew brand name.In 1999, products sold under the J. Crew brand contributed $716.6 million inrevenues. J. Crew brand revenues in 1999 were comprised of $333.6 million fromJ. Crew Retail, $278.5 million from J. Crew Direct, $102.0 million from J. CrewFactory Outlet and $2.5 million of licensing revenues. The Company also marketsto its customers through its Internet site (jcrew.com). Revenues derived fromthe Internet, which were $65.2 million for 1999, are included in J. Crew Directrevenues.Effective as of October 30, 1998 the Company sold Popular Club Plan, Inc. andsubsidiaries (PCP) to The Fingerhut Companies, Inc. for $42.0 million and theassumption of an accounts receivable securitization facility. Revenues for thenine months ended October 30, 1998 were $124.1 million. A gain on the sale of$10.0 million was included in the results of operations in fiscal 1998. Anadditional gain of $1.0 million was recognized in fiscal 1999 from the reversalof certain estimated liabilities recorded at the date of sale.In 1998, management of the Company made a decision to exit the operations of itsClifford & Wills mail order and factory outlet subsidiaries (C&W). Revenues forthe year ended January 30, 1999 were $74.3 million. A charge of $13.3 millionwas included in fiscal 1998 operations to write down the assets of C&W to netrealizable value and to provide for certain additional costs in connection withthe discontinuance of the C&W operations, including severance and leasetermination costs. Additionally, fourth quarter charges of $1.7 million,included in selling expense, were incurred relating to deferred catalog costs.In February 2000 the Company sold certain intellectual property assets toSpiegel Catalog Inc. for $3.9 million. In connection with this sale the Companyagreed to cease the fulfillment of catalog orders but retained the right tooperate its outlet stores and conduct other liquidation sales of inventoriesthrough December 31, 2000. After consideration of the proceeds from this saleand other terms of the agreement the Company provided an additional $4,000,000to write down inventories to net realizable value as of January 29, 2000.J. Crew BrandMerchandising and Design StrategyOver time, the J. Crew merchandising strategy has evolved from providing unisexproducts to creating full lines of men's and women's clothing, shoes andaccessories. This strategy had the effect of increasing overall J. Crew brandsales volume, and significantly increasing revenues from sales of women'sapparel as a percentage of total J. Crew brand sales from 47% in 1995 to 65% in1999.Every J. Crew product is designed by an in-house design staff, to reflect aclassic, clean aesthetic that is consistent with the brand's American lifestyleimage. Design teams are formed around J. Crew product lines and categories todevelop concepts, themes and products for each of the Company's J. Crewbusinesses. Members of the J. Crew technical design team develop constructionand fit specifications for every product to ensure quality workmanship andconsistency across product lines. These teams work in close collaboration withthe merchandising and production staff in order to gain market and other input.Product merchandisers provide designers with market trend and other informationat initial stages of the design process. J. Crew designers and merchants sourceglobally for fabrics, yarns and finished products to ensure quality and value,while manufacturing teams research and develop key vendors worldwide to identifyand maintain the essential characteristics for every style. 2 Sourcing, Production and Quality The Company maintains separate merchandising, design, manufacturing and qualityassurance teams for the production of J. Crew brand merchandise. The Company'sproducts are designed exclusively by in-house design and product developmentteams which support each line and class of product. These teams provideindividual attention and expertise to every style, ensuring that these stylesfit the J. Crew brand image.The Company's merchandise is produced for the Company by a variety ofmanufacturers, both domestically and outside the United States. The Company doesnot own or operate any manufacturing facilities, instead contracting with thirdparty vendors in over 20 countries for the production of its products. In 1999,approximately 70% of the Company's J. Crew brand products were sourced in theFar East, 15% were sourced domestically and 15% were sourced in Europe and otherregions. Rarely does the Company represent the majority of any one vendor'sbusiness and no one vendor supplies more than 10% of the Company's merchandise.The Company retains independent buying agents to conduct in-line and finalquality inspections at each manufacturing site. Random inspections of allincoming merchandise at the Lynchburg and Asheville distribution facilitiesfurther assure that the Company's products are of a consistently high quality.Due to the high concentration of foreign suppliers of J. Crew brand merchandise,the Company estimates seven month lead times for its products. The Company hasestablished through the use of domestic vendors and strategic partnerships, acore group of long-term suppliers to provide quick response programs atsignificantly shorter lead times for certain product categories.DistributionThe Company operates two major telemarketing and distribution facilities for itsoperations. Order fulfillment for J. Crew Direct takes place at the 406,500square foot telemarketing and distribution center located in Lynchburg,Virginia. The Lynchburg facility processes approximately 3.8 million orders peryear and employs approximately 1,000 full and part-time employees during itsnon-peak season and an additional 500 employees during its peak season.A 192,500 square foot telemarketing and distribution facility in Asheville,North Carolina serves as the main distribution center for the retail and outletstore operations and also houses a J. Crew Direct telemarketing center. Thisfacility employs approximately 550 full- and part-time employees during its non-peak season and an additional 200 employees during the peak holiday season.The Company ships merchandise via UPS, the United States Postal Service andFedEx. To enhance efficiency, each facility is fully equipped with a highlyadvanced telephone system, an automated warehouse locator system and aninventory bar coding system.Management Information SystemsThe Company's management information systems are designed to provide, amongother things, comprehensive order processing, production, accounting andmanagement information for the marketing, manufacturing, importing anddistribution functions of the Company's business. The Company has sophisticatedpoint-of-sale registers in its J. Crew Retail and Factory Outlet stores thatenable it to track inventory from store receipt to final sale on a real-timebasis. The Company believes its merchandising and financial systems, coupledwith its point-of-sale registers and software programs, allow for rapid stockreplenishment, concise merchandise planning and real-time inventory accountingpractices. The Company's telephone and telemarketing systems, warehouse packagesorting systems, automated warehouse locator and inventory bar coding systemsutilize advanced technology. These systems have provided the Company with anumber of benefits in the form of enhanced customer service, improvedoperational efficiency and increased management control and reporting. Inaddition, the Company's real-time inventory systems provide inventory managementon a per SKU basis and allow for a more efficient fulfillment process. 3 The Company is in the process of installing an enterprise resource planningsystem for its future information technology requirements. This system isscheduled for a phased-in implementation over a period of three years.J. Crew RetailDuring fiscal 1999, J. Crew Retail generated revenues of $333.6 million,representing 46.5% of the Company's total J. Crew brand revenues.The principal aspect of the Company's business strategy is an expansion programdesigned to reach new and existing customers through the opening of J. CrewRetail stores. In addition to generating sales of J. Crew products, J. CrewRetail stores help set and reinforce the J. Crew brand image. The stores aredesigned in-house and fixtured to create a distinctive J. Crew environment andstore associates are trained to maintain high standards of visual presentationand customer service. The result is a complete statement of J. Crew's timelessAmerican style, classic design and attractive product value.The Company believes that J. Crew Retail derives significant benefits from theconcurrent operation of J. Crew Direct. The broad circulation of J. Crewcatalogs performs an advertising function, enhancing the visibility and exposureof the brand, aiding the expansion of the retail concept and increasing theprofitability of the stores.The Company believes that its J. Crew Retail stores are among the mostproductive in its industry segment. All of the Company's J. Crew Retail storesare profitable and have generated positive store contribution within the first12 months of opening. J. Crew Retail stores that were open during all of fiscal1999 averaged $4.7 million per store in sales, produced sales per gross squarefoot of approximately $571 and generated store contribution margins ofapproximately 26.0%. The Company believes that these results compare favorablyto the average among retailers that the Company believes to be its primarycompetitors. J. Crew Retail stores have an average size of 8,243 total squarefeet.As of January 29, 2000 J. Crew Retail operated 81 retail stores nationwide,having expanded from 29 stores in 1995. The Company opened 16 stores in fiscal1999 and intends to open approximately 20 stores in fiscal 2000. The stores arelocated in upscale shopping malls and in retail areas within major metropolitanmarkets that have an established higher-end retail business.The table below highlights certain information regarding J. Crew Retail storesopened through fiscal 1999. Stores Stores Average ------ ------ ----------- Opened Closed Stores Total Store Total ------ ------ ----------- -------- ----------- Stores Open During During Open at Square Square -------------- ------ ------ ----------- -------- ----------- At Beginning Fiscal Fiscal End of Footage Footage at -------------- ------ ------ ----------- -------- ----------- Of Fiscal Year Year Year Fiscal Year (000's) End of Year -------------- ---- ---- ----------- -------- ----------- 1995 29 2 -- 31 266 8,5811996 31 8 -- 39 338 8,6671997 39 12 -- 51 428 8,3921998 51 14 -- 65 530 8,1501999 65 16 -- 81 668 8,243J. Crew Retail plans to increase the number of stores in operation by 20 to 30stores annually, resulting in approximately 100 stores in operation by the end of fiscal 2000. The retail expansion plan focuses on markets in which J. CrewDirect has been successful and, more generally, in areas within majormetropolitan markets with affluent and well educated populations. 4 J. Crew DirectSince its inception in 1983, J. Crew Direct has distinguished itself from othercatalog retailers by its award-winning catalog, which utilizes magazine-quality"real moment" pictures to depict an aspirational lifestyle image. During fiscal1999, J. Crew Direct distributed 31 catalog editions with a combined circulationof more than 75 million, and expanded its direct marketing concept to e-commercevia its Internet site (jcrew.com). J. Crew Direct generated $278.6 million inrevenues (including $65.2 million from its Internet site) or 38.9% of theCompany's total J. Crew brand revenues in fiscal 1999.Circulation StrategyJ. Crew Direct circulation strategy focuses on continually improving thesegmentation of customer files and the acquisition of additional customer names.In 1999, approximately 60% of J. Crew Direct revenues were from customers in the12-month buyer file (buyers who have made a purchase from any J. Crew catalog inthe prior 12 months).The Company segments its customer file and tailors its catalog offerings toaddress the different product needs of its customer segments. To increase corecatalog productivity and improve the effectiveness of marginal and prospectingcirculation, each customer segment is offered appropriate catalog editions. TheCompany currently circulates Base, Women's, Prospect and Sale catalogs totargeted customer segments.Descriptions of the Company's current catalogs follow:Base Books. These catalogs contain the entire mail order product offering andare sent primarily to 12-month buyers.Women's Books. The Women's books feature women's merchandise and are sent tobuyers who purchase primarily women's merchandise. These books represent anadditional customer contact potentially generating incremental revenue fromwomen customers.Prospect Books. These editions are abridged versions of the Base Books andare sent to less active and prospective customers in order to cost-effectivelyreactivate old customers and acquire new customers.Sale Books. These catalogs contain overstock merchandise to be sold at reducedprices without adversely affecting the J. Crew brand image.In 1999, total circulation increased to approximately 75 million from 73 millionin 1998, while pages circulated were approximately 9.3 billion in 1999 and 8.8billion in 1998.J. Crew Direct name acquisition programs are designed to attract new customersin a cost-effective manner. The Company acquires new names from various sources,including its Internet site, list rentals, exchanges with other catalog andcredit card companies, "friends' name" card inserts, and through J. Crew Retailstores which represent an increasingly significant resource in prospecting fornew names. Names and addresses of 25% to 30% of the customers making credit cardpurchases at J. Crew Retail stores are automatically captured at the point ofsale. Customers are also asked to fill out cards at the cash register when theymake purchases. In addition, the Company is in the process of placing telephonesin its J. Crew Retail stores with direct access to the J. Crew Directtelemarketing center to allow customers in the stores to order catalog-specificor out-of-stock items.Catalog Creation and Production The Company is distinguished from other catalog retailers by its award-winningcatalog, which utilizes magazine-quality "real moment" pictures to depict anaspirational lifestyle image. All creative work on the catalogs is coordinatedby J. Crew personnel to maintain and reinforce the J. Crew brand image.Photography is executed both on location and in studios, and creative design andcopy writing are executed on a desk-top publishing system. Digital images aretransmitted directly to outside printers, thereby reducing lead times andimproving reproduction quality. The Company believes that appropriate pagepresentation of its merchandise stimulates demand and therefore places greatemphasis on page layout. 5 J. Crew Direct does not have long-term contracts with paper mills. Projectedpaper requirements are communicated on an annual basis to paper mills to ensurethe availability of an adequate supply. Management believes that the Company'slong-standing relationships with a number of the largest coated paper mills inthe United States allow it to purchase paper at favorable prices commensuratewith the Company's size and payment terms.Telemarketing and Customer ServiceJ. Crew Direct's primary telemarketing and fulfillment facilities are located inLynchburg, Virginia. An additional telemarketing facility is located inAsheville, North Carolina. Telemarketing operations are open 24 hours a day,seven days a week and handled over 5.9 million calls in fiscal 1999. Orders formerchandise may be received by telephone, facsimile, mail and on the Company'sInternet site. The telemarketing centers are staffed by a total of 850 full-timeand part time telemarketing associates, and up to 600 additional associatesduring peak periods, who are trained to assist customers in determining thecustomer's correct size and to describe merchandise fabric, texture andfunction. Each telemarketing associate utilizes a terminal with access to an IBMmainframe computer which houses complete and up-to-date product and orderinformation. The fulfillment operations are designed to process and shipcustomer orders in a quick and cost-effective manner. Orders placed before 9:00p.m. are shipped the following day. Same-day shipping is available for ordersplaced before noon.J. Crew Factory OutletsThe Company extends its reach to additional consumers through its 42 J. CrewFactory Outlets. Offering J. Crew products at an average of 30% below fullretail prices, J. Crew Factory Outlets target value-oriented consumers. Thefactory outlet stores also serve to liquidate excess, irregular or out-of-seasonJ. Crew products outside of the Company's three primary distribution channels.During fiscal 1999, J. Crew Factory Outlets generated revenues of $102.0million, representing 14.2% of the Company's total J. Crew brand revenues.J. Crew Factory Outlets offer selections of J. Crew menswear and womenswear.Ranging in size from 3,800 to 10,000 square feet with an average of 6,500 squarefeet, the stores are generally located in major outlet centers in 25 statesacross the United States. The Company believes that the outlet stores, which aredesigned in-house, maintain fixturing, visual presentation and service standardssuperior to those typically associated with outlet stores.Trademarks and International LicensingJ. Crew International, Inc., an indirect subsidiary of J. Crew Group, Inc.,currently owns all of the trademarks and domain names for the J. Crew name thatthe Company holds throughout the world, as well as its international licensingcontracts with third parties. Trademarks related to the J. Crew name areregistered in the United States Patent and Trademark Office.The Company derives revenues from the international licensing of its trademarksin the J. Crew name and the know-how it has developed. The Company has enteredinto a licensing agreement with Itochu Corporation in Japan which gives theCompany the right to receive payments of percentage royalty fees in exchange for the exclusive right to use the Company's trademarks in Japan. Under the licenseagreement the Company retains a high degree of control over the manufacture,design, marketing and sale of merchandise under the J. Crew trademarks. Thisagreement expires in January, 2003. In 1999, licensing revenues totaled $2.5million.EmployeesThe Company focuses significant resources on the selection and training of salesassociates in both its mail order, retail and factory operations. Salesassociates are required to be familiar with the full range of merchandise of thebusiness in which they are working and have the ability to assist customers withmerchandise selection. Both retail and factory store management are compensatedin a combination of annual salary plus performance-based bonuses. Retail,telemarketing and factory associates are compensated on an hourly basis and mayearn team-based performance incentives. 6 At January 29, 2000, the Company had approximately 5,400 associates, of whomapproximately 1,900 were full-time associates and 3,500 were part-timeassociates. In addition, approximately 3,000 associates are hired on a seasonalbasis to meet demand during the peak holiday buying season. None of theassociates employed by J. Crew are represented by a union. The Company believesthat its relationship with its associates is good.CompetitionAll aspects of the Company's businesses are highly competitive. The Companycompetes primarily with specialty brand retailers, other catalog operations,department stores, and mass merchandisers engaged in the retail sale of men'sand women's apparel, accessories, footwear and general merchandise. The Companybelieves that the principal bases upon which it competes are quality, design,efficient service, selection and price.The RecapitalizationOn October 17, 1997, the recapitalization of J. Crew Group, Inc. ("Holdings")(the "Recapitalization") was consummated pursuant to a RecapitalizationAgreement, dated as of July 22, 1997, as amended as of October 17, 1997 (the"Recapitalization Agreement"), among Holdings, its shareholders and TPG PartnersII, L.P. ("TPG"). Pursuant to the Recapitalization Agreement, Holdings purchasedfrom its shareholders all outstanding shares of Holdings' capital stock, otherthan shares having an implied value of $11.1 million, almost all of whichcontinue to be held by Emily Woods, and which represented approximately 14.8% ofthe outstanding shares of common stock of Holdings ("Common Stock") immediatelyfollowing the transaction.In connection with the Recapitalization, Holdings organized J. Crew OperatingCorp. ("Operating Corp.") and immediately prior to the consummation of theRecapitalization, Holdings transferred substantially all of its assets andliabilities to Operating Corp. Holdings' current operations are, and futureoperations are expected to continue to be, limited to owning the stock ofOperating Corp. Operating Corp. repaid substantially all of the Company's fundeddebt obligations existing immediately before the consummation of theRecapitalization.Cash funding requirements for the Recapitalization totaled $559.8 million(including $99.0 million in seasonal borrowings) and were satisfied through thepurchase by TPG, certain of its affiliates and other investors of an aggregate$188.9 million in Holdings' equity securities together with an aggregate $330.9million in borrowings and $40.0 million in proceeds from the securitization ofcertain of the Company's accounts receivable. 7 ITEM 2. PROPERTIESThe Company is headquartered in New York City. The New York City headquarters'offices are leased under a lease agreement expiring in 2012 (not includingrenewal options). The Company owns two telemarketing and distributionfacilities: a 406,500-square-foot telemarketing and distribution center for J.Crew Direct operations in Lynchburg, Virginia and a 192,500-square-foottelemarketing and distribution center in Asheville, North Carolina servicing theJ. Crew Retail and Factory Outlet store operations.As of January 29, 2000, the Company operated 81 J. Crew retail stores and 42factory outlet stores in 34 states and the District of Columbia. All of theretail and factory outlet stores are leased from third parties, and the leasesin most cases have terms of 10 to 12 years, not including renewal options. As ageneral matter, the leases contain standard provisions concerning the payment ofrent, events of default and the rights and obligations of each party. Rent dueunder the leases is comprised of annual base rent plus a contingent rent paymentbased on the store's sales in excess of a specified threshold. Substantially allthe leases are guaranteed by the Company.The table below sets forth the number of stores by state operated by the Company(excludes 7 C&W Outlet stores) in the United States as of January 29, 2000: Total ----- Retail Outlet Number ------ ------ ------ Stores Stores Of Stores ------ ------ ---------Alabama 1 1 2Arizona 1 -- 1California 14 3 17Colorado 2 2 4Connecticut 3 1 4Delaware 1 1 2Florida 4 3 7Georgia 3 2 5Illinois 4 -- 4Indiana 1 2 3Kansas 1 -- 1Maine -- 2 2Maryland 2 1 3Massachusetts 5 1 6Michigan 2 1 3Minnesota 1 -- 1Missouri 1 1 2Nevada -- 1 1New Hampshire -- 2 2New Jersey 4 1 5New Mexico 1 -- 1New York 9 4 13North Carolina 2 -- 2Ohio 4 -- 4Oregon 2 -- 2Pennsylvania 2 3 5Rhode Island 1 - 1South Carolina -- 2 2Tennessee 1 1 2Texas 3 3 6Vermont -- 1 1Virginia 3 1 4Washington 2 1 3Wisconsin -- 1 1District of Columbia 1 -- 1 -- -- --- Total. 81 42 123 == == === 8 ITEM 3. LEGAL PROCEEDINGS Routine litigation is pending against the Company with respect to mattersincidental to its business. Although the outcome of litigation cannot bepredicted with certainty, in the opinion of the Company none of those actionsshould have a material adverse effect on the financial condition of the CompanyITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERSNo matters were submitted to a vote of security holders during the quarter endedJanuary 29, 2000. 9 PART IIITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERSThere is no established public market for Holdings Common Stock. As of April 1,2000, there were 37 shareholders of record of the Common Stock. See "Item 12.Security Ownership of Certain Beneficial Owners and Management" for a discussionof the ownership of Holdings.Holdings has not paid cash dividends on its Common Stock and does not anticipatepaying any such dividends in the foreseeable future.The Credit Agreement entered into a connection with the Recapitalization (the"Credit Agreement") and the Indenture relating to the Senior Discount Debentures(the "Holdings Indenture") prohibits the payment of dividends by Holdings onshares of Common Stock (other than dividends payable solely in shares of capitalstock of Holdings). Additionally, because Holdings is a holding company, itsability to pay dividends is dependent upon the receipt of dividends from itsdirect and indirect subsidiaries. Each of the Credit Agreement, the HoldingsIndenture and the Indenture relating to the Senior Subordinated Notes containscovenants which impose substantial restrictions on Operating Corp's ability tomake dividends or distributions to Holdings.The Directors of Holdings have the right to receive all or a portion of the feesfor their services as a Director in Common Stock at a purchase price of $6.82per share for meetings prior to April 13, 1999 and $10 per share for meetingsheld thereafter. In fiscal 1999, certain Directors elected to receive a total of17,665 shares of Common Stock in payment of their fees. Holdings issued theCommon Stock to the Directors in transactions which did not involve any publicoffering in reliance upon Section 4(2) of the Securities Act of 1933, as amended(the "Securities Act").ITEM 6. SELECTED FINANCIAL DATAThe following table sets forth selected consolidated historical financial,operating, balance sheet and other data of the Company. The selected incomestatement and balance sheet data for each of the two fiscal years ended January31, 1997 are derived from the Consolidated Financial Statements of the Company,which have been audited by Deloitte & Touche LLP, independent auditors. Theselected income statement and balance sheet data for each of the three fiscalyears ended January 29, 2000 are derived from the Consolidated FinancialStatements of the Company, which have been audited by KPMG LLP, independentauditors. The data presented below should be read in conjunction with theConsolidated Financial Statements, including the related Notes thereto, includedherein, the other financial information included herein, and "Management'sDiscussion and Analysis of Financial Condition and Results of Operations." Fiscal Year Ended February 2, January 31, January 31, January 30, January 29, ----------- ----------- ----------- ----------- ----------- 1996 1997 1998 1999 2000 ---- ---- ---- ---- ---- (dollars in thousands, except per square foot data) Income Statement Data: Revenues $745,909 $808,843 $ 834,031 $ 824,258 $ 716,624 Cost of goods sold(a) 399,668 428,719 465,168 460,592 394,813 Selling, general and administrative 327,672 348,305 359,811 336,590 281,610 expenses Charges incurred in connection with discontinuance of Clifford &Wills 13,300 4,000 Other charges -- -- -- 7,995 7,018 Income from operations 18,569 31,819 9,052 5,781 29,183 Interest expense-net 9,350 10,470 20,494 39,323 38,861 Gain on sale of Popular Club Plan -- -- -- (10,000) (1,000) Expenses incurred-Recapitalization -- -- 20,707 -- -- Provision (benefit) for income taxes 3,700 8,800 (5,262) (8,162) (2,050) Extraordinary items and cumulative effect of accounting changes, net of taxes 931 -- (4,500) -- -- -------- -------- --------- --------- --------- Net income (loss) $ 6,450 $ 12,549 $ (31,387) $ (15,380) $ (6,628) ======== ======== ========= ========= --------- 10 Fiscal Year Ended February 2, January 31, January 31, January 30, January 29, 1996 1997 1998 1999 2000 Balance Sheet Data (at period end): Cash and cash equivalents $ 13,529 $ 7,132 $ 12,166 $ 9,643 $ 38,693 Working capital 132,256 132,222 142,677 95,710 75,929 Total assets 355,249 410,821 421,878 376,330 373,604 Total long term debt and redeemable preferred stock 87,329 87,092 428,457 433,243 458,218 Stockholders' equity (deficit) 89,633 102,006 (201,642) (235,773) (264,593)Operating Data:Revenues:J. Crew retail $134,959 $167,957 $ 209,559 $ 273,972 $ 333,575J. Crew direct Catalog 274,653 289,773 260,853 230,752 213,308 Internet -- -- 4,000 22,000 65,249 -------- -------- --------- --------- --------- 274,653 289,773 264,853 252,752 278,557 -------- -------- --------- --------- ---------J. Crew factory outlet 79,203 94,579 100,285 96,461 101,987J. Crew licensing 3,975 3,817 2,897 2,712 2,505 -------- -------- --------- --------- ---------Total J. Crew brand 492,790 556,126 577,594 625,897 716,624Other divisions(b) 253,119 252,717 256,437 198,361 -- -------- -------- --------- --------- ---------Total $745,909 $808,843 $ 834,031 $ 824,258 $ 716,624 ======== ======== ========= ========= =========J. Crew Direct:Number of catalogs circulated (in 67,519 76,087 76,994 73,440 75,479thousands)Number of pages circulated (in millions) 10,198 9,827 9,830 8,819 9,319J. Crew Retail:Sales per gross square foot(c) $ 533 $ 551 $ 542 $ 558 $ 571Store contribution margin(c) 25.5% 25.4% 23.4% 25.0% 26.0%Number of stores open at end of period 31 39 51 65 81Comparable store sales change(c) (6.0)% 4.5% (6.6)% 9.0% 1.8%Depreciation and amortization $ 10,272 $ 10,541 $ 15,255 $ 15,972 $ 19,241Net capital expenditures(d)New store openings $ 6,009 $ 10,894 $ 19,802 $ 14,749 $ 13,300Other 8,631 11,587 11,565 21,605 27,953 -------- -------- --------- --------- ---------Total net capital expenditures $ 14,640 $ 22,481 $ 31,367 $ 36,354 $ 41,253(a) Includes buying and occupancy costs.(b) Includes revenues from the Company's PCP and C&W divisions and finance charge income from PCP installment sales. PCP was sold effective October 30, 1998 and the Company made a decision in 1998 to exit the catalog and outlet store operations of C&W.(c) Includes stores that have been opened for a full twelve month period.(d) Capital expenditures are net of proceeds from construction allowances. 11 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSThis discussion summarizes the significant factors affecting the consolidatedoperating results, financial condition and liquidity of the Company during thethree-year period ended January 29, 2000. This discussion should be read inconjunction with the audited consolidated financial statements of the Companyfor the three-year period ended January 29, 2000 and notes thereto includedelsewhere in this Annual Report on Form 10-K.Results of OperationsConsolidated statements of operations presented as a percentage of revenues areas follows: Fiscal Year ended January January January 29,2000 30,1999 31,1998 Revenues 100.0% 100.0% 100.0%Cost of goods sold, including buying and occupancy costs 55.1 55.9 55.8Selling, general and administrative expenses 39.3 40.8 43.1Charges incurred in connection with discontinuance of C&W .5 1.6 --Other charges 1.0 1.0 --Income from operations 4.1 .7 1.1Interest expense, net (5.4) (4.8) (2.5)Gain on the sale of Popular Club Plan .1 1.2 --Expenses incurred-recapitalization -- -- (2.5)Loss before income taxes and extraordinary items (1.2) (2.9) (3.9)Benefit for income taxes .3 1.0 .6 ------- ------- -------Loss before extraordinary items (.9)% (1.9)% (3.3)% ======= ======= =======Fiscal 1999 Compared to Fiscal 1998Revenues--------Revenues decreased 13.1% to $716.6 million in the fiscal year ended January 29,2000 from $824.3 million in the fiscal year ended January 30, 1999. The decreasein revenues was attributable to the sale of Popular Club Plan, effective as ofOctober 30, 1998, and the discontinuance of Clifford & Wills operations whichresulted in a decrease of $198.4 million. This decrease was offset by increasesof $59.6 million in J. Crew Retail and $25.8 million in J.Crew Direct. ExcludingPopular Club Plan and Clifford & Wills, revenues increased 14.5% from $625.9million in fiscal 1998 to $716.6 million in fiscal 1999.J. Crew Retail revenues increased by 21.8% from $274.0 million in fiscal 1998 to$333.6 million in fiscal 1999. The percentage of the Company's total revenuesderived from J. Crew Retail increased to 46.6% in fiscal year 1999 compared to33.2% in fiscal 1998. This increase was attributed to $54.6 million from theopening of new stores and $5.0 million from an increase in comparable storesales of 1.8%. The number of stores opened at January 29, 2000 increased to 81from 65 at January 30, 1999.J. Crew Direct revenues (which includes revenues from catalog and internetoperations) increased by 10.2% from $252.8 million in fiscal 1998 to $278.5million in fiscal 1999. The percentage of the Company's total revenues derivedfrom J. Crew Direct increased to 38.9% in fiscal 1999 from 30.7% in fiscal 1998.This increase was primarily due to an increase in net sales from j.crew.comwhich increased to $65.2 million fiscal 1999 from $21.6 million in fiscal1998.Catalog sales decreased to $213.3 million in fiscal 1999 from $231.2million in fiscal 1998 as the Company adopted initiatives to migrate catalogcustomers to the Internet. 12 J. Crew Factory Outlet revenues increased by 5.7% from $96.5 million in fiscal 1998 to $102.0 million in fiscal 1999. The percentage of the Company's totalrevenues derived from J. Crew Factory Outlet increased to 14.2% in fiscal 1999from 11.7% in fiscal 1998. Comparable store sales for J. Crew Factory Outletincreased by 3.8% in fiscal 1999. J. Crew Factory Outlet closed three stores infiscal 1999 and 42 stores were open at January 29, 2000.Cost of sales, including buying and occupancy costs---------------------------------------------------Cost of sales, including buying and occupancy costs as a percentage of revenuesdecreased to 55.1% in fiscal 1999 compared to 55.9% in fiscal 1998. Excludingthe operations of PCP and C&W, cost of sales including buying and occupancycosts decreased to 55.1% in fiscal 1999 from 56.2% in fiscal 1998. This decreasewas caused primarily by an increase in initial mark up caused by a decrease inthe cost of merchandise.Selling, general and administrative expenses--------------------------------------------Selling, general and administrative expenses decreased to $281.6 million infiscal 1999 (39.3% of revenues) from $336.6 million in fiscal 1998 (40.8% ofrevenues). Approximately $94.4 million of selling, general, and administrativeexpenses in fiscal 1998 resulted from the operations of PCP and C&W.Selling, general and administrative expenses of the J.Crew brand increased to$281.6 million in fiscal 1999 (39.3% of revenues) from $242.2 million in fiscal1998 (38.7% of revenues). This increase resulted primarily from an increase ingeneral and administrative expenses of $31.5 million due to (a) an increase inthe number of retail stores in operation during fiscal 1999 compared to fiscal1998; (b) an increase in consulting fees and other expenses attributable toinformation technology initiatives; and (c) an increase in marketing expenses ofapproximately $8 million, primarily direct advertising, devoted to increasingcustomer awareness of the Company's Internet site.Selling expenses were $75.7 million in fiscal 1999 (10.6% of revenues) comparedto $67.8 million in fiscal 1998 (10.8% of revenues). This increase was due to$6.0 million of direct advertising related to the Internet and an increase inpages circulated from 8.8 billion pages in fiscal 1998 to 9.3 billion pages infiscal year 1999, an increase of 5.7%. These increases in selling expenses werepartially offset by decreases related to efficiencies in the catalog productionprocess.Write-down of assets and other charges in connection with the discontinuance of-------------------------------------------------------------------------------Clifford & Wills----------------An additional charge of $4.0 million was incurred in fiscal 1999 to write downthe carrying value of inventories to net realizable value. (See note 2 to theconsolidated financial statements).Other charges-------------Other charges in fiscal 1999 include $7.0 million relating to the write off ofcertain software development costs which were impaired by the decision of theCompany to adopt an enterprise resource planning system for its futureinformation technology requirements.Gain on sale of subsidiary--------------------------An additional gain of $1.0 million was recognized in fiscal 1999 from areduction in certain estimated liabilities established at the time of sale.(Seenote 2 to the consolidated financial statements).Interest expense ----------------Interest expense, net decreased to $38.9 million in fiscal 1999 from $39.3million in fiscal 1998. This decrease resulted primarily from lower averageborrowings during fiscal 1999 under the Revolving Credit Facility and thereduced term loan balances which was offset by higher non-cash interest andinterest related to the settlement of a sales and use tax assessment. Averageborrowings under a Revolving Credit Facility required to fund inventories andcapital expenditures were $30.8 million in fiscal 1999 and $47.5 million infiscal 1998. 13 Interest expense included non-cash interest and amortization of deferredfinancing costs of $14.2 million in fiscal 1999 compared to $12.7 million fiscal1998.Income Taxes------------The effective tax rate was (23.6%) in fiscal 1999 compared to (34.7)% in fiscal1998. The decrease in the effective tax rate in 1999 was primarily due to theinability of certain subsidiaries to deduct net operating losses for state taxpurposes.Fiscal 1998 Compared to Fiscal 1997Revenues--------Revenues decreased 1.2% to $824.3 million in the fiscal year ended January 30,1999 from $834.0 million in the fiscal year ended January 31, 1998. The decreasein revenues was due primarily to (a) the sale of Popular Club Plan, effective asof October 30, 1998, which resulted in a decrease of $60.3 million and (b) adecrease in J. Crew Direct revenues of $12.0 million. These decreases wereoffset by an increase of $64.4 million in the revenues of J. Crew Retail.Excluding Popular Club Plan, revenues increased 7.8% from $649.6 million infiscal 1997 to $700.3 million in fiscal 1998.J. Crew Retail revenues increased by 30.7% from $209.6 million in fiscal 1997 to$274.0 million in fiscal 1998. The percentage of the Company's total revenuesderived from J. Crew Retail increased to 33.2% in fiscal 1998 from 25.1% infiscal 1997. This increase was attributed to $45.5 million from the opening ofnew stores and $18.9 million from an increase in comparable store sales of 9.0%.The number of stores opened at January 30, 1999 increased to 65 from 51 atJanuary 31, 1998.J. Crew Direct revenues decreased by 4.5% from $264.8 million in fiscal 1997 to$252.8 million in fiscal 1998. The percentage of the Company's total revenuesderived from J. Crew Direct decreased to 30.7% in fiscal 1998 from 31.8% infiscal 1997. This decrease was primarily due to a decrease in catalogcirculation from 9.8 billion pages circulated in fiscal 1997 to 8.8 billionpages circulated in fiscal 1998 and a continuing weak performance in menswearsales. J. Crew Direct revenues in fiscal 1998 include approximately $22.0million from jcrew.com compared to approximately $4.0 million in fiscal 1997.J. Crew Factory Outlet revenues decreased by 3.8% from $100.3 million in fiscal1997 to $96.5 million in fiscal 1998. The percentage of the Company's totalrevenues derived from J. Crew Factory Outlet decreased to 11.7% in fiscal 1998from 12.0% in fiscal 1997. Comparable store sales for J. Crew Factory Outletdecreased by 11.5% in fiscal 1998. The decrease in comparable store salesresulted from additional markdowns required to sell through overstockmerchandise, primarily in the Spring of 1998. J. Crew Factory Outlet openedthree new stores in fiscal 1998 and 45 stores were open at January 30, 1999.C&W revenues increased by 3.2% to $74.3 million in fiscal 1998 from $72.0million in fiscal 1997. The percentage of the Company's revenues derived from C&W increased to 9.0% in fiscal 1998 from 8.6% in fiscal 1997. The increase inrevenues resulted from an increase in the number of catalogs mailed fromapproximately 40 million in fiscal 1997, to 42 million in fiscal 1998 and theintroduction of a deferred payment program in the fall of 1998. During 1998 theCompany made a decision to exit the operations of C&W and incurred a charge of$13.3 million to write-down C&W assets to estimated realizable value and toprovide for other costs to be incurred in the discontinuance of operations, suchas severance and lease termination costs. Additionally fourth quarter charges of$1.7 million were incurred relating to deferred catalog costs.Cost of sales, including buying and occupancy costs---------------------------------------------------Cost of sales, including buying and occupancy costs as a percentage of revenueswas 55.9% for fiscal 1998 compared to 55.8% for fiscal 1997. This increase wascaused primarily by higher markdowns in fiscal 1998 to liquidate overstocks. 14 Selling, general and administrative expenses--------------------------------------------Selling, general and administrative expenses as a percentage of revenues was40.8% in fiscal year 1998 and 43.1% in fiscal year 1997.As a percentage of revenues, selling expenses (catalog circulation costs)decreased to 13.1% in fiscal 1998 from 14.7% in 1997 and general andadministrative expenses decreased to 27.7% in fiscal 1998 from 28.4% in fiscal1997. The decrease in selling expense resulted primarily from the reduction incatalog circulation from 9.8 billion pages circulated in 1997 to 8.8 billionpages circulated in 1998 and the implementation of cost reduction initiativesrelating primarily to printing costs at J. Crew Direct.The decrease in general and administrative expenses in fiscal 1998 as apercentage of revenues was due to a decrease in expenses at J. Crew Direct andJ. Crew Retail from the implementation of cost reduction initiatives.The absolute dollar amount of selling, general and administrative expensesdecreased to $336.6 million in fiscal 1998 from $359.8 million in fiscal 1997primarily as a result of the sale of Popular Club Plan as of October 30, 1998which accounted for $20.0 million of the decrease.Write-down of assets and other charges in connection with the discontinuance of-------------------------------------------------------------------------------Clifford & Wills----------------A charge of $13.3 million was included in fiscal 1998 operations to write-downthe assets of C&W to net realizable value and to provide for certain additionalcosts in connection with the discontinuanceAdditionally fourth quarter charges of $1.7 million were included in sellingexpense relating to deferred catalog costs. (See note 2 to the consolidatedfinancial statements).Other charges-------------Other charges in fiscal 1998 include $2.9 million of costs incurred inconnection with the termination of the employment contracts of two seniorexecutives, including the former Chief Executive Officer, and $5.1 million oftax gross-up payments made on behalf of senior executives relating to restrictedstock grants (See note 19 to the consolidated financial statements).Gain on sale of subsidiary-------------------------- During 1998 the Company sold the capital stock of Popular Club Plan Inc. andsubsidiaries to the Fingerhut Companies, Inc. for gross proceeds of $42.0million and realized a gain of $10.0 million. (See note 2 to the consolidatedfinancial statements).Interest expense----------------Interest expense, net increased to $39.3 million in fiscal 1998 from $20.5million in fiscal 1997. This increase resulted primarily from the issuance of$295.3 million of debt in October 1997 to fund the Recapitalization including$85.0 million to retire senior indebtedness outstanding at the time of theRecapitalization. Average borrowings under a Revolving Credit Facility requiredto fund inventories and capital expenditures were $54.3 million in fiscal 1997and $47.5 million in fiscal 1998.Interest expense included non-cash interest and amortization of deferredfinancing costs of $12.7 million in fiscal 1998 compared to $3.9 million fiscal1997.Income Taxes------------The effective tax rate was (34.7)% in fiscal 1998 compared to (21.1)% in fiscal1997. The effective tax rate in fiscal 1997 was effected by the non-deductibility of certain expenses related to the Recapitalization. 15 Liquidity and Capital ResourcesThe Company's primary cash needs have been for capital expenditures incurredprimarily for opening new stores and system enhancements, debt servicerequirements and working capital. The Company's sources of liquidity have beenprimarily cash flows from operations and borrowings under the revolving creditfacility.In October 1997 the Company incurred substantial indebtedness in connection withthe Recapitalization. After giving effect to the Recapitalization, the Companyhad $298.2 million of indebtedness outstanding and $201.6 million ofstockholders' deficit at January 31, 1998. The Company's significant debtservice obligations following the Recapitalization could, under certaincircumstances, have material consequences to security holders of the Company. Infiscal 1998 the Company sold its Popular Club Plan subsidiary and used $26.0million of the proceeds to repay debt. In fiscal 1999 the Company used netproceeds from the sale of assets of its discontinued Clifford & Wills subsidiaryto prepay an additional $10.0 million of the term loan.Cash provided by operating activities was $94.1 million in fiscal year 1999compared to $8.1 million in fiscal 1998. The increase in cash provided byoperations resulted from (a) a decrease in the level of inventories of $26.1million despite an increase in the number of retail stores from 65 to 81, (b) anincrease in income from operations of $23.4 million, and (c) a federal incometax refund of $8.7 million.Capital expenditures, net of construction allowances, were $41.3 million infiscal 1999. The 1999 capital expenditures consisted primarily of the opening of16 new J. Crew retail stores and systems enhancements. Capital expenditures infiscal 1998 were $36.4 million (including $5.2 million for Popular Club Planwhich was sold in October 1998). The capital expenditures in 1998 were incurredprimarily from the opening of 14 new J.Crew Retail Stores and systemenhancements.Capital expenditures are expected to be approximately $45.0 million in fiscal2000, primarily for the opening of at least 20 J. Crew retail stores and forsystem enhancements. The expected capital expenditures will be funded frominternally generated cash flows and by borrowings from available financing sources.There were no borrowings under the Revolving Credit Facility at January 29,2000, compared to $14.0 million of borrowings outstanding at January 30, 1999.Average borrowings under the Revolving Credit Facility were $30.8 million forthe fiscal year ended January 29, 2000 and $47.5 million for the fiscal yearended January 30, 1999.Management believes that cash flow from operations and availability under theRevolving Credit Facility will provide adequate funds for the Company'sforeseeable working capital needs, planned capital expenditures and debt serviceobligations. The Company's ability to fund its operations and make plannedcapital expenditures, to make scheduled debt payments, to refinance indebtednessand to remain in compliance with all of the financial covenants under its debtagreements depends on its future operating performance and cash flow, which inturn, are subject to prevailing economic conditions and to financial, businessand other factors, some of which are beyond its control.Year 2000The Company completed its Year 2000 software program conversions and complianceprograms during the fourth quarter of 1999. The total external costs for suchprograms were approximately $2.6 million. Subsequent to December 31, 1999, theCompany has not experienced any Year 2000 problems either internally or fromoutside sources. The Company has no reason to believe that Year 2000 failureswill materially affect it in the future. However, since it may take severaladditional months before it is known whether the Company or third partysuppliers, vendors or customers may have undergone Year 2000 problems, noassurances can be given that the Company will not experience losses ordisruptions due to Year 2000 computer-related problems. The Company willcontinue to monitor the operation of its computers and microprocessor-baseddevices for any Year 2000 problems. 16 Impact of InflationThe Company's results of operations and financial condition are presented basedupon historical cost. While it is difficult to accurately measure the impact ofinflation due to the imprecise nature of the estimates required, the Companybelieves that the effects of inflation, if any, on its results of operations andfinancial condition have been minor. However, there can be no assurance thatduring a period of significant inflation, the Company's results of operationswould not be adversely affected.SeasonalityThe Company's retail and direct businesses experience two distinct sellingseasons, spring and fall. The spring season is comprised of the first and secondquarters and the fall season is comprised of the third and fourth quarters. Netsales are usually substantially higher in the fall season and selling, generaland administrative expenses as a percentage of net sales are usually higher inthe spring season. Approximately 35% of annual net sales in fiscal 1999 occurredin the fourth quarter. The Company's working capital requirements also fluctuatethroughout the year, increasing substantially in September and October inanticipation of the holiday season inventory requirements.Recent Accounting PronouncementsIn June 1998, the Financial Accounting Standards Board issued Statement ofFinancial Accounting Standards No. 133, "Accounting for Derivative Instrumentsand Hedging Activities" which requires entities to recognize all derivatives aseither assets or liabilities in the statement of financial position and measurethose instruments at fair value. SFAS No. 133 is effective for all fiscal yearsbeginning after June 15, 1999. In June 1999 the effective date of SFAS No.133was deferred to all fiscal years beginning after June 15, 2000. The Company iscurrently reviewing SFAS No. 133 and is not able to evaluate the impact, if any, it may have on future operating results or financial statement disclosures.ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKThe Company's principal market risk relates to interest rate sensitivity whichis the risk that future changes in interest rates will reduce net income or thenet assets of the Company. The Company's variable rate debt consists ofborrowings under the Revolving Credit Facility and the Term Loan Facility. Inorder to manage this interest rate risk, the Company entered into an interestrate swap agreement for a notional principal amount of $50 million which expiresin October 2000. This agreement converts the interest rate to a fixed rate of6.23%. If this interest rate swap agreement was settled on January 29, 2000 theCompany would have received $62,000.The Company enters into letters of credit to facilitate the internationalpurchase of merchandise. The letters of credit are primarily denominated in U.S.dollars. Outstanding letters of credit at January 29, 2000 were approximately$38.3 million.Furthermore, the Company has a licensing agreement in Japan which provides forroyalty payments based on sales of J. Crew merchandise as denominated in yen.The Company has from time to time entered into forward foreign exchangecontracts to minimize this risk. At January 29, 2000, there was a forwardforeign exchange contract outstanding to sell 120 million Yen which expires onMarch 31, 2000. 17 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATAThe Financial Statements are set forth herein commencing on page F-1 of thisReport.ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURENot applicable. PART IIIITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANTThe following table sets forth the name, age and position of individuals who areserving as directors of Holdings and executive officers of Holdings andOperating Corp. Each Director of Holdings will hold office until the next annualmeeting of shareholders or until his or her successor has been elected andqualified. Officers are elected by the respective Boards of Directors and serveat the discretion of such Board.Name Age Position---- --- -------- Emily Woods........... 38 Director, Chairman of the BoardMark A. Sarvary....... 40 Director, Chief Executive OfficerCharlotte L. Beers.... 64 DirectorDavid Bonderman....... 57 DirectorRichard W. Boyce...... 45 DirectorGregory D. Brenneman.. 38 DirectorJohn W. Burden, III... 63 DirectorJames G. Coulter...... 40 DirectorRichard M. Anders..... 43 President of RetailBarbara K. Eisenberg.. 54 Senior Vice President, General Counsel and Corporate SecretaryScott Formby.......... 38 Executive Vice President, DesignScott D. Hyatt........ 42 Senior Vice President, ManufacturingWalter Killough....... 45 Chief Operating Officer Walter Killough....... 45 Chief Operating OfficerDavid F. Kozel........ 44 Senior Vice President, Human ResourcesNicholas Lamberti..... 57 Vice President-Corporate ControllerThomas A. Lesica...... 40 Senior Vice President, Chief Information OfficerMichael Ovitz......... 53 DirectorScott M. Rosen........ 41 Executive Vice President, Chief Financial OfficerCarol Sharpe.......... 45 Executive Vice President, Merchandising - BrandTrudy Sullivan........ 50 PresidentBrian T. Swette....... 46 DirectorMark T. Walsh......... 38 Executive Vice President, e-commerce and Strategic PlanningJosh S. Weston........ 71 Director 18 Emily Woods Ms. Woods became Chairman of the Board of Directors of Holdings uponconsummation of the Recapitalization. Ms. Woods is also a director and Chairmanof the Board of Operating Corp. Ms. Woods co-founded the J. Crew brand in 1983.Ms. Woods has also served as Chief Executive Officer and Vice-Chairman ofHoldings and as Chief Executive Officer of Operating Corp. She is also adirector of Yankee Candle Company.Mark A. Sarvary Mr. Sarvary joined the Company in May 1999 as Chief Executive Officerand as a Director. He was President/General Manager of the Nestle Frozen FoodDivision of Nestle USA from 1996 to May 1999 and Vice President Marketing from1995 to 1996.Charlotte L. Beers Ms. Beers became a director of Holdings in 1998. Ms. Beers has beenChairman of J. Walter Thompson (advertising agency) since March 1999. She wasChairman and Chief Executive Officer of Ogilvy & Mather (advertising agency)from 1992 until 1997 and Chairman Emeritus from 1997 until March 1999. She alsoserves as a director of Martha Stewart Living, Omnimedia and IBeauty.com.David Bonderman Mr. Bonderman became a director of Holdings upon consummation of theRecapitalization. Mr. Bonderman is a founding partner of Texas Pacific Groupand has been Managing General Partner of TPG for more than six years. Mr.Bonderman serves on the Boards of Directors of Bell & Howell, Inc., BeringerWine Estates, Inc., Continental Airlines, Inc., Co-Star Realty Information,Inc., Denbury Resources Inc., Ducati Motor Holdings S.p.A., Magellan HealthServices, Inc., Oxford Health Plans, Inc., Paradyne Networks, Inc. and RyanairLtd.Richard W. Boyce Mr. Boyce became a director of Holdings upon consummation of theRecapitalization and was Chief Executive Officer from January 1999 until May1999. Mr. Boyce is the President of CAF, Inc. ("CAF"), a management consultingfirm which advises various companies controlled by TPG. Prior to founding CAF in1997, Mr. Boyce served as Senior Vice President of Operations for Pepsi-ColaNorth America ("PCNA") from 1996 to 1997, and Chief Financial Officer of PCNAfrom 1994 to 1996. He is also Chairman of Del Monte Foods Company. He isChairman of Favorite Brands International Holding Corp., which filed forprotection under Chapter 11 of the Bankruptcy Code on March 30, 1999. Mr. Boyceis also a director of ON Semiconductor.Gregory D. Brenneman Mr. Brenneman became a director of Holdings in 1998. He has been Presidentof Continental Airlines Inc. since 1996 and Chief Operating Officer ofContinental Airlines Inc. since 1995. He has been a director of Continentalsince 1995.John W. Burden, III Mr. Burden became a director of Holdings in 1998. Mr. Burden has been aretail consultant for more than five years. He also serves as a director of SaksIncorporated and Chicos Fas Inc. James G. Coulter Mr. Coulter became a director of Holdings upon consummation of theRecapitalization. Mr. Coulter is a founding partner of Texas Pacific Group andhas been Managing General Partner of TPG for more than six years. Mr. Coulterserves on the Boards of Directors of Beringer Wine Estates, Inc., Genesis HealthVentures, Inc., Northwest Airlines, Inc., Oxford Health Plans, Inc. andGlobespan Semiconductor, Inc. 19 Barbara K. Eisenberg Ms. Eisenberg has been Senior Vice President, General Counsel and CorporateSecretary since August 1999 and was Vice President, General Counsel andCorporate Secretary from 1998 until then. Prior thereto, she was VicePresident, Associate General Counsel and Corporate Secretary of BurlingtonIndustries, Inc. (textile manufacturer) for more than five years.Richard M. Anders Mr. Anders joined the Company in May 1999 as President of Retail. Hewas Zone Vice President of Old Navy, a division of The Gap, Inc., from 1996 toMay 1999 and Regional Manager, Gap brand prior thereto.Scott Formby Mr. Formby became Executive Vice President, Design of J. Crew in 1999.Prior thereto, he was Vice President, Design for more than five years.Scott D. Hyatt Mr. Hyatt joined the Company in 1998 as Senior Vice President,Manufacturing. He was with Express Inc. as Vice President, Production andSourcing from 1996 to 1998 and Vice President, Manufacturing of Bernard ChausInc. for more than five years prior thereto.Walter Killough Mr. Killough became Chief Operating Officer of the Company in October 1999.Prior thereto, he was Senior Vice President, General Manager, Mail Order formore than five years.David F. Kozel Mr. Kozel joined the Company in 1999 as Senior Vice President, HumanResources. Prior thereto, he was with Grey Advertising as Vice President, HumanResources from 1998, Vice President, Human Resources of Deluxe Corporation from1997 to 1998 and Vice President, Human Resources of Citibank from 1995 to 1996.Nicholas Lamberti Mr. Lamberti has been Vice President - Corporate Controller for more thanfive years.Thomas A. Lesica Mr. Lesica joined the Company in 1999 as Senior Vice President and ChiefInformation Officer. He was with PepsiCo, Inc. as Vice President and ChiefInformation Officer from 1997 until joining the Company and Director ofInformation Technology of Pepsi Cola Company prior thereto.Michael Ovitz Mr. Ovitz became a director of Holdings in 1998. He is an independentbusinessman and investor and co-founded Artists Management Group, LLC, amanagement/production multi-media company. He has been a Principal of ArtistManagement Group since December 1998. From 1995 to 1996, Mr. Ovitz was Presidentof the Walt Disney Company. For more than five years prior to 1995, Mr. Ovitzserved as Chairman of Creative Artists Agency, which he co-founded. Mr. Ovitz isalso a director of Gulfstream Aerospace Corp. and Livent, Inc.Scott M. Rosen Mr. Rosen has been Executive Vice President and Chief Financial Officersince August 1999, Senior Vice President and Chief Financial Officer from 1998until then and Chief Financial Officer of Mail Order for more than five years prior thereto.Carol Sharpe Ms. Sharpe has been Executive Vice President, Merchandising - Brand sinceAugust 1999 and was Senior Vice President, General Merchandising Manager, Retailprior thereto. She was Senior Vice President and General Merchandising Manager-Women's from 1998 until then and Vice President, Women's for more than 5 yearsprior to 1998. 20 Trudy Sullivan Ms. Sullivan has been President since rejoining the Company in February2000. She was President of Kids "R" Us, a division of Toys "R" Us, Inc., fromOctober 1999 to February 2000. Ms. Sullivan was President, Mail Order of theCompany from 1998 to October 1999 and President of Clifford and Wills from 1995to 1998.Brian T. Swette Mr. Swette became a director of Holdings in 1998. He has been ChiefOperating Officer of eBay Inc. (person-to-person trading community on theInternet), since November 1999 and from 1998 until then was Senior VicePresident of Marketing and International of eBay. He was Executive VicePresident and Chief Marketing Officer-Global Beverages of Pepsi-Cola Beveragesfrom 1996 until joining eBay and Executive Vice President Marketing-NorthAmerica of Pepsi-Cola Beverages from 1994 to 1996. He is also a director of eBayInc.Mark T. Walsh Mr. Walsh joined the Company in September 1999 as Senior VicePresident Strategic Planning, Marketing and Internet and was elected ExecutiveVice-President e-commerce and Strategic Planning in March 2000. Prior thereto,he was Director, Global Marketing Strategy of Citibank, N.A., from 1998. He wasChief Financial Officer, Fountain Beverage Division of Pepsico, Inc. from 1997to 1998 and Vice President, Mergers and Acquisitions of Pepsico from 1996 to1997.Josh S. Weston Mr. Weston became a director of Holdings in 1998. He has been HonoraryChairman of the Board of Directors of Automatic Data Processing (computingservices business) since 1998. He was Chairman of the Board of Automatic DataProcessing from 1996 until 1998 and Chairman and Chief Executive Officer formore than five years prior thereto. Mr. Weston is also a director of GentivaHealth Services, Shared Medical Systems Corporation and Russ Berrie & Company,Inc. 21 ITEM 11. EXECUTIVE COMPENSATIONThe following table sets forth compensation paid for fiscal years 1999, 1998 and1997 to each individual serving as its chief executive officer during fiscal1999 and to each of the four other most highly compensated executive officers ofthe Company as of the end of fiscal 1999. Annual Compensation --------------------------------------------Name Other AnnualAnd Fiscal Salary Bonus Comp.Principal Position Year ($) ($) ($)------------------------------------------------------------------------------------------------- Emily Woods 1999 $1,000,000 $1,000,000 $-- Chairman 1998 1,000,000 1,000,000 -- 1997 700,000 -- --Mark Sarvary 1999 560,190 335,000 1,000,000(5)Chief Executive Officer 1998 -- -- -- 1997 -- -- -- Richard W. Boyce 1999 250,000 -- --Former Chief Executive Officer 1998 83,333 -- -- 1997 -- -- -- Scott Formby 1999 422,115 106,800 --Executive Vice President, Design 1998 392,158 107,000 -- 1997 358,654 30,000 -- Carol Sharpe 1999 402,500 240,000 360,000(5)Executive Vice President, Merchandising - 1998 362,500 100,300 -- Brand 1997 315,856 75,000 -- Richard Anders 1999 304,220 75,000 300,000(5)President, Retail 1998 -- -- -- 1997 -- -- -- Long-Term Compensation Awards Payouts ---------------------------------------- Securities Restricted Underlying LTIP All Other Stock Options/ Payouts Comp. Award(s)($)(1) SARS (#)(1) ($) ($) ------------------------------------------------------------ Emily Woods -- -- -- $5,000(6)Chairman (2) -- -- 2,907,590(3)(6) -- 492,200 -- 10,004,750(4)(6) Mark Sarvary -- 272,000 -- --Chief Executive Officer -- -- -- -- -- -- -- -- Richard W. Boyce -- -- -- --Former Chief Executive Officer -- 55,200 -- -- -- -- -- -- Scott Formby -- 8,800 -- 5,000(6)Executive Vice President, Design -- -- -- 5,000(6) -- 31,200 -- 64,750(4)(6) Carol Sharpe -- 12,000 -- 5,000(6)Executive Vice President, Merchandising - -- 12,400 -- 5,000(6) Brand -- 12,600 -- 54,750(4)(6) Richard Anders -- 60,000 --President, Retail -- -- -- -- -- -- -- -- __________(1) There is no established public market for shares of Common Stock. Holders of restricted stock have the same right to receive dividends as other holders of Common Stock. The Company has not paid any cash dividends on its Common Stock. All share amounts have been adjusted to reflect a 200 for 1 stock split effective April 1999.(2) Ms. Woods was granted 661,600 shares of Common Stock ("Woods Restricted Shares"), of which 78,600 shares vested immediately upon grant, 194,400 shares will vest on each of the 3rd and 4th anniversaries of the Recapitalization and 194,200 shares will vest on the 5th anniversary of the Recapitalization.(3) The amount set forth in this column includes reimbursement for income taxes in the amount of $ 2,902,590 incurred by Ms. Woods as a result of the grant of the Woods Restricted Shares.(4) The amount set forth in this column includes a bonus paid in connection with the consummation of the Recapitalization.(5) This amount is a signing bonus.(6) Includes Company matching contributions to 401(k) plan in the amounts of $5,000, $5,000 and $4,750 for fiscal years 1999, 1998 and 1997, respectively. 22 The following Table shows information concerning stock options granted to anyof the named executive officers during fiscal year 1999. Option Grants In Fiscal Year 1999 Potential Realizable Value At Assumed Annual Rates Of Stock Price Appreciation For Individual Grants Option Term------------------------------------------------------------------------------------------------------------ Number of Percent Of Securities Total Options Underlying Granted To Options Employees In Exercise ExpirationName Granted(#) (1)(2) Fiscal Year Price($/Sh) Date 5%($) $10% ($)------------------------------------------------------------------------------------------------------------ Richard Anders 60,000 7.9% $6.82 5/3/09 $257,344 $652,319Scott Formby 8,800 1.2% 10.00 4/13/09 55,344 140,250Mark Sarvary 272,000 35.7% 10.00 5/10/09 1,710,594 4,334,979Carol Sharpe 12,000 1.6% 6.82 4/13/09 51,468 131,094__________(1) The Company has not granted any SARs.(2) The options have 10-year terms and are exercisable in the case of Messrs. Anders and Formby, 20% on January 31st in each of 2000 through 2004; in the case of Mr. Sarvary, 20% on May 10th in each of 2000 through 2004; and in the case of Ms. Sharpe, 20% on April 30th in each of 2000 through 2004. The following Table shows the number of stock options held by the namedexecutive officers at the end of fiscal year 1999. The named executive officersdid not exercise any stock options in fiscal year 1999. Aggregated Option Exercises in Fiscal Year 1999 and Fiscal Year-End Option Values Number Of Securities Underlying Unexercised Options At Fiscal Year End (1) (#)Name Exercisable/Unexercisable---- ------------------------- Richard Anders.............................................. 12,000 / 48,000Scott Formby................................................ 14,240 / 25,760Mark Sarvary................................................ 0 / 272,000Carol Sharpe................................................ 10,000 / 27,000Emily Woods................................................. 65,600 / 426,600__________(1) There is no established public market for shares of the Company's Common Stock. 23 Employment Agreements and Other Compensation ArrangementsMs. Woods has an employment agreement with Holdings and Operating Corp. (the"Employers") which provides that, for a period of five years beginning onOctober 17, 1997, she will serve as Chairman of the Board of Directors ofHoldings. The employment agreement provides for an annual base salary of $1.0 Holdings. The employment agreement provides for an annual base salary of $1.0million, and an annual target bonus of up to $1.0 million based on achievementof earnings objectives to be determined each year. The employment agreementalso provided for the grant of 661,600 shares of Common stock (the "WoodsRestricted Shares"). (See footnotes 2 and 3 to the Executive Compensation Tablefor information on the vesting of the Woods Restricted Shares and thereimbursement of income taxes incurred by Ms. Woods in connection with suchgrant.) Ms. Woods is also entitled to various executive benefits andperquisites under the employment agreement.Under the terms of stock options awarded to Ms. Woods under the Company's StockOption Plan, all unvested options shall become exercisable (i) if Ms. Woods'employment is terminated by Holdings without cause, by Ms. Woods for good reasonor by reason of death or disability, or (ii) in the event of a change in controlof Holdings. Because of a change in Ms. Woods' duties and responsibilities,upon the termination of Ms. Woods' employment, she will be entitled to severancebenefits and other benefits as described in the February 4, 2000 amendment toher agreement.Mr. Sarvary has an Employment Agreement with Operating Corp., which providesthat, for a period of five years commencing on May 10, 1999, he will serve asChief Executive Officer of Operating Corp. The Employers also agreed to causeMr. Sarvary to be elected to the Board of Directors of Holdings. The EmploymentAgreement provides for an annual base salary $670,000 and an annual target bonusof 50% of his annual base salary based on achievement of earnings objectives tobe determined each year, provided that with respect to fiscal year 1999, thebonus would be at least $335,000 regardless of whether the bonus objectives wereachieved. The Employment Agreement also provides for the payment of a signingbonus of $1,000,000 and the grant of options to purchase 272,000 shares ofCommon Stock as well as the grant of additional stock options to purchase 68,000shares on the earlier of the date of an initial public offering of Holdings'Common Stock or May 10, 2004. Mr. Sarvary is also entitled to various executivebenefits and perquisites under the Employment Agreement. Mr. Sarvary'sEmployment Agreement also provides that in the event of his termination byOperating Corp. without cause or termination by Mr. Sarvary for Good Reason (asdefined in the Agreement), he will receive an amount equal to two times his basesalary.Ms. Sharpe has an Employment Agreement with Operating Corp. which provides that,for a period of five years commencing on April 30, 1999, she will serve asExecutive Vice President-Merchandising of Operating Corp. The EmploymentAgreement provides for an annual base salary of $400,000 and an annual targetbonus of 60% of her annual base salary based on achievement of earningsobjectives to be determined for each year, provided that with respect to fiscalyear 1999, the bonus would be at least $240,000 regardless of whether the bonusobjectives were achieved. The Employment Agreement also provides for a signingbonus of $360,000 and the grant of options to purchase 12,000 shares of CommonStock. The Agreement provides for continuation of salary for a period of oneyear if Ms. Sharpe's employment is terminated without cause (as defined in theAgreement). Ms. Sharpe's employment agreement also provides that if, on April30, 2003, the aggregate spread between the fair market value per share and theexercise price per share of her options to purchase 34,600 shares of HoldingsCommon Stock does not equal or exceed $1,124,500, then Operating Corp. will payher a cash payment equal to any such shortfall, subject to adjustment in theevent she has disposed of any of the shares underlying such options.The Woods Restricted Shares and any shares of Common Stock acquired by Ms.Woods, Mr. Sarvary and Ms. Sharpe pursuant to the exercise of options aresubject to a shareholders' agreement providing for certain transferrestrictions, registration rights and customary tag-along and drag-along rights.Compensation Committee Interlocks and Insider ParticipationMs. Woods, Chairman, is a member of the Compensation Committee of Holdings. 24 Compensation of Directors An attendance fee of $10,000 for each Board of Directors meeting is paid to eachDirector who is neither an employee of the Company nor a representative of TPG.Directors have the option to receive all or a portion of that fee paid in cashor in shares of Common Stock at a per share purchase price of $6.82 for meetingsprior to April 13, 1999 and $10.00 for meetings held thereafter.ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENTThe following table sets forth information regarding the beneficial ownership ofthe Common Stock of Holdings as of March 9, 2000 for each person who is known toHoldings to be the beneficial owner of 5% or more of Holdings Common Stock. Theholders listed have sole voting power and investment power over the shares heldby them, except as indicated by the notes following the table. Name and Address Amount and Nature of Percent of Title of Class of Beneficial Owner Beneficial Ownership Class------------------------------------------------------------------------------------------- Common Stock TPG Partners II, L.P. 7,313,797.6 shares (1) 60.3% 201 Main Street, Suite 2420 Fort Worth, TX 76102Common Stock Emily Woods 2,330,776.6 shares (2) 19.2% J. Crew Group, Inc. 770 Broadway New York, NY 10003__________(1) These shares of Common Stock are held by TPG and the following affiliates of TPG (collectively, "TPG Affiliates"): TPG Parallel II L.P. and TPG Investors II, L.P.(2) Includes (a) 65,600 shares not currently owned but which are issuable upon the exercise of stock options awarded under the Company's Stock Option Plan that are currently exercisable, and (b) 583,000 shares of Common Stock that have not vested and are held in custody by the Company until vesting thereof. 25 The following table sets forth information regarding the beneficialownership of each class of equity securities of Holdings as of March 9, 2000 for(i) each director, (ii) each of the executive officers identified in the tableset forth under Item 11. "Executive Compensation", and (iii) all directors andall such executive officers as a group. The holders listed have sole votingpower and investment power over the shares held by them, except as indicated bythe notes following the table. Number of Shares and Nature of Percent ofTitle of Class Name of Beneficial Owner Beneficial Ownership Class----------------------------------------------------------------------------------------------------------------- Common Stock Richard M. Anders 12,000 (2) *Common Stock Charlotte L. Beers 13,466.276 *Common Stock David Bonderman 7,313,797.6 (1) 60.3%Common Stock Richard W. Boyce 55,200 (2) *Common Stock Gregory D. Brenneman 10,600 *Common Stock John W. Burden, III 2,466.276 *Common Stock James G. Coulter 7,313,797.6 (1) 60.3%Common Stock Scott Formby 14,240 (2) *Common Stock Michael Ovitz 11,400 *Common Stock Mark A. Sarvary 54,400 (2) *Common Stock Carol Sharpe 12,400 (2) *Common Stock Brian T. Swette 13,866.276 *Common Stock Josh S. Weston 13,466.276 *Common Stock Emily Woods 2,330,776.6 (3) 19.2%Common Stock All Directors and executive 9,926,239.304 (1) (2) (3) 81.8% officers as a groupSeries A Preferred Stock Charlotte L. Beers 60 *Series A Preferred Stock David Bonderman 73,474.58 (1) 79.2%Series A Preferred Stock Gregory D. Brenneman 60 * Series A Preferred Stock James G. Coulter 73,474.58 (1) 79.2%Series A Preferred Stock Michael Ovitz 60 *Series A Preferred Stock Brian T. Swette 60 *Series A Preferred Stock Josh S. Weston 60 *Series A Preferred Stock Emily Woods 2,978.505 3.2%Series A Preferred Stock All Directors and executive 76,753.085 82.7% officers as a group__________*Represents less than 1% of the class.(1) Attributes ownership of the shares owned by TPG Affiliates to Messrs. Bonderman and Coulter, who are partners of TPG. Each of Messrs. Bonderman and Coulter disclaim beneficial ownership of the shares owned by TPG Affiliates.(2) These are shares not currently owned but which are issuable upon the exercise of stock options awarded under the Company's Stock Option Plan that are currently exercisable or become exercisable within 60 days.(3) Includes (a) 65,600 shares not currently owned but which are issuable upon the exercise of stock options awarded under the Company's Stock Option Plan that are currently exercisable, and (b) 583,000 shares of Common Stock that have not vested and are held in custody by the Company until vesting thereof. 26 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS In connection with Mr. Sarvary's relocation to the Company'sheadquarters, the Company loaned Mr. Sarvary $1.0 million on an interest-freebasis to purchase a residence. The loan is secured by a mortgage on thatresidence and $950,000 is still outstanding. The Company loaned Mr. Gilbertson $250,000 in connection with hispurchase of a residence. The loan bears interest at 8% per annum and is securedby a mortgage on that residence and a life insurance policy of $250,000 namingthe Company as the sole beneficiary. Mr. Gilbertson resigned as President of theCompany's e-commerce business on March 31, 2000, to return to TPG and the loanis in the process of being repaid in full with accrued interest. Holdings and its subsidiaries entered into a tax sharing agreementproviding (among other things) that each of the subsidiaries will reimburseHoldings for its share of income taxes determined as if such subsidiary hadfiled its tax returns separately from Holdings. 27 PART IVITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K(a) 1. Financial Statements The following financial statements of J. Crew Group, Inc. and subsidiaries are included in Item 8: (i) Report of KPMG LLP, Independent Auditors (ii) Consolidated Balance Sheets as of January 29, 2000 and January 30, 1999 (iii) Consolidated Statements of Operations - Years ended January 29, 2000, January 30, 1999 and January 31, 1998 (iv) Consolidated Statements of changes in Stockholders' Deficit - Years ended January 29, 2000, January 30, 1999 and January 31, 1998 (v) Consolidated Statements of Cash Flows - Years ended January 29, 2000, January 30, 1999 and January 31, 1998 (vi) Notes to consolidated financial statements 2. Financial Statements Schedules Schedule II Valuation and Qualifying Accounts. 3. Exhibits The exhibits listed on the accompanying Exhibit Index are incorporated by reference herein and filed as part of this report.(b) Reports on Form 8-K The Company has not filed any reports on Form 8-K during the fiscal quarter ended January 29, 2000.(c) Exhibits See Item 14(a)3 above.(d) Financial Statement Schedules See Item 14(a)1 and 14(a)2 above. 28 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signed onits behalf by the undersigned, thereunto duly authorized. J. CREW GROUP, INC.Date: April 17, 2000 By: /s/ Mark A. Sarvary --------------------- Mark A. Sarvary Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, thisreport has been signed below by the following persons on behalf of theregistrant and in the capacities and on the dates indicated. Signature Title Date --------- ----- ---- /s/ Emily Woods Director; Chairman of the Board April 17, 2000--------------------------Emily Woods/s/ Mark A. Sarvary Director; Chief Executive Officer April 17, 2000--------------------------Mark A. Sarvary (Principal Executive Officer)/s/ Scott M. Rosen Executive Vice President, Chief Financial April 17, 2000--------------------------Scott M. Rosen Officer (Principal Financial Officer)/s/ Nicholas Lamberti Vice President, Corporate Controller April 17, 2000--------------------------Nicholas Lamberti (Principal Accounting Officer)/s/ Charlotte L. Beers Director April 17, 2000 /s/ Charlotte L. Beers Director April 17, 2000--------------------------Charlotte Beers/s/ David Bonderman Director April 17, 2000--------------------------David Bonderman/s/ Richard W. Boyce Director April 17, 2000--------------------------Richard W. Boyce/s/ Gregory D. Brenneman Director April 17, 2000--------------------------Gregory D. Brenneman/s/ John W. Burden, III Director April 17, 2000--------------------------John W. Burden, III/s/ James G. Coulter Director April 17, 2000--------------------------James G. Coulter/s/ Michael Ovitz Director April 17, 2000--------------------------Michael Ovitz/s/ Brian T. Swette Director April 17, 2000--------------------------Brian T. Swette/s/ Josh S. Weston Director April 17, 2000--------------------------Josh S. Weston Independent Auditors' ReportThe Board of Directors and StockholdersJ. Crew Group, Inc. and Subsidiaries:We have audited the consolidated financial statements of J. Crew Group, Inc. andsubsidiaries (the "Company") as listed in the accompanying index. In connectionwith our audits of the consolidated financial statements, we also have auditedthe financial statement schedule listed in the accompanying index. Theseconsolidated financial statements and financial statement schedule are theresponsibility of the Company's management. Our responsibility is to express anopinion on these consolidated financial statements and financial statementschedule based on our audits.We conducted our audits in accordance with generally accepted auditingstandards. Those standards require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.In our opinion, the consolidated financial statements referred to above presentfairly, in all material respects, the financial position of J. Crew Group, Inc.and subsidiaries as of January 29, 2000 and January 30, 1999 and the results oftheir operations and their cash flows for each of the years in the three-yearperiod ended January 29, 2000, in conformity with generally accepted accountingprinciples. Also, in our opinion, the related financial statement whenconsidered in relation to the basic consolidated financial statements taken as awhole, presents fairly, in all material respects the information set forththerein. KPMG LLPMarch 31, 2000 F-1 J. CREW GROUP, INC. AND SUBSIDIARIES Consolidated Balance Sheets January 29, January 30, Assets 2000 1999 ------ ---- ---- (in thousands)Current assets: Cash and cash equivalents $ 38,693 $ 9,643 Merchandise inventories 129,928 156,022 Prepaid expenses and other current assets 30,083 46,729 Net assets held for disposal 8,927 17,377 -------- -------- Total current assets 207,631 229,771 -------- -------- Property and equipment - at cost: Land 1,460 1,460 Buildings and improvements 11,363 11,167 Furniture, fixtures and equipment 60,355 53,344 Leasehold improvements 130,054 114,424 Construction in progress 12,851 3,932 ------- ------- 216,083 184,327 Less accumulated depreciation and amortization 77,683 64,577 ------- ------- 138,400 119,750 ------- ------- Deferred income tax assets 14,830 11,624 Other assets 12,743 15,185 ------- ------- Total assets $373,604 $376,330 ======= ======= Liabilities and Stockholders' Deficit---------------------------------------------------- Current liabilities: Notes payable - bank $ -- $14,000 Accounts payable 40,951 40,130 Other current liabilities 70,222 59,175 Federal and state income taxes payable 14,687 11,280 Deferred income tax liabilities 5,842 9,476 ------- ------- Total current liabilities 131,702 134,061 ------- ------- Long-term debt 284,684 282,695 ------- ------- Deferred credits and other long-term liabilities 48,277 44,799 ------- ------- Redeemable preferred stock 173,534 150,548 ------- ------- Stockholders' deficit (264,593) (235,773) ------- ------- Total liabilities and stockholders' deficit $373,604 $376,330 ======= ======= See accompanying notes to consolidated financial statements. F-2 J. CREW GROUP, INC. AND SUBSIDIARIES Consolidated Statements of Operations Years ended ----------- January 29, January 30, January 31, ----------- ----------- ----------- 2000 1999 1998 ---- ---- ---- (in thousands)Revenues: Net sales $714,119 $816,221 $822,840 Other 2,505 8,037 11,191 -------- -------- -------- 716,624 824,258 834,031 Operating costs and expenses: Cost of goods sold, including buying and occupancy costs 394,813 460,592 465,168 Selling, general and administrative expenses 281,610 336,590 359,811 Write off of software development costs 7,018 -- -- Write down of assets and other charges in connection with discontinuance of Clifford & Wills 4,000 13,300 -- Termination costs and other nonrecurring employment contract charges - 7,995 -- -------- -------- -------- 687,441 818,477 824,979 -------- -------- -------- Income from operations 29,183 5,781 9,052 Interest expense - net 38,861 39,323 20,494 Gain on sale of Popular Club Plan (1,000) (10,000) -- Expenses incurred in connection with the Recapitalization -- -- 20,707 -------- -------- -------- Loss before income taxes and extraordinary item (8,678) (23,542) (32,149)Benefit for income taxes 2,050 8,162 5,262 -------- ----- ----- Loss before extraordinary item (6,628) (15,380) (26,887) -------- -------- --------Extraordinary item - loss on early retirement of debt (net of income tax benefit of $3,127) -- -- (4,500) -------- -------- -------- Net loss $(6,628) $(15,380) $(31,387) ======= ======== ========See accompanying notes to consolidated financial statements. F-3 J. CREW GROUP, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows Years ended ----------- January 29, January 30, January 31, ----------- ----------- ----------- 2000 1999 1998 ---- ---- ---- (in thousands)Cash flows from operating activities:Net loss $ (6,628) $(15,380) $ (31,387)Adjustments to reconcile net loss to net cashprovided by (used in) operating activities: Depreciation and amortization 19,241 15,972 15,255 Write off of software development costs 7,018 -- -- Amortization of deferred financing costs 2,196 2,119 958 Noncash interest expense 11,989 10,534 2,904 Deferred income taxes (6,840) (10,129) (5,010) Provision for losses on accounts receivable -- 5,627 7,343 Noncash compensation expense 636 881 150 Gain on sale of subsidiary (1,000) (10,000) -- Write down of assets and other charges in connection with discontinued catalog 4,000 15,000 -- Loss on early retirement of debt -- -- 7,627Changes in operating assets and liabilities:Accounts receivable -- (8,242) 33,902Merchandise inventories 26,094 (15,608) (5,106)Net assets held for disposal 4,450 -- --Prepaid expenses and other current assets 16,646 (536) (4,081)Other assets (777) (2,559) (587)Accounts payable 821 7,415 (37,726)Other liabilities 12,892 1,931 17,577Federal and state income taxes payable 3,407 11,029 (9,268) -------- -------- --------- Net cash provided by (used in) operating activities 94,145 8,054 (7,449) -------- -------- --------- Cash flows from investing activities:Capital expenditures (48,684) (41,177) (43,134)Proceeds from construction allowances 7,431 4,823 11,767Proceeds from sale of subsidiary, net of related expenses - 37,157 - -------- -------- --------- Net cash provided by (used in) investing activities (41,253) 803 (31,367) -------- -------- --------- Cash flows from financing activities:(Decrease)/increase in notes payable, bank (14,000) 14,000 --Issuance of long-term debt -- -- 295,257Repayment of long-term debt (10,000) (26,000) (92,863)Costs incurred in connection with the issuance of debt -- -- (16,429)Proceeds from the issuance of common stock 158 320 63,891Proceeds from the issuance of redeemable preferred stock -- 300 125,000Repurchase and retirement of capital stock -- -- (316,688)Costs incurred in connection with the repurchase of capital stock -- -- (14,318) -------- -------- --------- Net cash provided by (used in) financing activities (23,842) (11,380) 43,850 -------- -------- --------- Increase (decrease) in cash and cash equivalents 29,050 (2,523) 5,034 Cash and cash equivalents at beginning of year 9,643 12,166 7,132 -------- -------- ---------Cash and cash equivalents at end of year $ 38,693 $ 9,643 $ 12,166 ======== ======== =========Supplementary cash flow information: Income taxes paid (refunded) $ (7,570) $ (515) $ 5,180 ======== ======== ========= Interest paid $ 24,792 $ 27,763 $ 12,655 ======== ======== =========Noncash financing activities: Dividends on redeemable preferred stock $ 22,986 $ 19,952 $ 5,296 ======== ======== =========See accompanying notes to consolidated financial statements. F-4 J. CREW GROUP, INC. AND SUBSIDIARIES Consolidated Statements of Changes in Stockholders' Deficit (in thousands, except shares) 6% noncumulative 8% cumulative preferred stock preferred stock --------------- ---------------- Shares Amount Shares Amount ------ ------ ------ ------ Balance at January 31, 1997 15,794 $ 1,579 5,000 $ 500 Net loss -- -- -- -- Repurchase and retirement of capital stock (15,794) (1,579) (5,000) (500) Costs incurred in connection with the repurchase of capital stock -- -- -- -- Issuance of common stock -- -- -- -- Preferred stock dividends -- -- -- -- Issuance of common stock pursuant to grant of restricted stock -- -- -- -- Amortization of restricted stock -- -- -- -- -- -- -- -- Balance at January 31, 1998 -- $ -- -- $ -- Net lossIssuance of common stockPreferred stock dividendsIssuance of common stock pursuantto grant of restricted stock, netForfeiture of shares of restricted stockAmortization of restricted stockBalance at January 30, 1999Net lossIssuance of common stockPreferred stock dividendsAmortization of restricted stockBalance at January 29, 2000See accompanying notes to consolidated financial statements. F-5 Stock- Additional Retained Deferred holders' Common stock paid-in earnings Treasury compen- equity ------------Shares Amount capital (Deficit) stock sation (Deficit)------ ------ ------- --------- ----- ------ --------- 262,912 $ 263 $ 3,710 $ 101,850 $(5,896) $ -- $ 102,006 -- -- -- (31,387) -- -- (31,387) (262,912) (263) (3,161) (317,081) 5,896 -- (316,688) -- -- -- (14,318) -- -- (14,318) 11,000,000 1 63,890 -- -- -- 63,891 -- -- -- (5,296) -- -- (5,296) 661,600 -- 4,500 -- -- (4,500) -- ----------- ------- ------- -------- -- 150 150 ----------- -------- ------- --------- ------- ------- --------- 11,661,600 1 68,939 (266,232) -- (4,350) (201,642) -- -- -- (15,380) -- -- (15,380) 47,600 -- 320 -- -- -- 320 -- -- -- (19,952) -- -- (19,952) 487,400 -- 1,120 -- -- (1,120) -- -- -- -- -- (2,325) 2,325 -- --- -- -- -- -- 881 881 ---------- -------- ------- --------- ------- ------- --------- 12,196,600 1 70,379 (301,564) (2,325) (2,264) (235,773) (6,628) (6,628) 17,665 158 158 (22,986) (22,986) 636 636 _____ ___ _______ _________ _______ _______ _________ 12,214,265 $1 $70,537 $(331,178) $(2,325) $(1,628) $(264,593) ========== === ======= ========= ======= ======= ========= F-6 J. CREW GROUP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended January 29, 2000, January 30, 1999 and January 31, 1998 (1) Nature Of Business And Summary Of Significant Accounting Policies (a) Principles of Consolidation The accompanying consolidated financial statements include the accounts of J. Crew Group, Inc. ("Holdings") and its wholly-owned subsidiaries (collectively, the "Company"). All significant intercompany balances and transactions have been eliminated in consolidation. (b) Business The Company designs, contracts for the manufacture of, markets and distributes men's and women's apparel and accessories. The Company's products are marketed, primarily in the United States, through retail stores, catalogs, and the Internet. The Company is also party to a licensing agreement which grants the licensee exclusive rights to use the Company's trademarks in connection with the manufacture and sale of products in Japan. The license agreement provides for payments based on a specified percentage of net sales. The Company is subject to seasonal fluctuations in its merchandise sales and results of operations. The Company expects its sales and operating results generally to be lower in the first and second quarters than in the third and fourth quarters (which include the back-to-school and holiday seasons) of each fiscal year. A significant amount of the Company's products are produced in the Far East through arrangements with independent contractors. As a result, the Company's operations could be adversely affected by political instability resulting in the disruption of trade from the countries in which these contractors are located or by the imposition of additional duties or regulations relating to imports or by the contractor's inability to meet the Company's production requirements. (c) Fiscal Year The Company's fiscal year ends on the Saturday closest to January 31. The fiscal years 1999, 1998 and 1997 ended on January 29, 2000 (52 weeks), January 30, 1999 (52 weeks) and January 31, 1998 (52 weeks). (d) Cash Equivalents For purposes of the consolidated statements of cash flows, the Company considers all highly liquid debt instruments, with maturities of 90 days or less when purchased, to be cash equivalents. Cash equivalents, which were $23,896,000 and $755,000 at January 29, 2000 and January 30, 1999, are stated at cost, which approximates market value. F-7 J. CREW GROUP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended January 29, 2000, January 30, 1999 and January 31, 1998 (e) Merchandise Inventories Merchandise inventories are stated at the lower of cost (determined on a first-in, first-out basis) or market. The Company capitalizes certain design, purchasing and warehousing costs into inventory. (f) Advertising and Catalog Costs Direct response advertising which consists primarily of catalog production and mailing costs, are capitalized and amortized over the expected future revenue stream. The Company accounts for catalog costs in accordance with the AICPA Statement of Position ("SOP") 93-7, "Reporting on Advertising Costs." SOP 93-7 requires that the amortization of capitalized advertising costs be the amount computed using the ratio that current period revenues for the catalog cost pool bear to the total of current and estimated future period revenues for that catalog cost pool. Deferred catalog costs, included in prepaid expenses and other current assets, as of January 29, 2000 and January 30, 1999 were $14,300,000 and $21,130,000. Catalog costs, which are reflected in selling and administrative expenses, for the fiscal years 1999, 1998 and 1997 were $84,077,000, $116,515,000, and $131,103,000. All other advertising costs are expensed as incurred. Advertising expenses were $6,671,000 for fiscal year 1999. Prior year amounts were not significant. (g) Property and Equipment Property and equipment are stated at cost. Buildings and improvements are depreciated by the straight-line method over the estimated useful lives of twenty years. Furniture, fixtures and equipment are depreciated by the straight-line method over the estimated useful lives, ranging from three to ten years. Leasehold improvements are amortized over the shorter of their useful lives or related lease terms. Significant systems development costs are capitalized and amortized on a straight-line basis over periods ranging from three to five years. Approximately $6.0 million of systems development costs were capitalized in fiscal 1999. The Company receives construction allowances upon entering into certain store leases. These construction allowances are recorded as deferred credits and are amortized over the term of the related lease. (h) Other Assets Other assets consist primarily of debt issuance costs of $11,282,000 and $12,857,000 at January 29, 2000 and January 30, 1999, which are amortized over the term of the related debt agreements. (i) Income Taxes The provision for income taxes includes taxes currently payable and deferred taxes resulting from the tax effects of temporary differences between the financial statement and tax bases of assets and liabilities, in accordance with Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes." F-8 J. CREW GROUP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended January 29, 2000, January 30, 1999 and January 31, 1998 (j) Revenue Recognition Revenue is recognized for catalog and Internet sales when merchandise is shipped to customers, and at the time of sale for retail sales. The Company accrues a sales return allowance for estimated returns of merchandise subsequent to the balance sheet date that relate to sales prior to the balance sheet date. (k) Store Preopening Costs Costs associated with the opening of new retail and outlet stores are expensed as incurred. (l) Derivative Financial Instruments Derivative financial instruments are used by the Company to manage its interest rate and foreign currency exposures. For interest rate swap agreements, the net interest paid is recorded as interest expense on a current basis. Gains or losses resulting from market fluctuations are not recognized. The Company from time to time enters into forward foreign exchange contracts as hedges relating to identifiable currency positions to reduce the risk from exchange rate fluctuations. Gains and losses on contracts accounted for as hedges are deferred and recognized as adjustments to the bases of those assets. Contracts accounted for as speculative are marked to market and gains and losses are recorded currently. Such gains and losses were not material for the fiscal years ended January 29, 2000, January 30, 1999 and January 31, 1998. (m) Use of Estimates in the Preparation of Financial Statements The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. (n) Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of The Company reviews long-lived assets and certain identifiable intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company assesses the recoverability of such assets based upon estimated cash flow forecasts. During fiscal 1999 the Company wrote off $7,018,000 of capitalized computer software costs which were impaired by the Company's decision to adopt an enterprise resource planning system for its future information technology requirements. (o) Stock Based Compensation The Company accounts for stock-based compensation using the intrinsic value method of accounting for employee stock options as permitted by SFAS No. 123, "Accounting for Stock-Based Compensation". Accordingly compensation expense is not recorded for options granted if the option price is equal to the fair market price at the date of grant, as determined by management. (p) Reclassifications Certain amounts in the prior year have been reclassified to conform with the current year presentation. F-9 J. CREW GROUP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended January 29, 2000, January 30, 1999 and January 31, 1998 (2) Disposal of Businesses (a) Popular Club Plan In accordance with a sale agreement dated November 24, 1998 the Company sold all of the capital stock of Popular Club Plan, Inc. and subsidiaries ("PCP") to The Fingerhut Companies, Inc. effective as of October 30, 1998 for gross proceeds of $42.0 million in cash. A gain on the sale of PCP of $10.0 million is included in the statement of operations for fiscal 1998. An additional gain of $1.0 million was recognized in fiscal 1999 from the reversal of certain estimated liabilities recorded at the date of sale. For the nine months ended October 30, 1998 revenues of $124.1 million were included in the statement of operations. (b) Clifford & Wills In 1998, management of the Company made a decision to exit the catalog and outlet store operations of Clifford & Wills ("C&W"). Revenues of C&W included in the statement of operations for the year ended January 30, 1999 were $74.3 million. Revenues and expenses for fiscal 1999 were not material and as a result have been netted in the accompanying consolidated statement of operations. The statement of operations for fiscal year 1998 includes a charge of $13,300,000 to write down assets to net realizable value and provide for other costs to be incurred in the discontinuance of operations including lease termination and severance costs. This loss includes the write down of inventories of $9,400,000; the estimated loss on cancellation of leases of $1,000,000, severance costs of $1,100,000, write down of property and equipment of $600,000, and other related costs of $1,200,000. The inventory write down of $9,400,000 was required due to lower than anticipated recovery rates on the liquidation of these inventories. Additionally fourth quarter charges of $1,700,000 included in selling expense were incurred relating to deferred catalog costs. In February 2000 the Company sold certain intellectual property assets to Spiegel Catalog Inc. for $3.9 million. In connection with this sale the Company agreed to cease the fulfillment of catalog orders but retained the right to operate its outlet stores and conduct other liquidation sales of inventories through December 31, 2000. After consideration of the proceeds from the sale and other terms of the agreement the Company provided an additional $4,000,000 to write down inventories to net realizable value as of January 29, 2000. F-10 J. CREW GROUP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended January 29, 2000, January 30, 1999 and January 31, 1998 (3) Recapitalization Transaction In October 1997, the Company entered into a recapitalization transaction (the "Recapitalization"). Holdings purchased from the existing Shareholders for an aggregate purchase price of approximately $316,688,000 all of the outstanding shares of Holdings' capital stock, other than a certain number of shares of Holdings' common stock held by existing shareholders which represented 14.8% of the outstanding shares of Holdings' common stock immediately following consummation of the Recapitalization. The purchase of such outstanding shares of capital stock was financed in part by (a) issuing to TPG Partners II, L.P., its affiliates and other investors shares of common stock of Holdings for approximately $63,891,000 and shares of preferred stock of Holdings for $125,000,000 and (b) consummating the debt and securitization transactions described in Notes 5, 6 and 7. In connection with the Recapitalization, the Company repaid substantially all of its preexisting debt obligations immediately before the consummation of the Recapitalization. Expenses incurred in connection with the Recapitalization consisted of: Management bonuses $12,163,000 TPG financial advisory fee 5,550,000 Legal and accounting fees 1,454,000 Consulting fee 1,000,000 Other 540,000 ----------- Total $20,707,000 ----------- (4) Other Current Liabilities Other current liabilities consist of: January 29, January 30, 2000 1999 ---- ---- Customer liabilities $ 8,855,000 $ 6,861,000 Accrued catalog and marketing costs 11,503,000 5,155,000 Taxes, other than income taxes 2,372,000 3,834,000 Accrued interest 4,926,000 5,042,000 Accrued occupancy 6,957,000 4,059,000 Reserve for sales returns 5,011,000 3,473,000 Accrued compensation (including employment contract termination costs of $2,850,000 at January 30, 1999) 7,411,000 11,984,000 Other 23,187,000 18,767,000 ---------- ---------- $70,222,000 $59,175,000 ----------- ----------- F-11 J. CREW GROUP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended January 29, 2000, January 30, 1999 and January 31, 1998 (5) Sale of Accounts Receivable In October 1997, the Company entered into an agreement to securitize certain customer installment receivables of Popular Club Plan, Inc. on a revolving basis. The Company had no obligation to reimburse the trust or the purchasers of beneficial interests for credit losses. The transactions were accounted for as a sale in accordance with the provisions of SFAS No. 125 "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities." Under SFAS No. 125, no servicing asset or liability was recorded as fees charged were expected to cover related expenses. At January 31, 1998, $46,000,000 of accounts receivable had been sold pursuant to this agreement. The sale of receivables resulted in a gain of $1,472,000 during the year ended January 31, 1998. Finance charge income, including the gain on sale, was $5,325,000 and $8,294,000 for fiscal years 1998 and 1997. Obligations under the securitization agreement were assumed by the acquiror under the terms of the sale agreement with The Fingerhut Companies, Inc. (see Note 2). (6) Long-Term Debt January 29, January 30, 2000 1999 ---- ---- Term loan (a) $ 34,000,000 $ 44,000,000 10-3/8% senior subordinated notes (b) 150,000,000 150,000,000 13-1/8% senior discount debentures (c) 100,684,000 88,695,000 ------------ ------------ Total $284,684,000 $282,695,000 ============ ============ (a) The term loan is subject to the same interest rates and security terms as the Revolving Credit Agreement. Weighted average interest rates were 8.5% at January 29, 2000 and January 30, 1999 (see Note 7). The term loan is repayable in quarterly installments of $1,925,000 from February 2001 through November 2001 and $3,287,500 from February 2002 through November 2003. Proceeds of $26.0 million from the sale of PCP were used to prepay the term loan in 1998 and proceeds of $10.0 million from the sale of assets of its discontinued C&W subsidiary were used to prepay the term loan in 1999. (b) The senior subordinated notes are unsecured general obligations of J. Crew Operating Corp., a subsidiary of Holdings, and are subordinated in right of payment to all senior debt. Interest on the notes accrues at the rate of 10-3/8% per annum and is payable semi-annually in arrears on April 15 and October 15. The notes mature on October 15, 2007 and may be redeemed at the option of the issuer subsequent to October 15, 2002 at prices ranging from 105.188% in 2002 to 100% in 2005 and thereafter. F-12 J. CREW GROUP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended January 29, 2000, January 30, 1999 and January 31, 1998 (c) The senior discount debentures were issued in aggregate principal amount of $142.0 million at maturity and mature on October 15, 2008. These debentures are senior unsecured obligations of Holdings. Cash interest will not accrue prior to October 15, 2002. However, the Company records non-cash interest expense as an accretion of the principal amount of the debentures at a rate of 13-1/8% per annum. Interest will be payable in arrears on April 15 and October 15 of each year subsequent to October 15, 2002. The senior discount debentures may be redeemed at the option of Holdings on or after October 15, 2002 at prices ranging from 106.563%, to 100% in 2005 and thereafter. The maturities of long-term debt required during the next five years are: Fiscal year Amount ----------- ------ 2000 $ -- 2001 7,700,000 2002 13,150,000 2003 13,150,000 2004 ----(7) Lines of Credit On October 17, 1997, in connection with the Recapitalization, the Company entered into a syndicated revolving credit agreement of up to $200.0 million (the "Revolving Credit Agreement") with a group of banks. This agreement was amended on March 18, 1998, November 23, 1998 and April 20, 1999. Borrowings may be utilized to fund the working capital requirements of the Company including issuance of stand-by and trade letters of credit and bankers' acceptances. Borrowings are secured by a perfected first priority security interest in all assets of the Company's subsidiaries and bear interest, at the Company's option, at a base rate equal to the Administrative Agent's Eurodollar rate plus an applicable margin or an alternate base rate equal to the highest of the Administrative Agent's prime rate, a certificate of deposit rate plus 1% or the Federal Funds effective rate plus one-half of 1% plus, in each case, an applicable margin. The Revolving Credit Agreement matures on October 17, 2003. Maximum borrowings under revolving credit agreements were $58,000,000 during fiscal year 1999 and $104,000,000 during fiscal years 1998 and 1997; and average borrowings were $30,800,000, $47,500,000, and $54,300,000. Borrowings outstanding under the Company's revolving credit agreement were $14,000,000 at January 30, 1999. There were no borrowings outstanding at January 29, 2000. Outstanding letters of credit established to facilitate international merchandise purchases at January 29, 2000 and January 30, 1999 amounted to $38,315,000 and $41,628,000. The provisions of the Revolving Credit Agreement, as amended, require that the Company maintain certain levels of (i) leverage ratio, (ii) interest coverage ratio and (iii) inventory coverage ratio; provide for limitations on capital expenditures, sale and leaseback transactions, liens, investments, sales of assets and indebtedness; and prohibit the payment of cash dividends on shares of common stock. F-13 J. CREW GROUP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended January 29, 2000, January 30, 1999 and January 31,1998(8) Common Stock The restated certificate of incorporation authorizes Holdings to issue up to 100,000,000 shares of common stock; par value $.01 per share. In April 1999 the Board of Directors approved a 200 for 1 stock split of its common stock in the form of a stock dividend. All references to shares of common stock have been restated to reflect the stock split. During 1998 directors acquired 30,000 shares of common stock and converted fees into 17,600 shares of common stock. During 1999 directors converted fees into 17,665 shares of common stock.(9) Redeemable Preferred Stock The restated certificate of incorporation authorizes Holdings to issue up to: (a) 1,000,000 shares of Series A cumulative preferred stock; par value $.01 per share; and (b) 1,000,000 shares of Series B cumulative preferred stock; par value $.01 per share. In connection with the Recapitalization, Holdings issued 92,500 shares of Series A Preferred Stock and 32,500 shares of Series B Preferred Stock. During 1998 directors acquired 300 shares of preferred stock at $1,000 per share. The Preferred Stock accumulates dividends at the rate of 14.5% per annum (payable quarterly) for periods ending on or prior to October 17, 2009. Dividends compound to the extent not paid in cash. On October 17, 2009, Holdings is required to redeem the Series B Preferred Stock and to pay all accumulated but unpaid dividends on the Series A Preferred Stock. Thereafter, the Series A Preferred Stock will accumulate dividends at the rate of 16.5% per annum. Subject to restrictions imposed by certain indebtedness of the Company, Holdings may redeem shares of the Preferred Stock at any time at redemption prices ranging from 103% of liquidation value plus accumulated and unpaid dividends at October 17, 1998 to 100% of liquidation value plus accumulated and unpaid dividends at October 17, 2000 and thereafter. In certain circumstances (including a change of control of Holdings), subject to restrictions imposed by certain indebtedness of the Company, Holdings may be required to repurchase shares of the Preferred Stock at liquidation value plus accumulated and unpaid dividends. Accumulated but unpaid dividends amounted to $48,234,000 at January 29, 2000. Dividends are recorded as an increase to redeemable preferred stock and a reduction of retained earnings.(10) Commitments and Contingencies (a) Operating Leases As of January 29, 2000, the Company was obligated under various long-term operating leases for retail and outlet stores, warehouses, office space and equipment requiring minimum annual rentals. These operating leases expire on varying dates to 2012. At January 29, 2000 aggregate minimum rentals in future periods are as follows: Fiscal year Amount ----------- ------ 2000 $ 36,900,000 2001 34,720,000 2002 33,611,000 2003 33,317,000 2004 29,609,000 Thereafter 132,817,000 F-14 J. CREW GROUP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended January 29, 2000, January 30, 1999 and January 31, 1998 Certain of these leases include renewal options and escalation clauses and provide for contingent rentals based upon sales and require the lessee to pay taxes, insurance and other occupancy costs. Rent expense for fiscal 1999, 1998 and 1997 was $ 39,474,000, $42,347,000 and $35,753,000, including contingent rent based on store sales of $2,600,000, $3,270,000, and $2,877,000. (b) Employment Agreements The Company is party to employment agreements with certain executives which provide for compensation and certain other benefits. The agreements also provide for severance payments under certain circumstances. (c) Litigation The Company is subject to various legal proceedings and claims that arise in the ordinary conduct of its business. Although the outcome of these claims cannot be predicted with certainty, management does not believe that the ultimate resolution of these matters will have a material adverse effect on the Company's financial condition or results of operations.(11) Employee Benefit Plan The Company has a thrift/savings plan pursuant to Section 401 of the Internal Revenue Code whereby all eligible employees may contribute up to 15% of their annual base salaries subject to certain limitations. The Company's contribution is based on a percentage formula set forth in the plan agreement. Company contributions to the thrift/savings plan were $1,320,000 for fiscal 1999 and $1,780,000 for fiscal 1998 and 1997.(12) License Agreement The Company has a licensing agreement through January 2003 with Itochu Corporation, a Japanese trading company. The agreement permits Itochu to distribute J. Crew merchandise in Japan. The Company earns royalty payments under the agreement based on the sales of its merchandise. Royalty income, which is included in other revenues, for fiscal 1999, 1998 and 1997 was $2,505,000, $2,712,000 and $2,897,000. (13) Interest Expense - Net Interest expense, net consists of the following: 1999 1998 1997 ---- ---- ---- Interest expense $39,099,000 $40,379,000 $20,636,000 Interest income (238,000) (1,056,000) (142,000) ----------- ----------- ----------- Interest expense, net $38,861,000 $39,323,000 $20,494,000 ----------- ----------- ----------- Interest expense in fiscal 1999 includes $1,029,000 incurred in connection with the settlement of a sales and use tax assessment. Interest income in fiscal 1998 includes $979,000 related to a federal income tax refund. F-15 J. CREW GROUP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended January 29, 2000, January 30, 1999 and January 31, 1998 (14) Financial Instruments The following disclosure about the fair value of financial instruments is made in accordance with the requirements of SFAS No. 107, "Disclosures About Fair Value of Financial Instruments." The fair value of the Company's long-term debt is estimated to be approximately $235,215,000 and $246,680,000 at January 29, 2000 and January 30, 1999, and is based on dealer quotes or quoted market prices of the same or similar instruments The carrying amounts of long-term debt were $284,684,000 and $282,695,000 at January 29, 2000 and January 30, 1999. The carrying amounts reported in the consolidated balance sheets for cash and cash equivalents, notes payable-bank, accounts payable and other current liabilities approximate fair value because of the short-term maturity of those financial instruments. The estimates presented herein are not necessarily indicative of amounts the Company could realize in a current market exchange. In October 1997 the Company entered into an interest rate swap agreement for $70 million notional amount, which was reduced to $50 million in October 1998. This agreement effectively converted the interest rate on its term loan and borrowings on the Revolving Credit Agreement from a variable rate to a fixed rate of 6.23% through October 2000. If this agreement had been settled on January 29, 2000, the Company would have received $62,000. At January 29, 2000, the Company had a forward foreign exchange contract outstanding to sell 120 million yen on March 31, 2000. At January 30, 1999 the company had two forward foreign exchange contracts outstanding to sell 130 million yen each on March 31, 1999 at different rates of exchange. These contracts are entered into to manage the foreign exchange rate exposure relating to foreign licensing revenues. The fair value of the contracts approximate carrying value. The Company is exposed to credit losses in the event of nonperformance by the counterparties to these contracts, but it does not expect any counterparties to fail to meet their obligation given their high-credit rating.(15) Income Taxes The Company accounts for income taxes in accordance with SFAS No. 109, "Accounting for Income Taxes". This statement requires the use of the liability method of accounting for income taxes. Under the liability method, deferred taxes are determined based on the difference between the financial reporting and tax bases of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. F-16 J. CREW GROUP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended January 29, 2000, January 30, 1999 and January 31, 1998The income tax benefit consists of: 1999 1998 1997 ---- ---- ---- Current: Foreign $ 250,000 $ 270,000 $ 309,000 Federal 3,100,000 600,000 (866,000) State and local 1,440,000 1,097,000 305,000 ----------- ------------ ----------- 4,790,000 1,967,000 (252,000) ----------- ------------ ----------- Deferred - Federal, state and local (6,840,000) (10,129,000) (5,010,000) ----------- ------------ ----------- Income taxes before tax effect of extraordinary items (2,050,000) (8,162,000) (5,262,000) Tax effect of extraordinary items - -- (3,127,000) ----------- ------------ ----------- Total $(2,050,000) $ (8,162,000) $(8,389,000) =========== ============ ===========A reconciliation between the benefit for income taxes based on the U.S. Federalstatutory rate and the Company's effective rate is as follows. 1999 1998 1997 ---- ---- ---- Federal income tax rate (35.0)% (35.0)% (35.0)% State and local income taxes, net of federal benefit 7.0 (1.4) (1.8) Nondeductible expenses and other 4.4 1.7 15.7 --- --- ---- Effective tax rate (23.6)% (34.7)% (21.1)% ===== ===== ===== The tax effect of temporary differences which give rise to deferred tax assetsand liabilities are: January 29, January 30, 2000 1999 ---- ---- Deferred tax assets: Original issue discount $ 8,629,000 $ 4,519,000 State and local net operating loss carryforwards 3,034,000 4,132,000 Difference in book and tax basis for property and equipment 1,885,000 2,302,000 Reserve for sales returns 2,012,000 1,396,000 Other 2,298,000 1,073,000 ----------- ------------ 17,858,000 13,422,000 Deferred tax liabilities: Prepaid catalog expenses and other prepaid expenses (8,870,000) (11,274,000) ----------- ------------ Net deferred income tax asset $ 8,988,000 $ 2,148,000 =========== ============ F-17 J. CREW GROUP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended January 29, 2000, January 30, 1999 and January 31, 1998 Management believes that it is more likely than not that the results of future operations will generate sufficient taxable income to realize the deferred tax assets. The Company has state and local income tax net operating loss carryforwards of varying amounts.(16) Extraordinary Item In October 1997, the Company prepaid $85 million principal amount of senior notes and recorded an extraordinary loss of $4,500,000 (net of an income tax benefit of $3,127,000) consisting of the write-off of deferred financing costs and redemption premiums related to the early retirement of debt.(17) Stock Options The J. Crew Group, Inc. Stock Option Plan (the "Option Plan") was adopted by the Company in 1997. Under the terms of the Option Plan, an aggregate of 1,810,000 shares are available for grant to certain key employees or consultants. The options have terms of seven to ten years and become exercisable over a period of five years. Options granted under the Option Plan are subject to various conditions, including under some circumstances, the achievement of certain performance objectives. A summary of stock option activity for the Plan was, as follows: 1999 1998 1997 ---- ---- ---- Weighted Weighted Weighted -------- -------- -------- average average average ------- ------- ------- Shares exercise price Shares exercise price Shares exercise price ------ -------------- ------ -------------- ------ -------------- Outstanding,beginning of year 997,200 $8.00 786,800 $8.31 ---- $ --- Granted 772,800 9.47 431,000 6.82 786,800 8.31 Cancelled (237,200) 7.14 (220,600) 6.82 -- --------- -------- ------- Outstanding, end of year 1,532,800 $8.87 997,200 $8.00 786,800 $8.31 ========= ===== ======== ===== ======= ============== Options exercisable at end of year 318,040 $7.97 189,460 $7.06 -- -- ========= ===== ======== ===== ======= ==============(18) Employee Restricted Stock Under the terms of employment agreements with several key executives 661,600 shares of restricted stock were awarded in fiscal 1997 and 487,400 shares in fiscal 1998. These shares vest through October 2002. Deferred compensation of $5,620,000 was credited to additional paid in capital. Deferred compensation is charged to expense over the vesting period. In connection with the termination of an executive in 1998, 487,400 shares were forfeited and deferred compensation of $2,325,000 was reversed and the shares were reacquired as treasury stock.(19) Termination costs and other non-recurring employment contract charges Charges of $2,850,000 were incurred in fiscal 1998 in connection with the termination of the employment contracts of two senior executives including the former Chief Executive Officer. Additionally, during fiscal 1998, tax gross-up payments of $5,145,000 were made on behalf of senior executives relating to restricted stock grants. F-18 J. CREW GROUP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended January 29, 2000, January 30, 1999 and January 31,1998 (20) Segment Information On January 1, 1998, the Company adopted SFAS 131, "Disclosure About Segments of An Enterprise and Related Information". This statement does not affect the Company's financial position or results of operations. The Company designs, contracts to manufacture and markets men's, women's, and children's apparel, accessories and home furnishings primarily under Company owned brand names. The brands are marketed through various channels of distribution including retail and factory outlet stores, catalogs, the Internet and licensing arrangements with third parties. These operations have been aggregated into three reportable segments based on brand identification: J. Crew, Clifford & Wills and Popular Club Plan. Management evaluates the results of operations of its segments based on income from operations. All of the Company's identifiable assets are located in the United States. Export sales are not significant. During 1998, the Company sold PCP to The Fingerhut Companies, Inc. and decided to discontinue the operations of its C&W brand. The revenues and operating income of PCP are included through October 30, 1998 and through January 30, 1999 for C&W. Income from operations relating to Clifford & Wills for fiscal 1998 includes a noncash write-down of $13,300,000 relating to the discontinuance of C&W operations and $1,700,000 of fourth quarter charges to write off deferred catalog costs. Fiscal 1999 includes an additional charge of $4,000,000 to write down inventories to net realizable value. (See note 2 to the consolidated financial statements). F-19 J. CREW GROUP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended January 29, 2000, January 30, 1999 and January 31,1998 Corporate and other expenses include expenses incurred by the corporate officeand certain non-recurring expenses that are not allocated to specific businessunits. Corporate and other expenses in fiscal 1999 include the write off ofimpaired software development costs. Corporate and other expenses in fiscal 1998include tax gross-up payments related to restricted stock grants and employeecontract termination costs. Corporate and other expenses in fiscal 1997 includea one-time bonus expense related to the employment of a senior executive andnon-recurring consulting fees incurred as a result of the Recapitalization.Segment assets represent the assets used directly in the operations of eachbusiness unit such as inventories and property and equipment. Corporate assetsconsist principally of investments, deferred financing costs and certaincapitalized software.The accounting policies used for segment reporting are consistent with thosedescribed in the summary of significant accounting policies. [$ in thousands]Revenues 1999 1998 1997 ---- ---- ----J. Crew $716,624 $625,897 $577,594Clifford & Wills --- 74,303 72,063PCP --- 124,058 184,374 -------- -------- -------- 716,624 824,258 834,031 ======== ======== ======== Income from operations J. Crew 41,052 34,736 8,393Clifford & Wills (4,000) (16,694) (1,186)PCP -- (2,701) 7,550Corporate and other expenses (7,869) (9,560) (5,705) -------- -------- --------Income from operations 29,183 5,781 9,052 -------- -------- -------- Interest expense, net (38,861) (39,323) (20,494)Gain on sale of PCP 1,000 10,000 -Expenses incurred in connection with the Recapitalization - ---- (20,707) -------- -------- -------- Loss before income taxes $ (8,678) $(23,542) $(32,149) ======== ======== ======== Depreciation and amortizationJ. Crew $ 19,051 $ 14,455 $ 13,645Clifford & Wills --- 327 199PCP --- 1,015 1,279Corporate 190 175 132 -------- -------- -------- $ 19,241 $ 15,972 $ 15,255 ======== ======== ======== F-20 J. CREW GROUP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended January 29, 2000, January 30, 1999 and January 31, 1998 [$ in thousands] Identifiable assets 1999 1998 1997 ---- ---- ---- J. Crew $305,552 $324,949 $314,186Clifford & Wills 8,927 17,377 29,078PCP --- -- 57,811Corporate 59,125 34,004 20,803 -------- -------- -------- $373,604 $376,330 $421,878 ======== ======== ======== Capital expenditures (net of disposals) J. Crew $ 39,435 $ 34,084 $ 41,149Clifford & Wills -- (59) (98)PCP -- 5,264 2,058Corporate 9,249 1,888 25 -------- -------- -------- $ 48,684 $ 41,177 $ 43,134 ======== ======== ======== F-21 SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS beginning charged to cost charged to other ending balance and expenses accounts deductions balance ($ in thousands)Allowance for doubtful accounts------------------------------- (deducted from accounts receivable) fiscal year ended: January 29, 2000 $--------- $--------- $--------- $----------- $-------- (5,486)(a) January 30, 1999 5,438 5,627 ---- (5,579)(c) --- January 31, 1998 4,357 7,343 ---- (6,262)(a) 5,438 Inventory reserve----------------- (deducted from inventories) fiscal year ended:January 29, 2000 $6,122 (1,675)(b) $--------- -- $4,447 (2,200)(c)January 30, 1999 4,400 4,929(b) ---- (1,007)(d) 6,122January 31, 1998 3,289 1,111(b) ---- ---- 4,400 Allowance for sales returns--------------------------- (included in other current liabilities) fiscal year ended:January 29, 2000 $3,473 1,538(b) ---- $5,011 500(c) ---January 30, 1999 3,529 844(b) ---- 400(d) 3,473January 31, 1998 2,406 1,123(b) ---- ---- 3,529(a) accounts deemed to be uncollectible(b) The inventory reserve and allowance for sales returns are evaluated at the end of each fiscal quarter and adjusted (plus or minus) based on the quarterly evaluation. During each period inventory write-downs and sales returns are charged to the statement of operations as incurred.(c) charged to gain on sale of Popular Club Plan, Inc.(d) reclassified to net assets held for disposal (relating to discontinuance of Clifford & Wills operation) F-22 EXHIBIT INDEX Exhibit No. Description -- ----------- 3.2(a) By-laws of J. Crew Group, Inc. (incorporated by reference to Exhibit 3.2 to the Registration Statement)3.2(b) By-laws amendment adopted June 1, 1998 (incorporated by reference to Exhibit 3.2(b) to the Registrant's Annual Report on Form 10-K for the fiscal year ended January 30, 1999 ("1999 Form 10-K"))3.2(c) By-laws amendment adopted January 27, 20004.1 Indenture, dated as of October 17, 1997, between J. Crew Group, Inc., as issuer, and State Street Bank and Trust Company, as trustee, relating to the Debentures (the "Indenture") (incorporated by reference to Exhibit 4.3 to the Registration Statement)4.2(a) Credit Agreement, dated as of October 17, 1997 ("Credit Agreement"), among J. Crew Group, Inc., J. Crew Operating Corp., the Lenders Party thereto, the Chase Manhattan Bank, as Administrative Agent, and Donaldson, Lufkin & Jenrette Securities Corporation, as Syndication Agent (incorporated by reference to Exhibit 4.5 to Amendment No. 1 to the Registration Statement, filed February 6, 1998 (the "Amendment No. 1"))4.2(b) Amendment dated as of November 23, 1998 to the Credit Agreement (incorporated by reference to Exhibit 4.2(b) of the 1999 Form 10-K)4.2(c) Amendment dated as of March 18, 1998 to the Credit Agreement (incorporated by reference to Exhibit 4.2(c) of the 1999 Form 10-K)4.2(d) Amendment and Restatement Agreement dated as of April 20, 1999 relating to the Credit Agreement (incorporated by reference to Exhibit 4.2(d) of the 1999 Form 10-K)4.3 Guarantee Agreement dated as of October 17, 1997, among J. Crew Group, Inc., the subsidiary guarantors of J. Crew Operating Corp. that are signatories thereto and The Chase Manhattan Bank (incorporated by reference to Exhibit 4.6 to the Registration Statement)4.4 Indemnity, Subrogation and Contribution Agreement dated as of October 17, 1997, among J. Crew Operating Corp., the subsidiary guarantors of J. Crew Operating Corp. that are signatories thereto and The Chase Manhattan Bank (incorporated by reference to Exhibit 4.7 to the Registration Statement)4.5 Pledge Agreement, dated as of October 17, 1997 among J. Crew Operating Corp., J. Crew Group, Inc., the subsidiary guarantors of J. Crew Operating Corp. that are signatories thereto and The Chase Manhattan Bank (incorporated by reference to Exhibit 4.8 to the Registration Statement) 1 Exhibit No. Description -- -----------4.6 Security Agreement, dated as of October 17, 1997 among J. Crew Operating Corp., J. Crew Group, Inc., the subsidiary guarantors of J. Crew Operating Corp. that are signatories thereto and The Chase Manhattan Bank (incorporated by reference to Exhibit 4.9 to the Registration Statement)4.7 Registration Rights Agreement, dated as of October 17, 1997 by and among J. Crew Group, Inc., Donaldson, Lufkin & Jenrette Securities Corporation and Chase Securities Inc. (incorporated by reference to Exhibit 4.10 to the Registration Statement) NOTE: Pursuant to the provisions of paragraph (b)(4)(iii) of Item 601 of Regulation S-K, the Registrant hereby undertakes to furnish to the Commission upon request copies of the instruments pursuant to which various entities hold long-term debt of the Company or its parent or subsidiaries, none of which instruments govern indebtedness exceeding 10 percent of the total assets of the Company and its subsidiaries on a consolidated basis.10.1(a)+ Employment Agreement, dated October 17, 1997, among J. Crew Group, Inc., J. Crew Operating Corp., TPG Partners II, L.P. (only with respect to Section 2(c) therein) and Emily Woods (the "Woods Employment Agreement") (incorporated by reference to Exhibit 10.1 to the Registration Statement)10.1(b)+ Letter Agreement, dated February 4, 2000, between J. Crew Group, Inc. and Emily Woods10.2+ J. Crew Operating Corp. Senior Executive Bonus Plan (included as Exhibit A to the Woods Employment Agreement filed as Exhibit 10.1)10.3+ Stock Option Grant Agreement, made as of October 17, 1997 between J. Crew Group, Inc. and Emily Woods (time based) (incorporated by reference to Exhibit 10.3 to the Registration Statement)10.4+ Stock Option Grant Agreement, made as of October 17, 1997 between J. Crew Group, Inc. and Emily Woods (performance based) (incorporated by reference to Exhibit 10.4 to the Registration Statement)10.5(a) Employment Agreement, dated May 3, 1999, between J.Crew Group, Inc. and Mark Sarvary (incorporated by reference to Exhibit 10.1 to Registrant's Quarterly Report on Form 10-Q for the period ended May 1, 1999).10.5(b)+ Letter Agreement, dated August 9, 1999, between Mark Sarvary and J. Crew Operating Corp.10.6+ Letter Agreement, dated September 30, 1999, between J. Crew Operating Corp. and Carol Sharpe10.7 Stockholders' Agreement, dated as of October 17, 1997, among J. Crew Group, Inc. and the Stockholder signatories thereto (incorporated by reference to Exhibit 4.1 to the Registration Statement)10.8 Stockholders' Agreement, dated as of October 17, 1997, among J. Crew Group, Inc., TPG Partners II, L.P. and Emily Woods (included as Exhibit B to the Woods Employment Agreement filed as Exhibit 10.1)10.9 J. Crew Group, Inc. 1997 Stock Option Plan (incorporated by reference to Exhibit 10.13 to the Registration Statement)10.10 Contract Carrier Agreement, between J. Crew Group, Inc. and United Parcel Service, Inc. (incorporated by reference to Exhibit 10.6 to the Registration Statement) 2 Exhibit No. Description -- -----------10.11 Agreement dated August 14, 1997 between R.R. Donnelley & Sons Company and J. Crew Inc. (incorporated by reference to Exhibit 10.11 to the Registration Statement)21.1 Subsidiaries of J. Crew Group, Inc.27.1 Financial Data Schedule __________+Management contract or compensatory plan or arrangement. 3 Exhibit 3.2(c) -------------- Amendment to Section 5.02 of the ByLaws --------------------------------------- "Chairman. The Chairman of the Board, who shall be elected from among the -------- Directors, shall preside at all meetings of the stockholders and the Board ofDirectors. The Chairman shall have such other powers and duties as the Board ofDirectors may from time to time assign to him or her." Exhibit 10.1(b) --------------- J. Crew Group, Inc. 770 Broadway New York, NY 10003 February 4, 2000Emily Woods227 West 17th Street8th FloorNew York, NY 10013Dear Emily: We are delighted that you have decided to continue your relationship withJ. Crew Group, Inc. (the "Company") and its operating subsidiary, J. CrewOperating Corp., under the new arrangements described below. This letter shallconstitute an amendment to your Employment Agreement with the Company, datedOctober 17, 1997 (the "Employment Agreement"). All defined terms used hereinand not otherwise defined herein shall have the meanings ascribed to such termsin the Employment Agreement. Except as provided herein, all terms andconditions of the Employment Agreement shall remain in full force and effect.I. Employment Duties and Responsibilities. Effective February 7, 2000, in lieu of your duties, responsibilities andtitle provided in Section 1(a) of the Employment Agreement, you will (i)continue to be the Chairman of the Board of Directors of the Company (the"Board"), and shall be identified as such in all internal and externalcommunications in which you are referred to or mentioned, each of which shall besubject to your prior review and approval, (ii) serve on the Strategic PlanningCommittee of the Board (which will consist of yourself and Messrs. Bonderman,Coulter and Sarvary as long as each of you are serving on the Board), and (iii)perform certain services for the Company from time to time as you and theCompany may mutually agree and (iv) serve as a spokesperson for the Company atyour and the Company's discretion, and in such connection shall be kept apprisedof all public relations and other similar inquiries and requests concerningyourself. The provisions of Sections 1(b) and (c) of the Employment Agreementshall no longer apply, and you shall not be required to devote more than fourdays per month to the affairs of the Company, although you shall be free to doso at your discretion. The foregoing services shall be referred to in thisletter as the "Continuing Services." The Continuing Services and the titlereferred to above shall constitute your duties, responsibilities and title underthe Employment Agreement.II. Effect of Changed Responsibilities. Notwithstanding the modification effected hereby of your employment duties,but subject to your option to terminate the Employment Period as set forth inthe following paragraph, the Employment Period shall continue notwithstandingthe changes to the Employment Agreement effected hereby. During thecontinuation of the Employment Period, your entitlement to Compensation pursuantto Section 2 of the Employment Agreement, and all of the other rights andbenefits provided to you under the Employment Agreement shall continue withoutany change. Without limiting the generality of the foregoing, during thecontinuation of the Employment Period, your current office and its use willremain as they are currently. The Company hereby agrees and acknowledges that the above-described changein duties and responsibilities shall constitute Good Reason under the EmploymentAgreement and you may terminate your employment under the Employment Agreementat any time after February 7, 2000 pursuant to the procedures provided inSection 4 of the Employment Agreement and such termination shall be deemed to be a termination by the Company without Cause. Accordingly, upon such atermination you shall be entitled to all of the payments and benefits underSection 5(a) of the Employment Agreement as of the Date of Termination, and allof the other terms and provisions of the Employment Agreement and of theStockholders Agreement and of all other agreements and plans applicable toEmployee relevant to a termination by the Company without Cause shall beapplicable.III. Emily Woods Name. The Company shall relinquish any proprietary rights to the use of the names"Emily Woods," Emily Wood," "EMWoods", "EMWood" and any other similar name,trademark, registered mark or other similar right or intellectual property, andshall convey to you all of its right, title and interest in and to each suchname, trademark, registered mark or other similar right or intellectualproperty.IV. Put Rights. You and the Company hereby agree and acknowledge that in the event,following termination of your employment under the Employment Agreement, youexercise your Put Option (described in Section 3(b) of the Stockholders'Agreement among you, the Company and TPG Partners II, L.P. (the "Stockholders'Agreement")), notwithstanding anything to the contrary in the EmploymentAgreement or the Stockholders Agreement, (A) if the date you exercise your PutOption (and therefore the date on which the Appraised Value (as defined underthe Stockholders' Agreement) would otherwise be determined) shall be on or priorto October 31, 2000, the date as of which the Appraised Value shall bedetermined shall be, at your election, either (x) January 31, 2000 or (y) suchdate as you shall exercise the Put Option, and (B) if the date you exercise yourPut Option is after October 31, 2000, the date as of which the Appraised Valueshall be determined shall be the date on which you exercise the Put Option. Theremaining terms and conditions of the Stockholders' Agreement, including withoutlimitation as to the determination of Appraised Value, shall remain in fullforce and effect. This letter may be signed in counterparts and each counterpart shallconstitute a part hereof, and a facsimile of a signature shall be deemed anoriginal signature for purposes of this letter. 2 If the terms of this letter meet with your approval, please sign in thespace provided below. Sincerely, _____________________ David Bonderman Member, Board of DirectorsAgreed to and Accepted:_____________________Emily Woods 3 Exhibit 10.5(b) --------------- August 9, 1999Mr. Mark SarvaryChief Executive OfficerJ. Crew Group, Inc.770 BroadwayNew York, NY 10003Dear Mark: Pursuant to our recent discussions regarding the loan which J. CrewOperating Corp. (the "Company") will make to you in accordance with Section 2(g) ------- of the Employment Agreement dated as of May 3, 1999, among the Company, J. CrewGroup, Inc. and you, we thought it would be useful to lay out certain materialterms and conditions of such loan in this letter for both parties to sign.I. The Company Loan Immediately prior to the closing of the purchase of your proposedprimary residence (the "Closing"), the Company will lend you one million dollars ------- ($1,000,000) (the "Company Loan") to be used by you for the sole purpose of ------------ purchasing your primary residence, located at 7 Fox Run, Purchase, New York (the"Property"). It is understood that the funding of the Company Loan will take -------- place immediately prior to the Closing and will be initially secured by yourpledge to the Company of certain stock options (the "Stock Options") pursuant to ------------- the Pledge and Security Agreement to be executed by you, a copy of which isattached heret as Exhibit B. Immediately following the Closing, you will grantthe Company a second mortgage on the Property to secure the Company Loan byexecuting a second mortgage agreement substantially in the form attached heretoas Exhibit C (the "Second Mortgage"), and the Company will release its security --------------- interest in the Stock Options.II. Terms and Conditions of the Company Loan A. The obligation of the Company to make the Company Loan is subjectto your providing evidence satisfactory to the Company on the date of theClosing that: (1) the sum of (x) the Company Loan and (y) the loan to be obtained by you from Citibank, N.A. in connection with the purchase of the Property, which loan will be secured by a first mortgage on the Property (the "First ----- Mortgage Loan"), does not exceed ninety percent (90%) of the fair market ------------- value of the Property as appraised by Citibank, N.A. in connection with the First Mortgage Loan (a copy of such appraisal to be provided to the Company at the Closing); (2) there are no liens on the Property other than the lien created by the First Mortgage Loan (or other items acceptable to the Company identified on the Citibank, N.A. lender's title insurance policy, a copy of which you will provide to the Company); and (3) The terms and conditions of the First Mortgage Loan do not prohibit the Second Mortgage. B. As consideration for the Company making the Company Loan, youagree that: (1) Contemporaneously with the making of the Company Loan, you will execute the Promissory Note and the Pledge and Security Agreement, substantially in the forms attached hereto as Exhibit A and Exhibit B, respectively; (2) You will execute the Second Mortgage in the form attached hereto as Exhibit C immediately following the Closing and the Company shall record the same in the applicable recording office; (3) You will not grant any liens on the Property without the prior written consent of the Company (other than the lien securing the First Mortgage Loan); and (4) In the event the Closing does not occur on the date the Company makes the Company Loan to you, you will immediately repay the Company Loan to the Company. If the foregoing correctly reflects your understanding, please signthe enclosed copy of this letter and return it to me. Sincerely, Emily WoodsAgreed to and accepted:___________________________Mark SarvaryDate: PROMISSORY NOTE$1,000,000.00 New York, NY August __, 1999 Mark Sarvary ("Sarvary"), for value received, hereby promises to pay to theorder of J.Crew Operating Corp., a Delaware corporation ("J.Crew"), at itsoffices located at 770 Broadway, New York, NY, 10003, or such other place as theholder hereof may designate by notice to Sarvary, the principal amount of OneMillion Dollars ($1,000,000.00), in lawful money of the United States, withoutinterest, as follows: (i) $50,000.00 on April 15th in each of the years 2000,2001, 2002 and 2003; and (ii) the remaining balance of $800,000.00 on June 29,2004. Sarvary hereby grants J.Crew the right to deduct all or a portion of theprincipal payments when due from any bonus payable to him. Sarvary acknowledgesand confirms that (i) J.Crew has loaned Sarvary the principal amount of the Notefor the sole purpose of Sarvary purchasing a primary residence located at 7 FoxRun, Purchase, New York (the "Property") and (ii) he will use the proceeds ofthe Note solely for such purpose.1. Prepayment ---------- This Note may be prepaid at any time, in whole or in part, without penaltyor premium. Each partial prepayment shall be applied to installments ofprincipal in inverse order of maturity.2. Events of Acceleration ---------------------- The holder of this Note, by written notice to Sarvary, may declare theentire principal amount immediately due and payable if any of the followingevents ("Accelerated Events") shall have occurred and be continuing, in whichevent the maturity of the then unpaid balance of the Note shall be acceleratedand shall become immediately due and payable, without presentment, demand,protest or notice of any kind, all of which are hereby expressly waived inaccordance with Paragraph 3(f) hereunder. (a) Sarvary shall not have paid any installment of principal on this Noteas and when it has become due and payable and such default shall continue for aperiod of 10 days after notice to Sarvary; (b) Sarvary's employment with J.Crew is terminated for any reason; or (c) Sarvary is in default under any other agreement with J.Crew. 3. Miscellaneous ------------- (a) Sarvary shall pay all costs and expenses incurred by the holder inconnection with the collection of the Note, including reasonable attorneys'fees. (b) This Note shall be governed by and construed in accordance with thelaws of New York State applicable to agreements made and to be performed thereinand cannot be changed orally. Sarvary irrevocably consents to the sole andexclusive jurisdiction of the courts of New York State and of any federal court located in New York State in connection withany action or proceeding arising out of or related to this Note. (c) No delay or failure on the part of the holder of this Note to exerciseany power or right given under this Notice, including, but not limited to, theright to accelerate the amounts due, shall operate as a waiver of the power orright and no right or remedy of the holder shall be deemed abridged or modifiedby any course of conduct. All rights and remedies existing hereunder arecumulative and not exclusive of each other or any rights or remedies otherwiseavailable. (d) All notices and other communications hereunder shall be in writing andshall be deemed given when delivered personally, three days after being mailedby registered mail, return receipt requested, or the following day if sent byovernight courier service, to J.Crew at the address set forth at the beginningof this Note, attn: General Counsel, and to Sarvary at 770 Broadway, New York,NY 10003, or such other address as either party may specify by notice givenpursuant hereto. (e) To the extent permitted by applicable law, Sarvary hereby waives allbenefit that might accrue by virtue of any present or future moratorium lawsexempting any of the Property, or any other property, real or personal, or anypart of the proceeds arising from any sale of any such property, fromattachment, levy, or sale under execution, or providing for any stay ofexecution to be issued on any judgment recovered on this Note (excepting onlyany stay of execution). (f) SARVARY HEREBY WAIVES PRESENTMENT, DEMAND, DILIGENCE, PROTEST ANDNOTICE OF PROTEST, NOTICE OF INTENT TO ACCELERATE, NOTICE OF ACCELERATION,DEMAND, DISHONOR AND NON-PAYMENT OF THIS NOTE OR ANY OTHER NOTICE OF ANY KINDWHATSOEVER. (g) If any term or provision of this Note or the application thereof to anycircumstance shall, to any extent, be invalid, illegal or unenforceable, suchterm or such provisions shall be ineffective to the extent of such invalidity,illegality or unenforceability without invalidating or rendering unenforceableany remaining terms and provisions hereof or thereof or the application of suchterm or provision to circumstances other than those as to which it is heldinvalid, illegal or unenforceable. (h) This Note shall not be transferable, except that J.Crew may transferthe Note to any other person or entity without Sarvary's consent. ___________________________ Mark Sarvary 2 Exhibit "B"----------- PLEDGE AND SECURITY AGREEMENT This PLEDGE AND SECURITY AGREEMENT (as amended, restated, replaced,supplemented or otherwise modified from time to time, this "Agreement") is dated --------- as of August __, 1999 and entered into by and between Mark Sarvary, in hisindividual capacity, ("Grantor") and J.Crew Operating Corp., (together with it ------- successors and assigns, "Secured Party"). ------------- PRELIMINARY STATEMENTS WHEREAS, Secured Party has agreed to loan Grantor the principal amountof $1,000,000 (the "Loan") in accordance with that certain Promissory Note made ---- by Grantor, dated as of the date hereof (as the same may be amended, restated,supplemented or otherwise modified from time to time, the "Note") and in ---- accordance with that certain letter agreement between the parties, dated August9, 1999 (the "Letter Agreement") in order to finance Grantor's acquisition of a ---------------- certain property located at 7 Fox Run, Purchase, NY 10577 (the "Property"); -------- WHEREAS, Grantor is the legal and beneficial owner of those certainoptions to purchase 272,000 shares of the common stock of J.Crew Group, Inc.awarded to him under the J.Crew Group, Inc. 1997 Stock Option Plan (such optionsand such plan, the "Pledged Options" and the "Option Plan", respectively) and --------------- ----------- evidenced by that certain Stock Option Agreement dated as of June 28, 1999 (the"Option Agreement"); ---------------- WHEREAS, it is a condition precedent to the making of the Loan bySecured Party that Grantor shall have granted the security interests andundertaken the obligations contemplated by this Agreement; and WHEREAS, it is intended that the security interest granted hereundersecure the Loan until the closing of Grantor's purchase of the Property, atwhich time Grantor shall grant to Secured Party a second mortgage on theProperty, substantially in the form agreed to in the Letter Agreement (the"Second Mortgage"), after which this Agreement shall terminate.---------------- NOW, THEREFORE, in consideration of the premises and in order toinduce Secured Party to make the Loan and for other good and valuableconsideration, the receipt and adequacy of which are hereby conclusivelyacknowledged, Grantor hereby agrees with Secured Party as follows: SECTION 1. Grant and Pledge of Security. Grantor hereby assigns and ---------------------------- pledges to Secured Party, and hereby grants to Secured Party a security interestin, all of Grantor's right, title and interest in and to the following, whethernow or hereafter acquired (the "Pledged Collateral") the Option Agreement, ------------------ Pledged Options, and any interest of the Grantor in the entries on the books ofJ.Crew Group, Inc. or any financial intermediary pertaining to the PledgedOptions, and all dividends, cash, warrants, rights, instruments and otherproperty or proceeds from time to time received, receivable or otherwisedistributable in respect of or in exchange for any or all of the PledgedOptions. The Grantor shall deliver the original Option Agreement to the Secured Party and such Option Agreement shall remain in thepossession of the Secured Party until this Agreement is terminated, at whichtime, the Secured Party shall return the Option Agreement to the Grantor. SECTION 2. Security for Obligations. This Agreement secures, and the ------------------------ Pledged Collateral is collateral security for, all obligations of every natureof the Grantor now or hereafter existing under the Note and the Letter Agreement(all such obligations collectively, the "Secured Obligations"). ------------------- SECTION 3. No Assumption. Notwithstanding any of the foregoing, this ------------- Agreement shall not in any way be deemed to obligate Secured Party to assume anyof Grantor's obligations, duties, expenses or liabilities now existing orhereafter drafted or executed (collectively, the "Grantor Obligations") unless ------- ----------- Secured Party or any such purchaser otherwise expressly agrees to assume any orall of such Grantor Obligations in writing. SECTION 4. Further Assurances and Covenants of Grantor. Grantor ------------------------------------------- agrees that from time to time, at the expense of Grantor, Grantor will promptlyexecute and deliver all further instruments and documents, and take all furtheraction, that may be necessary or desirable, or that Secured Party may reasonablerequest, in order to perfect and protect any security interest granted orpurported to be granted hereby or to enable Secured Party to exercise andenforce its rights and remedies hereunder with respect to any PledgedCollateral. Grantor shall not, without the prior written consent of SecuredParty, which may be granted or withheld in Secured Party's sole discretion,sell, assign (by operation of law or otherwise), pledge or otherwise dispose ofor hypothecate all or any part of the Pledged Collateral. SECTION 5. Acceleration Event. In the case of an Acceleration Event, ------------------ as defined in the Note, in addition to all of Secured Party's other rights andremedies, Secured Party shall have the right, upon five days prior notice toGrantor, to cause J. Crew Group, Inc. to cancel all or any portion of thePledged Option and to apply the "Spread" (as defined below) on each of the ------ shares of Common Stock underlying the vested Pledged Option which Secured Partyelects to cancel as follows: (i) first to pay Secured Party's expenses(including reasonable attorney's fees) in connection with collection of theNote; (ii) second, to apply so much of the remaining Spread as may be necessaryto pay the unpaid principal of the Note; and (iii) third, to pay any remainingamount of the spread to Grantor. As used herein, the term "Spread" means thedifference obtained by subtracting the (a) exercise price per share underlyingthe Pledged Option, from (b) the Fair Market Value (as defined in the OptionPlan) of a share of J.Crew Group, Inc. Common Stock determined as of the date onwhich the Option is cancelled. SECTION 6. Substitution of Pledged Collateral. In accordance with ---------------------------------- the Letter Agreement, upon Grantor's execution and grant of the Second Mortgageon the Property and the recordation of such Second Mortgage, the PledgedCollateral hereunder shall be released to the Grantor and this Agreement shall terminate. SECTION 7. Continuing Security Interest; Transfer of Loan. This ---------------------------------------------- Agreement shall create a continuing security interest in the Pledged Collateraland shall (a) remain in full force and effect until the indefeasible payment infull of the Secured Obligations or granting and recordation of the SecondMortgage, (b) be binding upon Grantor, its 2 successors and assigns, and (c) inure, together with the rights and remedies ofSecured Party hereunder, to the benefit of Secured Party and its successors,transferees and assigns. Without limiting the generality of the foregoing clause(c), Secured Party may assign or otherwise transfer the Note to any otherPerson, and such other Person shall thereupon become vested with all thebenefits in respect thereof granted to Secured Party herein or otherwise. Uponthe indefeasible payment in full of all Secured Obligations or the granting byGrantor of the Second Mortgage on the Property (as described above), thesecurity interest granted hereby shall terminate and all rights to the PledgedCollateral shall revert to Grantor. SECTION 8. Amendments; Etc. No amendment, modification, termination --------------- or waiver of any provision of this Agreement, or consent to any departure byGrantor herefrom, shall in any event be effective unless the same shall be inwriting and signed by Secured Party, and, in the case of any such amendment ormodification by Grantor, such waiver or consent shall be effective only in thespecific instance and for the specific purpose for which it was given. SECTION 9. Notices. Any notice or other communication herein ------- required or permitted to be given hereunder shall be given in accordance withSection 4(d) of the Note. SECTION 10. Failure or Indulgence Not Waiver; Remedies Cumulative. ----------------------------------------------------- No failure or delay on the part of Secured Party in the exercise of any power,right or privilege hereunder shall impair such power, right, privilege or optionor be construed to be a waiver of any default or acquiescence therein, nor shallany single or partial exercise of any such power, right, privilege or optionpreclude any other or further exercise thereof or of any other power, right,privilege or option. All rights and remedies existing under this Agreement arecumulative to, and not exclusive of, any rights or remedies otherwise available. SECTION 11. Severability. In case any provision in or obligation ------------ under this Agreement shall be invalid, illegal or unenforceable in anyjurisdiction, the validity, legality and enforceability of the remainingprovisions or obligations, or of such provision or obligation in any otherjurisdiction, shall not in any way be affected or impaired thereby. SECTION 12. Headings. Section and subsection headings in this -------- Agreement are included herein for convenience of reference only and shall notconstitute a part of this Agreement for any other purpose or be given anysubstantive effect. SECTION 13. Governing Law; Terms. THIS AGREEMENT AND THE RIGHTS AND -------------------- OBLIGATIONS OF THE PARTIES HEREUNDER SHALL BE GOVERNED BY, AND SHALL BECONSTRUED AND ENFORCED IN ACCORDANCE WITH, THE LAWS OF THE STATE OF NEW YORK. SECTION 14. Consent to Jurisdiction and Service of Process. The ---------------------------------------------- provisions of Section 4(b) of the Note are hereby incorporated by reference in their entirety. SECTION 15. Waiver of Jury Trial. The provisions of Section 4(f) of -------------------- the Note are hereby incorporated by reference in their entirety. SECTION 16. Counterparts. This Agreement may be executed in one or ------------ more counterparts and by different parties hereto in separate counterparts, eachof which when so 3 executed and delivered shall be deemed an original, but all such counterpartstogether shall constitute but one and the same instrument; signature pages maybe detached from multiple separate counterparts and attached to a singlecounterpart so that all signature pages are physically attached to the samedocument. [Remainder of page intentionally left blank] 4 IN WITNESS WHEREOF, Grantor and Secured Party have caused thisAgreement to be duly executed and delivered by their respective officersthereunto duly authorized as of the date first written above.GRANTOR: Mark Sarvary, in his individual capacity By: ---------------------------- Name: Title: SECURED PARTY: J.Crew Operating Corp., a Delaware Corporation By: ---------------------------- Name: Title: 5 Exhibit 10.6 ------------ LETTER AGREEMENTSeptember 24, 1999Ms. Carol Sharpe6 Eno LaneWestport, CT 06880Dear Carol: Pursuant to our discussions and our letter dated March 23, 1999regarding your employment with J. Crew Operating Corp. (the "Company"), we ------- thought it would be useful to lay out the terms and conditions of our agreementin this letter agreement ("Agreement") for both parties to sign. --------- 1. Employment. (a) The Company hereby agrees to employ you as Senior Vice President -Merchandising and you hereby agree to serve the Company in such capacity duringthe "Employment Period" (as defined below). As Senior Vice President - ----------------- Merchandising, you will have merchandising responsibility for both men's andwomen's lines in retail. In the event that the Company decides, in its solediscretion, to reorganize around gender, you will have merchandisingresponsibility in all channels for either men's or women's lines, as determinedby the Company. You will report either to the Chief Executive Officer of theCompany or to a person immediately reporting to the Chief Executive Officer (a "span breaker"), as determined by the Company, provided that you shall have the------------- right to veto any individual candidate proposed by the Company to serve as aspan breaker between the Chief Executive Officer and you by notifying theCompany of your objection within five (5) days after the date you are notifiedof the candidate. (b) During the Employment Period, you shall devote your full business timeand energy, attention, skills and ability to the performance of your duties andresponsibilities as provided hereunder on an exclusive basis and shallfaithfully and diligently endeavor to promote the business and best interests ofthe Company. Accordingly, you may not, directly or indirectly, without theprior written consent of the Company, operate, participate in the management,operations or control of, or act as an employee, officer, consultant, agent orrepresentative of, any type of business or service (other than as an employee ofthe Company), provided that it shall not be a violation of the foregoing for youto (i) act or serve as a director, trustee or committee member of any civic orcharitable organization, and (ii) manage your personal, financial and legalaffairs, so long as such activities (described in clauses (i) or (ii)) do notinterfere with the performance of your duties and responsibilities to theCompany as provided hereunder.2. Employment Period. (a) The "Employment Period" shall commence as of April 30, 1999 (the ----------------- "Effective Date") and shall terminate ("Date of Termination") upon the earliest--------------- ------------------- to occur of (i) the fifth anniversary of the Effective Date, (ii) your death orDisability (as defined below), (iii) voluntary termination of employment by you, (iv) termination of employment by the Companywithout Cause (as defined below) or (v) termination of employment by the Companyfor Cause. (b) Upon termination of the Employment Period for any reason, you shall beentitled to any earned but unpaid Base Salary (as defined in Section 3(a) below)as of the Date of Termination. If the Company terminates the Employment Periodwithout Cause, you will be entitled to continuation of your Base Salary as ineffect immediately prior to such termination for a period of twelve (12) monthsafter the date of such termination (the "Salary Continuation Payments"), ---------------------------- provided that the Salary Continuation Payments are subject to and conditionedupon your execution of a valid general release and waiver (reasonably acceptableto the Company), waiving all claims that you may have against the Company, itssuccessors, assigns, affiliates, employees, officers and directors and yourcompliance with the Restrictive Covenants provided in Section 4 hereof. TheCompany shall have no additional obligations under this Agreement. (c) For purposes of this Agreement, the term "Cause" shall mean (i) the ----- commission of a felony, (ii) willful misconduct or gross negligence inconnection with the performance of your duties as an employee of the Company,(iii) a material breach of this Agreement, including without limitation yourfailure to perform your duties and responsibilities hereunder, (iv) a fraudulentact or omission by you adverse to the reputation of the Company or anyaffiliate, and (v) the disclosure by you of any Confidential Information (asdefined in Section 4(b) hereof) to persons not authorized to know same. Ifsubsequent to the termination of your employment, it is discovered that youremployment could have been terminated for Cause, your employment shall, at theelection of the Company, in its sole discretion, be deemed to have beenterminated for Cause. In addition, for purposes of this Agreement, the term "Disability" shall mean your incapacity due to physical or mental illness or----------- injury, which results in you being unable to perform your duties hereunder for aperiod of ninety (90) consecutive working days, and within thirty (30) daysafter the Company notifies you that your employment is being terminated forDisability, you shall not have returned to the performance of your duties on afull-time basis.3. Compensation and Benefits. (a) During the Employment Period, your annual base salary shall be $400,000("Base Salary") and shall be paid pursuant to regular Company payroll practices ----------- for the senior executives of the Company. The Base Salary will be reviewedannually by the Company. (b) In addition to the Base Salary, in each fiscal year during theEmployment Period, you will have the opportunity to earn an annual bonus ("Annual Bonus") at the following percentages of your Base Salary if the Company-------------- achieves certain performance objectives (which will be determined by the Companyfor each such fiscal year in accordance with the Company's bonus plan):Threshold - 25%, Target - 60% and Stretch - 120% of Base Salary. Any AnnualBonus (including the Guaranteed Bonus described below) will be paid only if youare actively employed with the Company and not in breach of this Agreement onthe date of payment (as described below). Notwithstanding the foregoing, withrespect to the fiscal year beginning January 31, 1999, your Annual Bonus will beat least $240,000 (the "Guaranteed Bonus") regardless of whether the performance ---------------- objectives for such fiscal year are achieved. The Annual Bonus will be paid nolater than May 1 following the fiscal year for which it relates. 2 (c) The Company has paid you $180,000 (the "First-Half Special Bonus") as ------------------------ consideration for entering into this Agreement. In addition, on or beforeAugust 31, 1999, the Company will pay you an additional $180,000 (the "Second- ------Half Special Bonus" and, together with the First-Half Special Bonus, the------------------ "Special Bonus"), provided that you are actively employed with the Company and-------------- not in breach of this Agreement on such date. You will be required toimmediately pay back a "pro-rata portion" as determined below of the SpecialBonus in the event you voluntarily terminate your employment hereunder prior toAugust 31, 2000, and to the extent that you fail to pay back any portion of theSpecial Bonus as provided herein, the Company shall have the right to offset anyother payments provided hereunder or otherwise owed to you in respect of suchamount. The "pro-rata portion" shall equal the product of (I) the sum of theFirst-Half Special Bonus and the Second-Half Special Bonus (if paid), and (ii) afraction, the numerator of which is the number of full months from and includingthe month in which the employment hereunder terminates through August 31, 2000,and the denominator of which is sixteen. (d) As soon as practicable after the Effective Date and subject to approvalof the Compensation Committee of the Board of Directors of J. Crew Group, Inc.,the Company will cause J. Crew Group, Inc. to grant you an option (the "Option") ------ to purchase twelve thousand (12,000) shares of common stock of J. Crew Group,Inc. (the "Common Stock") at an exercise price equal to $6.82 per share. Except ------------ as otherwise provided herein, the Option shall be governed by the terms andsubject to the conditions of the 1997 J. Crew Group, Inc. Stock Option Plan (the"Option Plan"), including the requirements regarding the execution of a Stock ----------- Option Grant Agreement and a Stockholders' Agreement. Twenty percent (20%) ofthe Option will become vested and exercisable on each of April 30, 2000 through2004, provided you are actively employed with the Company on such date. Subjectto the provisions of the Option Plan, with respect to the Option or any portionthereof which has not become exercisable, the Option shall expire on the dateyour employment with the Company is terminated for any reason, and with respectto any Option or any portion thereof which has become exercisable, the Optionshall expire on the earlier of: (i) 90 days after your termination of employmentwith the Company other than for Cause, death or Disability; (ii) one year aftertermination of your employment with the Company by reason of death orDisability; (iii) the commencement of business on the date your employment withthe Company is, or is deemed to have been, terminated for Cause; or (iv) thetenth anniversary of the Effective Date. (e) In addition to the Option granted hereunder, you currently hold optionsto purchase 25,000 shares of Common Stock, which were issued at an exerciseprice of $6.82 per share. If you are employed by the Company on April 30, 2003and not in breach of this Agreement, the Company will pay you an amount in cashequal to the Cash Payment, if any, determined in the manner described in ExhibitA hereto, not later than May 30, 2003. In general, the calculation described inExhibit A is intended to reflect our agreement that, as of April 30, 2003, thespread, with respect to options to purchase 34,600 shares of Common Stock,between the value of such shares and the exercise price of the options should beat least $32.50 per share, subject to adjustment to take into account sales orother dispositions of the shares by you prior to April 30, 2003. Any such CashPayment shall be in full satisfaction of the foregoing agreement. 3 (f) Given that the Cash Payment relates to the 34,600 shares of CommonStock (the "Option Shares") that you may acquire pursuant to the options ------------- described in Subparagraphs (d) and (e) above, if you actually acquired theOption Shares and then the Company exercised its call rights (the "Call") under ---- the Stockholders' Agreement (as provided under the Option Plan) with respect tothe Option Shares, it is possible that the Company would be required to paytwice for a portion of such Option Shares. Accordingly, if a Cash Payment ismade and the Fair Market Value per share of Common Stock on the date the Call isexercised is equal to or greater than the Fair Market Value per share as ofApril 30, 2003, notwithstanding anything herein or in Section 3 of suchStockholders' Agreement to the contrary, you hereby agree that the amount theCompany shall pay per Option Share pursuant to the Call (the "Call Price") shall ---------- equal the amount determined in accordance with Exhibit B hereto. (g) During the Employment Period, you will be entitled to participategenerally in the Company's benefit plans, except where specifically providedherein and except for any severance or other termination of employment plans.Currently, the Company's benefit package includes 3 weeks vacation, 3 personaldays, holidays, life insurance, medical insurance, long term disability, 401(k)tax deferred savings plan, a health flexible spending account, and the employeediscount. The Company reserves the right to change these benefits at any timein its sole discretion. (h) The Company will reimburse you for all reasonable business expensesupon the presentation of statements of such expenses in accordance with theCompany's policies and procedures now in force or as such policies andprocedures may be modified with respect to the senior executives of the Company.4. Restrictive Covenants. (a) As additional consideration for the Company entering into thisAgreement, you agree that for a period of twelve (12) months after the date onwhich the Employment Period is terminated for any reason, you shall not,directly or indirectly, (i) engage (either as owner, investor, partner,employer, employee, consultant or director) in or otherwise perform services forany Competitive Business (as defined below) which operates within a 100 mileradius of the location of any store of the Company or its affiliates or in thesame area as the Company directs its mail order operations or any other area inwhich the Company or any of its subsidiaries conducts business or in which theCompany or any of its subsidiaries' customers are located as of the Date ofTermination, provided that the foregoing restriction shall not prohibit you fromowning a passive investment of not more than 5% of the total outstandingsecurities of any publicly-traded company and (ii) solicit, hire, or seek toinfluence the employment decisions of, any employee of the Company on behalf ofany person or entity other than the Company. The term "Competitive Business" -------------------- means the retail, mail order and internet apparel and accessories business andany other business the Employer or its affiliates are engaged in on the Date ofTermination. (b) You agree that, during the Employment Period and thereafter, you willhold in strict confidence any proprietary or Confidential Information related tothe Company or its 4 affiliates. For purposes of this Agreement, the term "Confidential Information"shall mean all information of the Company and its affiliates in whatever formwhich is not generally known to the public, including without limitation,customer lists, trade practices, marketing techniques, fit specifications,design, pricing structures and practices, research, trade secrets, processes,systems, programs, methods, software, merchandising, planning, inventory andfinancial control, store design and staffing. (c) You also agree that breach of the confidentiality, non-competition oremployee non-solicitation provisions provided in paragraphs (a) or (b) of thisSection 4 would cause the Company to suffer irreparable harm for which moneydamages would not be an adequate remedy and therefore, if you breach any of theRestrictive Covenants provided in this Section 4, the Company will be entitledto an injunction restraining you from violating such restrictive covenant without the posting of any bond. If the Company shall institute any action orproceeding to enforce any such restrictive covenant, you hereby waive the claimor defense that the Company has an adequate remedy at law and you agree not toassert in any such action or proceeding the claim or defense that the Companyhas an adequate remedy at law. The foregoing shall not prejudice the Company'sright to require you to account for and pay over to the Company, and you herebyagree to account for and pay over, the compensation, profits, monies, accrualsand other benefits derived or received by you as a result of any transactionconstituting a breach of any of the Restrictive Covenants provided in thisSection 4. (d) You agree that during the Employment Period and thereafter you shallnot disclose any information regarding the existence or substance of thisAgreement to any third party (including employees of the Company) without theprior written consent of the Chairman of the Company except as may be requiredby law, during any legal proceeding brought by you relating to this Agreement orwith your professional advisers for purposes of discussing the subject matterhereof and, with respect to such professional advisers, you agree to inform themof your obligations hereunder and take all reasonable steps to ensure that suchprofessional advisers do not disclose the existence or substance hereof.Further, you agree not to directly or indirectly disparage or defame theCompany, its affiliates or any of their directors, officers or employees.5. Miscellaneous. (a) Any notice or other communication required or permitted under thisAgreement shall be effective only if it is in writing and shall be deemed to begiven when delivered personally or four days after it is mailed by registered orcertified mail, postage prepaid, return receipt requested or one day after it issent by a reputable overnight courier service and, in each case, addressed asfollows: If to the Company: J. Crew Operating Corp. 770 Broadway Twelfth Floor 5 New York, NY 10003 Attention: General Counsel If to you: Ms. Carol Sharpe 6 Eno Lane Westport, CT 06880or to such other address as any party hereto may designate by notice to theother, and shall be deemed to have been given upon receipt. (b) This Agreement constitutes the entire agreement between you and theCompany with respect to your employment by the Company, and supersedes and is infull substitution for any and all prior understandings or agreements withrespect to your employment, including without limitation the March 23, 1999letter agreement/term sheet. (c) This Agreement shall inure to the benefit of and be an obligation ofthe Company's assigns and successors; however you may not assign your duties andobligations hereunder to any other party. (d) No provision of this Agreement may be amended or waived, unless suchamendment or waiver is specifically agreed to in writing and signed by you andan officer of the Company duly authorized to execute such amendment. The failureby either you or the Company at any time to require the performance by the otherof any provision hereof shall in no way affect the full right to require such performance at any time thereafter, nor shall the waiver by you or the Companyof a breach of any provision hereof be taken or held to be a waiver of anysucceeding breach of such provision or a waiver of the provision itself or awaiver of any other provision of this Agreement. (e) You and the Company acknowledge and agree that each of you has reviewedand negotiated the terms and provisions of this Agreement and has had theopportunity to contribute to its revision. Accordingly, the rule ofconstruction to the effect that ambiguities are resolved against the draftingparty shall not be employed in the interpretation of this Agreement. Rather,the terms of this Agreement shall be construed fairly as to both parties and notin favor or against either party. (f) Any provision of this Agreement (or portion thereof) which is deemedinvalid, illegal or unenforceable in any jurisdiction shall, as to thatjurisdiction and subject to this Section, be ineffective to the extent of suchinvalidity, illegality or unenforceability, without affecting in any way theremaining provisions thereof in such jurisdiction or rendering that or any otherprovisions of this Agreement invalid, illegal, or unenforceable in any otherjurisdiction. If any covenant should be deemed invalid, illegal orunenforceable because its scope is considered excessive, such covenant shall bemodified so that the scope of the covenant is reduced only to the minimum extentnecessary to render the modified covenant valid, legal and 6 enforceable. No waiver of any provision or violation of this Agreement by theCompany shall be implied by the Company's forbearance or failure to take action. (g) The Company may withhold from any amounts payable to you hereunder allfederal, state, city or other taxes that the Company may reasonably determineare required to be withheld pursuant to any applicable law or regulation, (itbeing understood, that you shall be responsible for payment of all taxes inrespect of the payments and benefits provided herein). (h) This Agreement may be executed in several counterparts, each of whichshall be deemed an original, but all of which shall constitute one and the sameinstrument. (i) The headings in this Agreement are inserted for convenience ofreference only and shall not be a part of or control or affect the meaning ofany provision hereof. (j) This Agreement and all amendments thereof shall, in all respects, begoverned by and construed and enforced in accordance with the internal laws(without regard to principles of conflicts of law) of the State of NEW YORK.Each party hereto hereby agrees to and accepts the exclusive jurisdiction of anycourt in New York County or the U.S. District Court for the Southern District ofNew York in respect of any action or proceeding relating to the subject matterhereof, expressly waiving any defense relating to jurisdiction or forum non ---------conveniens, and consents to service of process by U.S. certified or registered---------- mail in any action or proceeding with respect to this Agreement. If the terms of this letter Agreement meet with your approval, pleasesign and return one copy to me. Sincerely, _____________________ Emily Woods Chairman Agreed to and Accepted: _____________________________Carol SharpeDate: ________________ 7 EXHIBIT A--------- GUARANTEED OPTION CASH PAYMENT FORMULA -------------------------------------- The Cash Payment, if any, provided in Section 3(e)hereof, shall be calculated as follows: CP = (X - SA) - (FMV x N) Where:CP = the Cash Payment, if any, provided under Section 3(e) hereof;X = $1,360,472;SA = the greater of (i) any proceeds received upon the actual or constructivesale or other disposition of any shares of Common Stock of the Company ("Sales -----Transactions") and (ii) $39.32 multiplied by the number of shares sold or------------ disposed of in the Sales Transaction;FMV = the greater of (i) $6.82 and (ii) the Fair Market Value per share ofCommon Stock as of April 30, 2003, as determined pursuant to the Option Plan;N = 34,600 less the number of shares of Common Stock sold in all SalesTransactions.In the event of an adjustment in the Options pursuant to Section 4.13 of theOption Plan, the foregoing amounts shall be equitably adjusted in a similarmanner in order to avoid the dilution or enlargement of rights or paymentshereunder. 8 EXHIBIT B--------- Call Price Formula ------------------ If the Fair Market Value per share of Common Stock (as determinedunder the Option Plan) on the date the Call is exercised is equal to or greaterthan the Fair Market Value per share on April 30, 2003, then the Call Price pershare in respect of the Option Shares shall equal: (the greater of Y or FMV1) - (CP/N)where,FMV1 = Fair Market Value per share on April 30, 2003; Y = $39.32;CP = The Cash Payment as determined under Exhibit A of this Letter Agreement;andN = The number of shares as determined under Exhibit A of this LetterAgreement. 9 Exhibit 21.1 ------------ SUBSIDIARIES OF THE REGISTRANT J. CREW GROUP, INC. State of Name Under WhichName of Subsidiary Incorporation Subsidiary Does Business------------------ ------------- ------------------------ J. Crew Operating Corp. Delaware J. Crew Operating Corp.J. Crew Inc. New Jersey J. Crew Inc.ERL, Inc. New Jersey ERL, Inc.Grace Holmes, Inc. Delaware (J. Crew Retail Stores)H.F.D. No. 55, Inc. Delaware (J. Crew Factory Outlet Stores)C & W Outlet, Inc. New York C & W Outlet, Inc.J. Crew International, Inc. Delaware J. Crew International, Inc.J. Crew Services, Inc. Delaware J. Crew Services, Inc.
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