J. Crew Group, Inc.
Annual Report 2002

Plain-text annual report

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 February 1, 2003Commission Registrant, State of Incorporation I.R.S. EmployerFile Number Address and Telephone Number Identification No.333-42427 J. CREW GROUP, INC. 22-2894486--------- ---------- (Incorporated in New York) 770 Broadway New York, New York 10003 Telephone: (212) 209-2500333-42423 J. CREW OPERATING CORP. 22-3540930--------- ---------- (Incorporated in Delaware) 770 Broadway New York, New York 10003 Telephone: (212) 209-2500 Securities Registered Pursuant to section 12(b) of the Act: J. Crew Group, Inc. None J. Crew Operating Corp. None Securities Registered Pursuant to section 12(g) of the Act: J. Crew Group, Inc. None J. Crew Operating Corp. NoneIndicate by check mark whether each registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements 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 each registrant's knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K. [X]The common stock of each registrant is not publicly traded. Therefore, theaggregate market value is not readily determinable. S-1As of March 15, 2003, there were 12,870,373 shares of Common Stock, par value$.01 per share, of J. Crew Group, Inc. outstanding and 100 shares of CommonStock, par value $.01 per share, of J. Crew Operating Corp. outstanding (all ofwhich are owned beneficially and of record by J. Crew Group, Inc.).Documents incorporated by reference: NoneJ. Crew Operating Corp. meets the conditions set forth in General Instruction(I)(1)(a) and (b) of the Form 10-K and is therefore filing this Form 10-K withthe reduced disclosure format.This combined Form 10-K is separately filed by each of J. Crew Group, Inc. andJ. Crew Operating Corp. The information contained herein relating to eachindividual registrant is filed by such registrant on its own behalf. Noregistrant makes any representation as to information relating to the otherregistrant. S-2FILING FORMATThis Annual Report on Form 10-K is a combined report being filed by twodifferent registrants: J. Crew Group, Inc. ("Holdings") and J. Crew OperatingCorp., a wholly-owned subsidiary of Holdings ("Operating Corp."). Except wherethe content clearly indicates otherwise, any references in this report to the"Company", "J. Crew" or "Holdings" include all subsidiaries of Holdings,including Operating Corp. Operating Corp. makes no representation as to theinformation contained in this report in relation to Holdings and itssubsidiaries other than Operating Corp.FORWARD LOOKING STATEMENTSCertain statements in this Annual Report on Form 10-K 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 Forms 10-Q, 8-K, etc., in press releasesand other written materials and in oral statements made by our officers,directors or employees to third parties. Statements that are not historicalfacts, including statements about our beliefs and expectations, areforward-looking statements. Such forward-looking statements involve known andunknown risks, uncertainties and other important factors that could cause theactual results, performance or achievements of the Company, or industry results,to differ materially 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, acts of war orterrorism in the United States or worldwide, political or financial instabilityin the countries where the Company's goods are manufactured, postal rateincreases, paper and printing costs, availability of suitable store locations atappropriate terms, the level of the Company's indebtedness and exposure tointerest rate fluctuations, and other risks and uncertainties described in thisreport and the Company's other reports and documents filed or which may befiled, from time to time, with the Securities and Exchange Commission. Thesestatements are based on current plans, estimates and projections, and thereforeyou should not place undue reliance on them. Forward looking statements speakonly as of the date they are made and we undertake no obligation to updatepublicly any of them in light of new information or future events.References herein to fiscal years are to the fiscal years of J. Crew Group, Inc.and J. Crew Operating Corp., which end on the Saturday closest to January 31 inthe following calendar year for fiscal years 1998, 1999, 2000, 2001 and 2002.Accordingly, fiscal years 1998, 1999, 2000, 2001 and 2002 ended on January 30,1999, January 29, 2000, February 3, 2001, February 2, 2002 and February 1, 2003.All fiscal years for which financial information is included had 52 weeks,except fiscal year 2000 which had 53 weeks.WEBSITE ACCESS TO COMPANY REPORTSThe Company's filings under the Securities Exchange Act of 1934 (includingannual reports on Form 10-K, quarterly reports on Form 10-Q, current reports onForm 8-K and all amendments to these reports) are available free of charge onour internet website at www.jcrew.com. These reports are available as soon asreasonably practicable after such material is electronically filed with orfurnished to the SEC. The reference to the Company's website address does notconstitute incorporation by reference of the information contained on thewebsite, and the information contained on the website is not part of thisdocument. Part I In this section, "we," "us" and "our" refer to Holdings and itssubsidiaries.General We are a leading retailer of women's and men's apparel, shoes, andaccessories sold under the "J. Crew" brand name. Started in 1983, we have builtand reinforced our brand name and image through the circulation of catalogs thatuse magazine-quality photography to portray a classic American perspective andaspirational lifestyle and the operation of our S-3stores and Internet website. We believe that the "J. Crew" brand name is widelyrecognized for its timeless styles at price points that represent exceptionalproduct value. We offer a full line of men's and women's clothing, includingbasic durables (casual weekend), workwear (casual weekday), swimwear, sport,accessories and shoes to meet our customers lifestyle needs. Many of theoriginal items introduced by us in the early 1980s (such as the rollnecksweater, weathered chino, barn jacket and pocket tee) were instrumental inestablishing the J. Crew brand and continue to be our core product offerings. J. Crew products are distributed exclusively through our retail andfactory stores, our catalog and our Internet website located at www.jcrew.com.As of February 1, 2003, we operated 152 retail stores and 42 factory outletstores in the United States. We believe that our customer base consistsprimarily of college-educated, professional and upscale customers who in ourexperience have demonstrated strong brand loyalty and a tendency to makerepeated purchases. In addition, J. Crew products are distributed through 50free-standing and shop-in-shop stores in Japan under a licensing agreement withItochu Corporation. We have three major operating divisions: J. Crew Retail, J. CrewDirect, and J. Crew Factory, each of which operate under the J. Crew brand name.In fiscal 2002, products sold under the J. Crew brand contributed $732.2 millionin revenues, comprised of: . $408.0 million from J. Crew Retail; . $248.0 million from J. Crew Direct; and . $76.2 million from J. Crew Factory. In addition, in fiscal 2002, we generated licensing revenues of $2.3million and shipping and handling revenues of $31.8 million. We refer you to "J.Crew Retail," "J. Crew Factory," "J. Crew Direct," "Trademarks and Licensing"and "Management's Discussion and Analysis of Financial Condition and Results ofOperations of Holdings." Holdings was incorporated in the State of New York in 1988. Ourprincipal executive offices are located at 770 Broadway, New York, NY 10003, andour telephone number is (202) 209-2500.Merchandising and Design Over time, the J. Crew merchandising strategy has evolved fromproviding unisex products to creating full lines of men's and women's clothing,shoes and accessories. This strategy had the effect of increasing overall J.Crew brand sales volume and significantly increasing revenues from sales ofwomen's apparel to 75% of J. Crew brand sales in 2002. All of our products are designed by an in-house design staff to reflecta classic, clean aesthetic that is consistent with our American lifestyle brandimage. Design teams are formed around J. Crew product lines and categories todevelop concepts, themes and products for each of our J. Crew businesses. Ourtechnical design team develop construction and fit specifications for everyproduct to ensure quality workmanship and consistency across product lines.These teams work in close collaboration with the merchandising, production andquality assurance staffs in order to gain market and other input and ensurequality of the J. Crew products.Sourcing and Production All of our merchandise is produced for us by a variety of manufacturersin over 22 countries. We do not own or operate any manufacturing facilities andinstead contract with third-party vendors for production of our merchandise. Infiscal 2002, approximately 80% of our merchandise was sourced in Asia, 5% wassourced in the United States and 15% was sourced in Europe and other regions.Any event causing a sudden disruption of manufacturing or imports from China,including the imposition of additional import restrictions, could have amaterial adverse impact on our operations. In addition, one vendor suppliesapproximately 16% of our merchandise, but we believe that the loss of thisvendor would not have a material adverse impact on our ability to source ourproducts. Substantially all of our foreign purchases are negotiated and paid forin U.S. dollars. S-4 We cannot predict whether any of the countries in which our merchandiseis currently produced or may be produced in the future will be subject toadditional trade restrictions imposed by the U.S. and other foreign governments,including the likelihood, type or effect of any such restrictions. Traderestrictions, including increased tariffs or quotas, against apparel and otheritems sold by us could increase the cost or reduce the supply of merchandiseavailable to us and adversely affect our business, financial condition andresults of operations. Our sourcing operations may also be adversely affected bypolitical and financial instability in any country in which our goods areproduced or acts of war or terrorism in the United States or worldwide to theextent these acts impact the production, shipment or receipt of merchandise.Sourcing operations may also be adversely affected by significant fluctuation inthe value of the U.S. dollar against foreign currencies or restrictions on thetransfer of funds.Distribution We operate two major customer contact and distribution facilities forour operations. Order fulfillment for J. Crew Direct takes place primarily at a406,500 square foot facility located in Lynchburg, Virginia. The Lynchburgfacility processes catalog and Internet website orders and serves as thedistribution center for our factory store operations. This facility employsapproximately 800 full and part-time employees during our non-peak season andadditional employees during our peak season. The main distribution center forour retail store operations and a back-up order taking facility for catalogorders is located in a 192,500 square foot facility in Asheville, NorthCarolina. This facility employs approximately 300 full- and part-time employeesduring our non-peak season and additional employees during our peak season.Orders for merchandise may be received by telephone, facsimile, mail and throughour Internet website. Each customer contact associate is trained to assistcustomers in determining the customer's correct size and describing merchandisefabric, texture and function. We believe that our fulfillment and distributionoperations are designed to process and ship customer orders in acustomer-friendly, quick, and cost-effective manner. In March 2003, we announced our plan to permanently close the customercontact department of the Asheville facility in May 2003. We ship merchandise via the United States Postal Service, Airborne andFedEx. To enhance efficiency, each facility is fully equipped with an advancedtelephone system, automated warehouse locator system and inventory bar codingsystem. In addition, our Lynchburg facility has automated packing and shippingsorters.Information Systems Our management information systems are designed to provide, among otherthings, comprehensive order processing, production, accounting and managementinformation for the marketing, manufacturing, importing and distributionfunctions of our business. We have point-of-sale registers in our retail andfactory outlet stores that enable us to track inventory from store receipt tofinal sale on a real-time basis. We believe our merchandising and financialsystems, coupled with our point-of-sale registers and software programs, allowfor rapid stock replenishment, concise merchandise planning and real-timeinventory accounting practices. Our telephone and telemarketing systems,warehouse package sorting systems, automated warehouse locator and inventory barcoding systems utilize advanced technology. These systems have provided us witha number of benefits in the form of enhanced customer service, improvedoperational efficiency and increased management control and reporting. Inaddition, our real-time inventory systems provide inventory management on astock keeping unit basis and allow for an efficient fulfillment process. We have installed a SAP enterprise resource planning system for ourinformation technology requirements. This system was implemented in fiscal years2000 and 2001. In fiscal 2000, our accounting systems were implemented. Acorporate-wide purchasing system, a retail sales and inventory system (includingnew point-of-sale registers) and a human resource and payroll system werecompleted in fiscal 2001. In November 2000, we outsourced our data center,desktop, network and telecommunication services management and operationssupport. In February 2001, we outsourced the hosting and support of our Internetwebsite to a third-party vendor.J. Crew Retail At February 1, 2003, we operated 152 retail stores throughout theUnited States, of which 16 stores were opened during fiscal 2002. These storesare located in upscale regional malls, lifestyle centers, shopping centers andstreet S-5locations. During fiscal 2002, J. Crew Retail generated revenues of $408.0million, representing 55.7% of our total revenues. An important aspect of our business strategy is an expansion programdesigned to reach new and existing customers through the opening of J. CrewRetail stores. As a result of the slowdown in the overall economic environmentand our declining comparable store sales trends for the last two years, we havedecided to restrict the number of new store openings in fiscal 2003 to four. Wedo not plan to close any retail stores in 2003. In addition to generating salesof J. Crew products, J. Crew Retail stores help set and reinforce the J. Crewbrand image. The stores are designed in-house and fixtured to create adistinctive J. Crew environment and store associates are trained to maintainhigh standards of visual presentation and customer service. Store locations aredetermined based on several factors, including the following: . geographic location; . demographic information; . anchor tenants in mall locations; and . proximity to other specialty retail stores in mall and street locations. J. Crew Retail stores that were open during all of fiscal 2002 averaged$2.8 million per store in sales, produced sales per gross square foot of $365and generated store contribution margins of approximately 14%. J. Crew Retailstores have an average size of 7,712 total square feet. The table below highlights certain information regarding J. Crew Retailstores opened through fiscal 2002. Stores Open Stores Stores At Beginning Opened Closed Stores Open Total Square Average of Fiscal During During at End of Footage (in Store SquareFiscal Year Year Fiscal Year Fiscal Year Fiscal Year thousands) Footage----------- -------------- ------------- ------------- ------------- -------------- -------------- 1998 ............................ 51 14 -- 65 530 8,1501999 ............................ 65 16 -- 81 668 8,2432000 ............................ 81 24 -- 105 833 7,9332001 ............................ 105 34 3 136 1,054 7,7522002 ............................ 136 16 -- 152 1,172 7,712J. Crew Direct J. Crew Direct consists of our catalog and Internet website operations.During fiscal 2002, J. Crew Direct generated $248.0 million in revenues(including $108.6 from the catalog and $139.4 million from the Internetwebsite), representing 33.9% of our total J. Crew revenues. We believe we have distinguished ourselves from other catalog retailersby our award-winning catalog which utilizes magazine-quality, "real moment"pictures to depict an aspirational lifestyle image. In fiscal 2002, wedistributed 32 catalog editions with a total circulation of approximately 66million and pages circulated of approximately 7.8 billion. This represented adecrease from fiscal 2001's total circulation of approximately 71 million andpages circulated of approximately 8.3 billion. J. Crew Direct's circulation strategy focuses on continually improvingthe segmentation of customer files and the acquisition of additional customernames. In fiscal 2002, approximately 65% of J. Crew Direct revenues were fromcustomers who have made a purchase from any J. Crew catalog or on the Internetin the prior 12 months. We segment our customer file and tailor our catalogofferings to address the different product needs of our customer segments. Toincrease core catalog productivity and improve the effectiveness of marginal andprospecting circulation, each customer segment is offered appropriate catalogeditions. We also acquire new names from various sources, including thefollowing: . our retail stores; . our Internet website; S-6 . list rentals; . exchanges with other catalog companies; and . "friend's names" card inserts. We are in the process of placing telephones in all of our J. Crew Retailstores with direct access to the J. Crew Direct telemarketing center to allowcustomers in the stores to order catalog-specific or out-of-stock items. All creative work on the catalogs is coordinated by J. Crew personnel tomaintain and reinforce the J. Crew brand image. Photography is executed both onlocation and in studios, and creative design and copy writing are executed on adesktop publishing system. Digital images are transmitted directly to outsideprinters, thereby reducing lead times and improving reproduction quality. Webelieve that appropriate page presentation of our merchandise stimulates demand,and therefore we place great emphasis on page layout. J. Crew Direct does not have long-term contracts with paper mills.Projected paper requirements are communicated on an annual basis to paper millsto ensure the availability of an adequate supply. Management believes that ourlong-standing relationships with a number of the largest coated paper mills inthe United States allow us to purchase paper at favorable prices commensuratewith our size. In 1996, we launched our Internet website located at www.jcrew.com, makingJ. Crew merchandise available to our customers over the Internet. In fiscal2002, the website logged over 41 million unique visitors and represents over 50%of the J. Crew Direct business. We design and operate our website using anin-house technical staff and our website emphasizes simplicity and ease ofcustomer use while integrating the J. Crew brand's aspirational lifestyleimagery used in the catalog. A significant aspect of our Internet marketingstrategy is to utilize an email program to generate repeat and new customers,and we deliver weekly marketing emails targeted to customers based upon certaindemographic and purchase transaction information.J. Crew Factory As of February 1, 2003, we operated 42 factory stores in the United States,which offer J. Crew merchandise at an average of 30% below retail prices. Thefactory stores target value-oriented customers and also serve to liquidateexcess, irregular or out-of-season J. Crew merchandise. During fiscal 2002, J.Crew Factory generated revenues of $76.2 million, representing 10.4% of ourtotal revenues. J. Crew Factory stores have an average size of 6,500 total square feet andare generally located in major regional outlet centers in 24 states across theUnited States. We believe that the factory stores, which are designed in-house,maintain fixturing, visual presentation and service standards comparable tothose typically associated with outlet stores.Trademarks and Licensing The "J. Crew" trademark and variations thereon, and certain othertrademarks, are registered or are subject to pending trademark applications withthe United States Patent and Trademark Office and with the registries of manyforeign countries. In addition, we license our "J. Crew" trademark to Itochu Corporation inJapan for which we receive royalty fees. Under the license agreement, we retaina high degree of control over the manufacture, design, marketing and sale ofmerchandise by Itochu Corporation under the J. Crew trademark. This agreementexpires in January 2005. In fiscal 2002, licensing revenues totaled $2.3million.Employees As of February 1, 2003, we had approximately 5,600 associates, of whomapproximately 1,800 were full-time associates and 3,800 were part-timeassociates. In addition, approximately 2,600 associates are hired on a seasonalbasis to meet demand during the peak season. None of our associates arerepresented by a union. We believe that our relationship with our associates isgood. S-7Competition All aspects of our business are highly competitive. We compete primarilywith specialty brand retailers, other catalog and Internet operations,department stores, and mass merchandisers that offer similar merchandise. Webelieve that the principal bases upon which we compete are quality, design,efficient service, selection and price. Many of our competitors aresubstantially larger, have a more established retail store presence andexperience and have greater financial, marketing and other resources than us.There is no assurance that we will be able to successfully compete with ourcompetitors in the future. In addition, our business is sensitive to a number offactors that could affect the level of consumer spending, including thefollowing: . adverse economic conditions; . the levels of disposable consumer income; . consumer confidence; and . interest rates. We have suffered a substantial loss of customer sales and traffic in therecent past and the continuation of this as well as further declines in thecurrent economic conditions and declines in consumer spending on apparel andaccessories could have a material adverse effect on our financial condition andoperating results.ITEM 2. PROPERTIES We are headquartered in New York City. The New York City headquarteroffices are leased under a lease agreement expiring in 2012, with an option torenew thereafter. We own two customer contact and distribution facilities: a406,500-square-foot customer contact and distribution center for J. Crew Directoperations in Lynchburg, Virginia and a 192,500-square-foot distribution centerin Asheville, North Carolina servicing the J. Crew Retail operations. In March2003, we announced our plan to permanently close the customer contact departmentof the Asheville facility in May 2003. As of February 1, 2003, we operated 152 J. Crew retail stores and 42factory stores in 38 states and the District of Columbia. All of the retail andfactory stores are leased from third parties, and the leases in most cases haveterms of 10 to 12 years, with options to renew for periods typically rangingfrom five to ten years. As a general matter, the leases contain standardprovisions concerning the payment of rent, events of default and the rights andobligations of each party. Rent due under the leases is generally comprised ofannual base rent plus a contingent rent payment based on the store's sales inexcess of a specified threshold. Substantially all of the leases are guaranteedby us. S-8 The table below sets forth the number of stores by state operated by us inthe United States as of February 1, 2003. Total ----- Retail Factory Number ------ ------- ------ Stores Stores Of Stores ------ ------ ---------Alabama 1 1 2Arizona 4 -- 4California 20 3 23Colorado 4 2 6Connecticut 5 1 6Delaware 1 1 2Florida 4 3 7Georgia 4 2 6Illinois 9 -- 9Indiana 2 2 4Kansas 1 -- 1Kentucky 1 -- 1Louisiana 1 -- 1Maine -- 2 2Maryland 3 1 4Massachusetts 6 2 8Michigan 6 1 7Minnesota 3 -- 3Missouri 2 1 3Nevada 1 -- 1New Hampshire 1 2 3New Jersey 9 1 10New Mexico 1 -- 1New York 15 4 19North Carolina 4 -- 4Ohio 7 -- 7Oklahoma 2 -- 2Oregon 2 -- 2Pennsylvania 7 3 10Rhode Island 1 - 1South Carolina 2 2 4Tennessee 3 1 4Texas 7 2 9Utah 2 -- 2Vermont 1 1 2Virginia 5 2 7Washington 2 1 3Wisconsin 1 1 2District of Columbia 2 -- 2 --- --- ---Total. 152 42 194 === === ===ITEM 3. LEGAL PROCEEDINGS Charles E. Hill & Associates, Inc., or Hill, filed a lawsuit on August 16,2002 in the U. S. District Court for the Eastern District of Texas against usand seventeen other defendants, primarily large retailers, alleging infringementof three patents registered to Hill relating to electronic catalog systems andmethods for processing data at a remote location and updating and displayingthat data. The suit seeks an injunction against continuing infringement,unspecified damages, including treble damages for willful infringement, andinterest, costs, expenses and fees. We believe that we have meritorious defensesand intend to defend ourselves vigorously. In addition, we are subject to various legal proceedings and claims thatarise in the ordinary conduct of our business. Although the outcome of theseother claims cannot be predicted with certainty, management does not believethat the ultimate resolution of these matters will have a material adverseeffect on our financial condition or results of operations. S-9ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERSNo matters were submitted to a vote of security holders during the quarter endedFebruary 1, 2003. PART IIITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERSThere is no established public trading market for Holdings or Operating Corp.Common Stock. As of March 15, 2003, there were 39 shareholders of record of theHoldings Common Stock. See "Item 12. Security Ownership of Certain BeneficialOwners and Management" for a discussion of the ownership of Holdings. Holdingsowns 100% of the Common Stock of Operating Corp.Holdings has not paid cash dividends on its Common Stock and does not anticipatepaying any such dividends in the foreseeable future. Operating Corp. may fromtime to time pay cash dividends on its Common Stock to permit Holdings to makerequired payments relating to its Senior Discount Debentures.The credit agreement (the "Credit Agreement") and the Indenture relating to theSenior Discount Debentures (the "Holdings Indenture") prohibit the payment ofdividends by Holdings on shares of Common Stock (other than dividends payablesolely in shares of capital stock of Holdings). Additionally, because Holdingsis a holding company, its ability to pay dividends is dependent upon the receiptof dividends from its direct and indirect subsidiaries. Each of the CreditAgreement, the Holdings Indenture and the Indenture relating to the SeniorSubordinated Notes of Operating Corp., contains covenants which imposesubstantial restrictions on Operating Corp.'s ability to pay dividends or makedistributions 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. In fiscal year 2002, certainDirectors elected to receive a total of 12,318 shares of Common Stock in paymentof their fees, at purchase price per share equal to the fair market valuethereof. Holdings issued the Common Stock to the Directors in transactions whichdid not involve any public offering in reliance upon Section 4(2) of theSecurities Act of 1933, as amended (the "Securities Act").Equity Compensation Plan InformationThe following table summarizes information about the Amended and Restated J.CrewGroup, Inc. 1997 Stock Option Plan and the J.Crew Group, Inc. 2003 EquityIncentive Plan (the "2003 Plan"), as of February 1, 2003. Our shareholders haveapproved both of these plans. (a) (b) (c) Number of Securites Number of Securities Remaining Available for to be Issued Upon Weighted Average Future Issuance Under Exercise of Exercise Price of Equity Compensation Plans Outstanding Options Outstanding Options, (Excluding Securites Plan Category Warrants and Rights Warrants and Rights Reflected in Column (a)) ------------- ------------------- ------------------- ------------------------ Equity CompensationPlans Approved byShareholders 4,474,469 $18.10 782,967Equity CompensationPlans Not Approved byShareholders 0 N/A 0 ---------- ------- --------TOTAL 4,474,469 $18.10 782,967 ========== ======= ======== S-10In addition to options, the 2003 Plan authorizes the issuance of restrictedstock of Holdings. The 2003 Plan contains a sub-limit of 1,450,724 shares on theaggregate number of shares of restricted Holdings Common Stock which may beissued.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 five fiscal years endedFebruary 1, 2003 are derived from the Consolidated Financial Statements of theCompany, which have been audited by KPMG LLP, independent auditors. The datapresented below should be read in conjunction with the Consolidated FinancialStatements, including the related Notes thereto, included herein, the otherfinancial information included herein, and "Management's Discussion and Analysisof Financial Condition and Results of Operations." S-11 Fiscal Year Ended January 30, January 29, February 3, February 2, February 1, ----------- ----------- ----------- ----------- ----------- 1999 2000 2001 2002 2003 ---- ---- ---- ---- ---- (dollars in thousands, except per square foot data) Income Statement Data: Revenues $ 870,842 $ 750,696 $ 825,975 $ 777,940 $ 766,382 Cost of goods sold(a) 511,716 431,193 463,909 462,371 478,700 Selling, general and administrative expenses 332,050 279,302 301,865 295,568 291,518 Other charges 7,995 7,018 -- -- -- Charges incurred in connection with discontinuance of Clifford & Wills 13,300 4,000 4,130 -- -- Income/(loss) from operations 5,781 29,183 56,071 20,001 (3,836) Interest expense-net 39,323 38,861 36,642 36,512 40,954 Gain on sale of Popular Club Plan (10,000) (1,000) -- -- -- Provision (benefit) for income taxes (8,162) (2,050) 7,500 (5,500) (4,200) --------- --------- --------- --------- --------- Net income (loss) $ (15,380) $ (6,628) $ 11,929 $ (11,011) $ (40,590) ========= ========= ========= ========= =========Balance Sheet Data (at period end): Cash and cash equivalents $ 9,643 $ 38,693 $ 32,930 $ 16,201 $ 18,895 Working capital 95,710 75,929 49,482 39,164 38,015 Total assets 376,330 373,604 389,861 401,320 348,878 Total long term debt and redeemable preferred stock 433,243 458,218 464,310 510,147 556,038 Stockholders' deficit $(235,773) $(264,593) $(278,347) $(319,043) $(391,663)Operating Data:Revenues:J. Crew retail $ 273,972 $ 333,575 $ 406,784 $ 397,998 $ 408,028J. Crew direct Catalog 230,752 213,308 177,535 135,353 108,531 Internet 22,000 65,249 107,225 122,844 139,456 --------- --------- --------- --------- --------- 252,752 278,557 284,760 258,197 247,987 --------- --------- --------- --------- ---------J. Crew factory 96,461 101,987 96,114 85,085 76,264J. Crew licensing 2,712 2,505 3,020 2,560 2,280J. Crew shipping & handling fees 30,575 34,072 35,297 34,100 31,823 --------- --------- --------- --------- ---------Total J. Crew brand 656,472 750,696 825,975 777,940 766,382Other divisions(b) 214,370 -- -- -- -- --------- --------- --------- --------- ---------Total $ 870,842 $ 750,696 $ 825,975 $ 777,940 $ 766,382 ========= ========= ========= ========= =========J. Crew Direct:Number of catalogs circulated (in thousands) 73,440 75,479 72,522 71,000 66,000Number of pages circulated (in millions) 8,819 9,319 8,677 8,300 7,800J. Crew Retail:Sales per gross square foot(c) $ 558 $ 571 $ 567 $ 439 $ 365Store contribution margin(c) 25.0% 26.0% 23.9% 18.0% 14.1%Number of stores open at end of period 65 81 105 136 152Comparable store sales change(c) 9.0% 1.8% 1.7% (15.5)% (10.4)%Depreciation and amortization $ 15,972 $ 19,241 $ 22,600 $ 31,718 $ 34,451Net capital expenditures(d)New store openings $ 14,749 $ 13,300 $ 16,700 $ 17,572 $ 11,400Other 21,605 27,953 25,475 25,003 9,018 --------- --------- --------- --------- ---------Total net capital expenditures $ 36,354 $ 41,253 $ 42,175 $ 42,575 $ 20,418 ========= ========= ========= ========= ========= S-12(a) Includes buying and occupancy costs.(b) Includes revenues from the Company's Popular Club Plan, Inc. ("PCP") and Clifford & Wills, Inc. ("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.ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS - J.CREW GROUP, INC.This discussion summarizes the significant factors affecting the consolidatedoperating results, financial condition and liquidity of J. Crew Group, Inc. andsubsidiaries during the three-year period ended February 1, 2003. Thisdiscussion should be read in conjunction with the audited consolidated financialstatements of J. Crew Group, Inc. and subsidiaries for the three-year periodended February 1, 2003 and notes thereto included elsewhere herein.Critical Accounting PoliciesManagement's discussion and analysis of financial condition and results ofoperations is based upon the consolidated financial statements which have beenprepared in accordance with accounting principles generally accepted in theUnited States. The preparation of these financial statements requires estimatesand judgements that effect the reported amounts of assets, liabilities, revenuesand expenses. The Company bases its estimates on historical experience and otherassumptions that are believed to be reasonable under the circumstances andevaluates these estimates on an on-going basis. Actual results may differ fromthese estimates under different assumptions or conditions.The following critical accounting policies reflect the more significantestimates and judgements used in the preparation of the consolidated financialstatements. (a) Inventory valuation Merchandise inventories are carried at the lower of average cost or market. We evaluate all of our inventories to determine excess inventories based on estimated future sales. Excess inventories may be disposed of through outlet stores, clearance catalogs, Internet clearance sales and other liquidations. Based on the historical results experienced by the Company through the various methods of disposition the Company writes down the carrying value of inventories which are not expected to be sold at or above costs. In March 2003 the Company decided to modify its strategy on the disposition of inventory to achieve inventory clearing at the end of each selling season. Under its previous disposition strategy, excess prior season inventories would have been carried over for sale in subsequent seasons. Under its new strategy, the Company will accelerate the disposition of these excess inventories through factory stores, Internet promotions, clearance catalogs and warehouse sales. These changes in the method and timing of inventory disposition are expected to result in a decrease in the amounts ultimately received for these inventories. Accordingly, the Company took additional inventory reserves of $9.0 million as of February 1, 2003. (b) Deferred catalog costs The costs associated with direct response advertising, which consist primarily of catalog production and mailing costs, are capitalized and amortized over the expected future revenue stream of the catalog mailings, which approximates four months. The expected future revenue stream is determined based on historical revenue trends developed over an extended period of time. If the current revenue streams were to diverge from the expected trend, the future revenue streams would be adjusted accordingly. (c) Asset impairment The Company is exposed to potential impairment if the book value of its assets exceeds their future cash flows. The major component of our long lived assets represents store fixtures, equipment and leasehold improvements. The impairment of unamortized costs is measured at the store level and the unamortized cost S-13 is reduced to fair value if it is determined that the sum of expected future net cash flows is less than net book value. (d) Sales returns The Company must make estimates of future sales returns related to current period sales. Management analyzes historical returns, current economic trends and changes in customer acceptance of its products when evaluating the adequacy of the reserve for sales returns. (e) Deferred income taxes The Company has significant deferred tax assets resulting from net operating loss carryforwards and deductible temporary differences, which will reduce taxable income in future periods. SFAS No. 109 "Accounting for Income Taxes" states that a valuation allowance is required when it is more likely than not that all or a portion of a deferred tax asset will not be realized. A review of all available positive and negative evidence needs to be considered, including a company's current and past performance, the market environment in which a company operates, length of carryback and carryforward periods, existing contracts or sales backlog that will result in future profits, etc. Forming a conclusion that a valuation allowance is not needed is difficult when there is negative evidence such as cumulative losses in recent years. Cumulative losses weigh heavily in the overall assessment. As a result of our assessment, we established a valuation allowance for the net deferred tax assets at February 1, 2003. The Company does not expect to recognize any tax benefit in future results of operations until an appropriate level of profitability is sustained.Results of OperationsConsolidated statements of operations presented as a percentage of revenues areas follows: Fiscal year ended February 1, February 2, February 3, 2003 2002 2001 ---- ---- ---- Revenues 100.0% 100.0% 100.0%Cost of goods sold, including buying and occupancy costs 62.5 59.4 56.2Selling, general and administrative expenses 38.0 38.0 36.5Charges incurred in connection with discontinuance of C&W -- -- .5Income/(loss) from operations (.5) 2.6 6.8Interest expense, net (5.3) (4.7) (4.4)Income/(loss) before income taxes (5.8) (2.1) 2.4Income taxes .5 .7 (.9) ----- ----- -----Net income/(loss) (5.3)% (1.4)% 1.5% ===== ===== =====Fiscal 2002 Compared to Fiscal 2001RevenuesRevenues in the fiscal year ended February 1, 2003 decreased 1.5% to $766.4million from $778.0 million in the fiscal year ended February 2, 2002.J. Crew Retail net sales increased by 2.5% from $398.0 million in fiscal 2001 to$408.0 million in fiscal 2002. The percentage of the Company's total net salesderived from J. Crew Retail increased to 55.7% in fiscal year 2002 compared to53.7% in fiscal 2001. The increase in net sales was due to net sales from storesopened for less than a full fiscal year. This increase was offset by a decreaseof 10.4% in comparable store sales. The decrease in comparable store sales wasprimarily attributable to a decrease in store traffic. There were 152 retailstores open at February 1, 2003 compared to 136 at February 2, 2002.J. Crew Direct net sales (which includes net sales from catalog and internetoperations) decreased by 4.0% from $258.2 million in fiscal 2001 to $248.0million in fiscal 2002. The percentage of the Company's total net sales derivedfrom J. Crew Direct decreased to 33.9% in fiscal 2002 from 34.8% in fiscal 2001.Catalog net sales decreased to $108.6 million in fiscal 2002 from $135.3 millionin fiscal 2001. Pages circulated decreased from 8.3 billion in fiscal 2001 to7.8 billion S-14in fiscal 2002. Internet net sales increased to $139.4 million in fiscal 2002from $122.9 million in fiscal 2001 as the Company continued to migrate catalogcustomers to the Internet.J.Crew Factory net sales decreased by 10.5% from $85.1 million in fiscal 2001 to$76.2 million in fiscal 2002. The percentage of the Company's total net salesderived from J. Crew Factory decreased to 10.4% in fiscal 2002 from 11.5% infiscal 2001. Comparable store sales for J. Crew Factory decreased by 14.1% infiscal 2002. There were 42 J. Crew Factory outlet stores open at February 1,2003 compared to 41 at February 2, 2002.Other revenues which consist of shipping and handling fees and royaltiesdecreased to $34.1 million in fiscal 2002 from $36.7 million in fiscal 2001,primarily as a result of a decrease in shipping and handling fees which isattributable to the decrease in net sales of J.Crew Direct.Cost of sales, including buying and occupancy costsCost of sales (including buying and occupancy costs) as a percentage of revenuesincreased to 62.5% in fiscal 2002 from 59.4% in fiscal 2001. This increase wascaused by a 130 basis point increase in buying and occupancy costs caused by adecrease in leverage related to the decline in comp store sales and a 180 basispoint decrease in merchandising margin due to markdowns taken to clearinventories in the fourth quarter which contributed to the improvement in ouryear-end inventory position compared to the prior year. The fourth quarter alsoincluded a $9,000,000 charge as a result of the Company's decision to modify itsstrategy on the disposition of inventory to accelerate inventory clearing at theend of each selling season.Selling, general and administrative expensesSelling, general and administrative expenses decreased to $291.5 million infiscal 2002 (38.0% of revenues) from $295.6 million in fiscal 2001 (38.0% ofrevenues).Selling expenses were $53.2 million in fiscal 2002 (6.9% of revenues) comparedto $60.8 million in fiscal 2001 (7.8% of revenues). This decrease was due to adecrease in pages circulated from 8.3 billion pages in fiscal year 2001 to 7.8billion pages in fiscal 2002 and a decrease in paper costs.General and administrative expenses increased to $238.3 million in fiscal 2002(31.0% of revenues) from $234.8 million in fiscal 2001 (30.2% of revenues). Thisincrease resulted from severance and other one-time employment related chargesof $13.7 million in fiscal year 2002 versus $3.2 million last year andadditional retail stores in operation in 2002 partially offset by the costreduction initiatives instituted in the first quarter of 2002.Interest expenseInterest expense, net was $41.0 million in fiscal year 2002 compared to $36.5million in fiscal 2001. The increase in interest expense resulted primarily from(a) an increase of $2.1 million relating to the 13-1/8% Senior Discount Notesand (b) an increase of $2.4 million in amortization of deferred financing costs,including $1.8 million written off in December 2002 related to the refinancingof the revolving credit arrangement with a new lender. Average borrowings underthe Revolving Credit Facility were $40.4 million in fiscal year 2002 compared to$43.1 million in fiscal 2001.Interest expense included non-cash interest and amortization of deferredfinancing costs of $16.7 million in fiscal 2002 compared to $17.4 million infiscal 2001. Interest expense related to the 13 1/8% Senior Discount Debenturesbecame cash pay commencing in October 2002 with the first semi-annual payment of$9.3 million due in April 2003.Income TaxesThe effective tax rate was a benefit of 9.4% in fiscal 2002 compared to abenefit of 33.3% in fiscal 2001. The lower effective rate in 2002 resulted fromthe non-recognition of a full tax benefit due to the establishment of avaluation allowance to reduce the net deferred tax assets to estimatedrecoverable amount at February 1, 2003. The Company does not expect to recognizeany tax benefits in future results of operations until an appropriate level ofprofitability is sustained. S-15Fiscal 2001 Compared to Fiscal 2000RevenuesRevenues in the fiscal year ended February 2, 2002 decreased 5.8% to $778.0million from $826.0 million in the fiscal year ended February 3, 2001. Thefiscal year ended February 2, 2002 consisted of 52 weeks compared to 53 weeks infiscal year 2000. Net sales for the fifty-third week were $10.8 million.J. Crew Retail net sales decreased by 2.2% from $406.8 million in fiscal 2000 to$398.0 million in fiscal 2001. The percentage of the Company's total net salesderived from J. Crew Retail increased to 53.7% in fiscal year 2001 compared to51.6% in fiscal 2000. The decrease in net sales was due to a decrease of 15.5%in comparable store sales. This decrease offset a 30% increase in the number ofstores from 105 at February 3, 2001 to 136 at February 2, 2002.J.Crew Direct net sales (which includes net sales from catalog and internetoperations) decreased by 9.3% from $284.8 million in fiscal 2000 to $258.2million in fiscal 2001. The percentage of the Company's total net sales derivedfrom J. Crew Direct decreased to 34.8% in fiscal 2001 from 36.2% in fiscal 2000.Catalog net sales decreased to $135.3 million in fiscal 2001 from $177.5 millionin fiscal 2000. Pages circulated decreased from 8.7 billion in fiscal 2000 to8.3 billion in fiscal 2001. Internet net sales increased to $122.9 million infiscal 2001 from $107.3 million in fiscal 2000 as the Company continued tomigrate catalog customers to the Internet.J.Crew Factory net sales decreased from $96.1 million in fiscal 2000 to $85.1million in fiscal 2001. The percentage of the Company's total net sales derivedfrom J. Crew Factory decreased to 11.5% in fiscal 2001 from 12.2% in fiscal2000. Comparable store sales for J. Crew Factory decreased by 10.5% in fiscal2001. There were 41 J. Crew Factory outlet stores at February 2, 2002 andFebruary 3, 2001.Other revenues which consist of shipping and handling fees and royaltiesdecreased to $36.7 million in fiscal 2001 from $38.3 million in fiscal 2000,primarily as a result of a decrease in shipping and handling fees which isattributable to the decrease in net sales of J.Crew Direct.Cost of sales, including buying and occupancy costsCost of sales (including buying and occupancy costs) as a percentage of revenuesincreased to 59.4% in fiscal 2001 from 56.2% in fiscal 2000. This increase wascaused by a significant increase in markdowns as a result of the highlypromotional retail environment and an increase in buying and occupancy costscaused by a decrease in leverage related to the decline in comp store sales.Selling, general and administrative expensesSelling, general and administrative expenses decreased to $295.6 million infiscal 2001 (38.0% of revenues) from $301.9 million in fiscal 2000 (36.6% ofrevenues).General and administrative expenses of the J.Crew brand decreased to $234.8million in fiscal 2001 (30.2% of revenues) from $239.2 million in fiscal 2000(29.0% of revenues). This decrease resulted from a decrease in bonus provisionin fiscal 2001 and the cost cutting initiatives instituted in the first quarterof 2001 which were offset by the additional retail stores in operation duringfiscal 2001 and a $10.1 million increase in depreciation and amortization.Selling expenses were $60.8 million in fiscal 2001 (7.8% of revenues) comparedto $62.7 million in fiscal 2000 (7.6% of revenues). This decrease was due to adecrease in pages circulated from 8.7 billion pages in fiscal year 2000 to 8.3billion pages in fiscal 2001.Interest expenseInterest expense, net was $36.5 million in fiscal year 2001 compared to $36.6million in fiscal 2000. The increase resulting from higher average borrowings infiscal 2001 under the Revolving Credit Facility and higher non-cash interest wasoffset by the pay off of the term loan in January 2001 and a decrease ininterest rates. Average borrowings under the Revolving Credit Facility requiredto fund inventories and capital expenditures were $43.1 million in fiscal 2001compared to $9.8 million in fiscal 2000. S-16Interest expense included non-cash interest and amortization of deferredfinancing costs of $17.4 million in fiscal 2001 compared to $16.4 million infiscal 2000.Income TaxesThe effective tax rate was a benefit of 33.3% in fiscal 2001 compared to aprovision of 38.6% in fiscal 2000. The effective rate in 2001 was less than thenormal rate due primarily to the inability of subsidiaries to carry back netoperating losses for state tax purposes.Liquidity and Capital ResourcesThe Company's sources of liquidity have been primarily cash flows fromoperations and borrowings under the Revolving Credit Facility. The Company'sprimary cash needs have been for capital expenditures incurred primarily foropening new stores and system enhancements, debt service requirements andworking capital.On December 23, 2002 the Company entered into a Loan and Security Agreement withWachovia Bank, N.A., as arranger, Congress Financial Corporation, asadministrative and collateral agent, and a syndicate of lenders which providesfor maximum credit availability of up to $180.0 million (the "Congress CreditFacility"). The Congress Credit Facility replaced a revolving credit facilitywhich was scheduled to expire in October 2003. The Congress Credit Facilityprovides for revolving loans of up to $160.0 million; supplemental loans of upto $20.0 million each year during the period from April 15 to September 15; andletter of credit accommodations. The Congress Credit Facility expires inDecember 2005. The total amount of availability is subject to limitations basedon specified percentages of eligible receivables, inventories and real property.The Congress Credit Facility includes restrictions, including the incurrence ofadditional indebtedness, the payment of dividends and other distributions, themaking of investments, the granting of loans and the making of capitalexpenditures. The Company is required to maintain minimum levels of earningsbefore interest, taxes, depreciation, amortization and certain non-cash items,("EBITDA") if excess availability is less than $15.0 million for any 30consecutive day period.Cash provided by operating activities was $24.7 million in fiscal 2002 comparedto $25.8 million in fiscal 2001. The increase in net loss in 2002 was offset byan improvement in working capital, primarily a $31.6 million decrease ininventories, net of an $11.8 million decrease in accounts payable.Capital expenditures, net of construction allowances, were $20.4 million infiscal 2002 compared to $42.6 million in fiscal 2001. Capital expenditures in2002 related primarily to the opening of 16 retail stores during the year.Capital expenditures in 2001 related primarily to the opening of 34 retailstores and for systems enhancements, primarily the SAP enterprise resourceplanning system.Capital expenditures are expected to be approximately $10.0 million in fiscal2003, primarily for the opening of four retail stores. The expected capitalexpenditures will be funded from internally generated cash flows and byborrowings from available financing sources.There were no borrowings under the Revolving Credit Facility at February 1, 2003and February 2, 2002. Average borrowings under the Revolving Credit Facilitywere $40.4 million for fiscal 2002 and $43.1 million for fiscal 2001.Effective October 15, 2002, the interest payments accruing on the 13 1/8% SeniorDiscount Debentures became payable in cash on April 15 and October 15 of eachyear subsequent thereto. The annual cash payments will be approximately $18.6million. On April 4, 2003, Holdings commenced through J. Crew Intermediate LLC,its newly formed wholly-owned subsidiary ("Intermediate"), an offer to exchangethe outstanding 13 1/8% Senior Discount Debentures due 2008 issued by Holdingsfor Intermediate's unissued 16.0% Senior Discount Contingent Principal Notes due2008.Holdings will not pay accrued and unpaid interest on the existing debentures onthe scheduled interest payment date of April 15, 2003. Rather, Holdings will paysuch interest on the settlement date of the exchange offer (which is expected tooccur on or about May 6, 2003) together with interest thereon at a rate of13 1/8% per annum from April 15, 2003 to the settlement date, to the holders ofthe existing debentures who do not tender their existing debentures in theexchange offer. S-17Management believes that cash flow from operations and availability under theCongress Credit Facility will provide adequate funds for the Company'sforeseeable working capital needs, planned capital expenditures and debt serviceobligations. The Company's ability to fund its operations and make plannedcapital expenditures, to make scheduled debt payments, to refinance indebtednessand to remain in compliance with the financial covenants under its debtagreements depends on its future operating performance and cash flow, which inturn, are subject to prevailing economic conditions and to financial, businessand other factors, some of which are beyond its control.Contractual Obligations And Other Commercial CommitmentsThe following summarizes the Company's contractual and other commercialobligations as of February 1, 2003 and the effect such obligations are expectedto have on its liquidity and cash flows in future periods.Contractual Obligations Within 1 year 2 - 3 years 4 - 5 years after 5 years Total----------------------- ------------- ----------- ----------- ------------- ----- ($ in millions) Long term debt $ -- $ -- $ 150.0 $ 142.0 $ 292.0Operating lease obligations 52.4 97.3 88.8 143.9 382.4Inventory purchase commitments 110.2 -- -- -- 110.2 ------- ------- ------- -------- ------- $ 162.6 $ 97.3 $ 238.8 $ 285.9 $ 784.6 ======= ======= ======= ======== =======Other commercial commitments Within 1 year 2 - 3 years 4 - 5 years after 5 years Total---------------------------- ------------- ----------- ----------- ------------- ----- Letters of Credit Stand by $ .7 $ -- $ -- $ 1.9 $ 2.6 Import 43.3 -- -- -- 43.3 ------- ------- ------- -------- ------- $ 44.0 $ -- $ -- $ 1.9 $ 45.9 ======= ======= ======= ======== =======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 32% of annual net sales in fiscal 2002 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.MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS - J.CREW OPERATING CORP.This discussion should be read in conjunction with the audited consolidatedfinancial statement of J.Crew Operating Corp. and subsidiaries for the two yearperiod ended February 1, 2003 and notes thereto included elsewhere in thisAnnual Report on Form 10-K. S-18Results of OperationsFiscal 2002 Compared to Fiscal 2001RevenuesRevenues in the fiscal year ended February 1, 2003 decreased 1.5% to $766.4million from $778.0 million in the fiscal year ended February 2, 2002.J. Crew Retail net sales increased by 2.5% from $398.0 million in fiscal 2001 to$408.0 million in fiscal 2002. The percentage of the Company's total net salesderived from J. Crew Retail increased to 55.7% in fiscal year 2002 compared to53.7% in fiscal 2001. The increase in net sales was due to net sales from storesopened for less than a full fiscal year. This increase was offset by a decreaseof 10.4% in comparable store sales. The decrease in comparable store sales wasprimarily attributable to a decrease in store traffic. There were 152 retailstores open at February 1, 2003 compared to 136 at February 2, 2002.J. Crew Direct net sales (which includes net sales from catalog and internetoperations) decreased by 4.0% from $258.2 million in fiscal 2001 to $248.0million in fiscal 2002. The percentage of the Company's total net sales derivedfrom J. Crew Direct decreased to 33.9% in fiscal 2002 from 34.8% in fiscal 2001.Catalog net sales decreased to $108.6 million in fiscal 2002 from $135.3 millionin fiscal 2001. Pages circulated decreased from 8.3 billion in fiscal 2001 to7.8 billion in fiscal 2002. Internet net sales increased to $139.4 million infiscal 2002 from $122.9 million in fiscal 2001 as the Company continued tomigrate catalog customers to the Internet.J.Crew Factory net sales decreased from $85.1 million in fiscal 2001 to $76.2million in fiscal 2002. The percentage of the Company's total net sales derivedfrom J. Crew Factory decreased to 10.4% in fiscal 2002 from 11.5% in fiscal2001. Comparable store sales for J. Crew Factory decreased by 14.1% in fiscal2002. There were 42 J. Crew Factory stores open at February 1, 2003 compared to41 at February 2, 2002.Other revenues which consist of shipping and handling fees and royaltiesdecreased to $34.1 million in fiscal 2002 from $36.7 million in fiscal 2001,primarily as a result of a decrease in shipping and handling fees which isattributable to the decrease in net sales of J.Crew Direct.Cost of sales, including buying and occupancy costsCost of sales (including buying and occupancy costs) as a percentage of revenuesincreased to 62.5% in fiscal 2002 from 59.4% in fiscal 2001. This increase wascaused by a 130 basis point increase in buying and occupancy costs caused by adecrease in leverage related to the decline in comp store sales and an 180 basispoint decrease in merchandising margin due to markdowns taken to clearinventories in the fourth quarter which contributed to the improvement in ouryear-end inventory position compared to the prior year. The fourth quarter alsoincluded a $9,000,000 charge as a result of the Company's decision to modify itsstrategy on the disposition of inventory to accelerate inventory clearing at theend of each selling season.Selling, general and administrative expensesSelling, general and administrative expenses decreased to $291.1 million infiscal 2002 (38.0% of revenues) from $294.9 million in fiscal 2001 (37.9% ofrevenues).Selling expenses were $53.2 million in fiscal 2002 (6.9% of revenues) comparedto $60.8 million in fiscal 2001 (7.8% of revenues). This decrease was due to adecrease in pages circulated from 8.3 billion pages in fiscal year 2001 to 7.8billion pages in fiscal 2002 and a decrease in paper costs.General and administrative expenses increased to $237.9 million in fiscal 2002(31.0% of revenues) from $234.1 million in fiscal 2001 (30.1% of revenues). Thisincrease resulted from severance and other one-time employment related chargesof $13.7 million in fiscal year 2002 versus $3.2 million last year andadditional retail stores in operation in 2002 partially offset by the costreduction initiatives instituted in the first quarter of 2002. S-19Interest expenseInterest expense, net was $23.4 million in fiscal year 2002 compared to $20.9million in fiscal 2001. The increase in interest expense resulted primarily froman increase of $2.5 million in amortization of deferred financing costs,including $1.8 million related to the old revolving credit arrangement whichwere written off in December 2002. Average borrowings under the Revolving CreditFacility were $40.4 million in fiscal year 2002 compared to $43.1 million infiscal 2001.Income TaxesThe effective tax rate was a benefit of 66.8% in fiscal 2002 compared to abenefit of 73.2% in fiscal 2001. The benefit in 2002 resulted from the reversalof prior year tax accruals, whereas the 2001 effective rate was effected by thelow dollar amount of pre-tax income.Factors Affecting Future Results of OperationsWe must successfully gauge fashion trends and changing consumer preferences tosucceed.We believe that our success depends in substantial part on our ability tooriginate and define product and fashion trends as well as to anticipate, gaugeand react to changing consumer demands in a timely manner. There can be noassurance that we will be successful in this regard. We attempt to reduce therisks of changing fashion trends and product acceptance by devoting asubstantial portion of our product line to basic durables which are notsignificantly modified from year to year. Nevertheless, if we misjudge themarket for our products, we may be faced with significant excess inventories forsome products and missed opportunities with others.The fashion and apparel industry is highly competitive.The fashion and apparel industry is highly competitive. We compete primarilywith other catalog operations, specialty brand retailers, department stores,mass merchandisers and Internet businesses that engage in the retail sale ofmen's and women's apparel, accessories footwear and general merchandise. Webelieve that the principal bases upon which we compete are quality, design,efficient service, selection and price. However, many of our competitors arelarger and have greater financial, marketing and other resources, and there canbe no assurance that we will be able to compete successfully with them in thefuture. We have lost market share to some of our competitors in the recent past,and we may not recover that share and could also lose additional market share inthe future if we do not strengthen our competitive position.Competition for qualified personnel is intense in the fashion and apparelindustry.Our ability to anticipate and effectively respond to changing fashion trendsdepends in part on our ability to attract and retain key personnel in ourdesign, merchandising and marketing staff. Competition for these personnel isintense, and there can be no assurance that we will be able to attract andretain a sufficient number of qualified personnel in the future. Our futureperformance depends, in substantial part, on the performance of our newmanagement team implemented in January 2003. We rely, in particular, on thestrategic guidance of Millard S. Drexler, our Chief Executive Officer, andJeffrey A. Pfeifle, our President. The loss, for any reason, of the services ofeither of these individuals could have a material adverse effect on us.The fashion and apparel industry is cyclical and further decline in consumerspending on apparel and accessories could have an adverse effect on our resultsof operation.The industry in which we operate is cyclical. Purchases of apparel and relatedmerchandise is sensitive to a number of factors that influence the levels ofgeneral consumer spending, including economic conditions and the level ofdisposable consumer income, consumer debt, interest rates and consumerconfidence. The recent and current recessionary economic environment has had anegative impact on our sales and has contributed to a higher level ofpromotional sales activities, which have adversely affected our profitability.The war in Iraq or acts of terrorism in the United States or world wide S-20may prolong the current recessionary economic environment. A further decline inconsumer spending on apparel and accessories could have an adverse effect on ourfinancial condition and results of operations.Increase in costs of mailing, paper and printing will have an adverse effect onour results of operations.Postal rate increases and paper and printing costs affect the cost of ourcatalog and promotional mailings. We rely on discounts from the basic postalrate structure, such as discounts for bulk mailings and sorting by zip code andcarrier routes. We are not a party to any long-term contracts for the supply ofpaper. Our cost of paper has fluctuated significantly, and our future papercosts are subject to supply and demand forces external to our business.Consequently, there can be no assurance that we will not be subject to anincrease in paper costs. Future increases in postal rates or paper or printingcosts would have a negative impact on our earnings to the extent that we areunable to pass such increases directly to customers or offset such increases byraising selling prices or by implementing more efficient mailings.We rely on foreign sourcing and are subject to a variety of risks associatedwith doing business abroad.In fiscal 2002, approximately 95% of our merchandise was sourced fromindependent foreign factories located primarily in Asia, and many of ourdomestic vendors import a substantial portion of their merchandise from abroad.Any event causing a sudden disruption of manufacturing or imports from China,including the imposition of additional import restrictions, could have amaterial adverse impact on our operations. We have no long-term merchandisesupply contracts, and many of our imports are subject to existing or potentialduties, tariffs or quotas that may limit the quantity of certain types of goodsthat may be imported into the United States from countries in those regions. Wecompete with other companies for production facilities and import quotacapacity. Our business is also subject to a variety of other risks generallyassociated with doing business abroad, such as political instability, currencyand exchange risks and potential local issues. Trade restrictions, includingincreased tariffs or quotas, against apparel and other items sold by us couldincrease the cost or reduce the supply of merchandise available to us andadversely affect our business, financial condition and results of operations.Our sourcing operations may also be adversely affected by political andfinancial instability in any country in which our goods are produced or acts ofwar or terrorism in the United States or worldwide to the extent these actsimpact the production, shipment or receipt of merchandise. Our futureperformance will be subject to such factors, which are beyond our control, andthere can be no assurance that such factors would not have a material adverseeffect on our financial condition and results of operations.We require our licensing partner and independent manufacturers to operate incompliance with applicable laws and regulations. While our internal and vendoroperating guidelines promote ethical business practices, we do not control suchmanufacturers or their labor practices. Violation of labor or other laws by ourindependent manufacturers or our licensing partner, or the divergence of anindependent manufacturer's or our licensing partner's labor practices from thosegenerally accepted as ethical in the United States, could have a materialadverse effect on our financial condition and results of operations if, as aresult of such violation, we were to incur substantial liability or attractnegative publicity that damaged our brand.Success of J.Crew Retail growth strategy remains uncertain.We intend to expand our base of J.Crew retail stores as part of our growthstrategy. There can be no assurance that this strategy will be successful. Oursuccess depends, in part on our ability to improve sales and margins in ourstores. Actual number and type of such stores to be opened and their successwill be dependent upon a number of factors, including, among other things, theability to manage such expansion and hire and train qualified associates, theavailability of suitable store locations and the negotiation of acceptable leaseterms for new locations and upon lease renewals for existing locations. Therecan be no assurance that we will be able to open and operate new stores on atimely or profitable basis. We believe that the opening of J.Crew retail storeshas diverted some revenues from the J.Crew Direct operations. There can be noassurance that future store openings will not continue to have such an effect.Our quarterly results of operations fluctuate significantly due to seasonalityand a variety of other factors.We experience seasonal fluctuations in revenues and operating income, with adisproportionate amount of our revenues and a majority of our income fromoperations typically realized during the fourth quarter of each fiscal year.Revenues and income from operations are generally weakest during the first andsecond quarters of each fiscal year. Our quarterly results of operations mayalso fluctuate significantly as a result of variety of other factors, includingthe timing of new S-21store openings and of catalog mailings, and the revenues contributed by newstores, merchandise mix and the timing and level of markdowns.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 Congress Credit Facility. The interest rates are a functionof the bank prime rate or LIBOR. A one percentage point change in the baseinterest rate would result in approximately $400,000 change in income beforetaxes.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 February 1, 2003 were approximately$45.9 million.The Company has a licensing agreement in Japan which provides for royaltypayments based on sales of J. Crew merchandise as denominated in yen. TheCompany has from time to time entered into forward foreign exchange contracts tominimize this risk. There were no forward foreign exchange contracts outstandingduring fiscal year 2002.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. S-22 PART IIIInformation required by items 10 - 14 with respect to Operating Corp. has beenomitted pursuant to General Instruction I of Form 10-K. Information required byitems 10 -14 with respect to Holdings is described below.ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANTThe following table sets forth the name, age and position of individuals who areserving as directors and executive officers of Holdings as of April 1, 2003.Each director of Holdings will hold office until the next annual meeting ofshareholders or until his or her successor has been elected and qualified.Officers are elected by the Board of Directors and serve at the discretion ofthe Board.Name Age Position---- --- -------- Millard S. Drexler ................... 58 Chief Executive Officer, Chairman of the Board and DirectorJeffrey A. Pfeifle ................... 44 PresidentKathy Boyer .......................... 54 Executive Vice President, MerchandisingMichael Dadario ...................... 44 Executive Vice President, StoresScott M. Rosen ....................... 44 Executive Vice President, Chief Financial OfficerScott Gilbertson ..................... 34 Chief Operating OfficerScott D. Hyatt ....................... 45 Senior Vice President, ManufacturingNicholas Lamberti .................... 60 Vice President, Corporate ControllerRichard W. Boyce ..................... 48 DirectorJonathan J. Coslet ................... 38 DirectorJames G. Coulter ..................... 43 DirectorSteven Grand-Jean .................... 60 DirectorThomas W. Scott ...................... 37 DirectorJosh S. Weston ....................... 74 DirectorEmily Woods .......................... 41 Director Millard S. Drexler Mr. Drexler has been Chief Executive Officer since January 2003 and becameChairman of the Board and a Director in March 2003. Before joining Holdings, hewas Chief Executive Officer of The Gap, Inc. from 1995 until September 2002, andprior thereto he was President of The Gap, Inc. since 1987. Mr. Drexler alsoserves as a director of Apple Computer Inc. Jeffrey A. Pfeifle Mr. Pfeifle has been President since February 2003. Before joiningHoldings, he was Executive Vice President, Product and Design of the Old Navydivision of The Gap, Inc. from 1995. Kathy Boyer Ms. Boyer has been Executive Vice President, Merchandising since June 2002.Before joining Holdings, she was Senior Vice President, Merchandising of theBanana Republic division of The Gap, Inc. from 1995 to September 2001. Michael Dadario Mr. Dadario has been Executive Vice President, Stores since January 2003.Before joining Holdings, he was a retail consultant with Sense Consulting fromFebruary 2000 until end of 2002 and Executive Vice President (retail storeoperations) of the Banana Republic division of The Gap, Inc. for more than fiveyears. S-23 Scott M. Rosen Mr. Rosen has been Executive Vice President and Chief Financial Officersince 1999. He was Senior Vice President and Chief Financial Officer from 1998to 1999 and prior thereto he was Chief Financial Officer of the Mail OrderDivision for four years. Scott Gilbertson Mr. Gilbertson has been Chief Operating Officer since January 2003. Beforejoining Holdings, he was a principal of Texas Pacific Group from January 2001 toJanuary 2003 and a portion of 1998. He was a founding partner of eVolutionGlobal Partners (a private venture capital company) from March 2000 to January2001 and held various positions at Holdings from September 1998 to April 2000,including President of e-commerce. Scott D. Hyatt Mr. Hyatt has been Senior Vice President, Manufacturing since 1998. Beforejoining Holdings, he was Vice President, Production and Source of the Expressdivision of Limited Brands (retail apparel company) from 1996 to 1998. Nicholas Lamberti Mr. Lamberti has been Vice President, Corporate Controller for more thanfive years. Richard W. Boyce Mr. Boyce became a director in 1997 and has served as Chief ExecutiveOfficer during portions of 1997 and 1999 while also providing operatingoversight to the remainder of the Texas Pacific Group portfolio. He is thesenior operating partner of Texas Pacific Group and joined Texas Pacific Groupin 1997. He was Chairman of Favorite Brands International Holding Corp., whichfiled for protection under Chapter 11 of the Bankruptcy Code in 1999. He is alsoa director of Burger King Corp., ON Semiconductor Corporation and Spirit GroupHoldings, Ltd. Jonathan J. Coslet Mr. Coslet became a director in 2003. He is a senior partner of TexasPacific Group, responsible for the firm's generalist and healthcare investmentactivities. Prior to joining Texas Pacific Group, Mr. Coslet worked in theinvestment banking department of Donaldson, Lufkin & Jenrett, specializing inleveraged acquisitions and high-yield finance from 1991 to 1993. He is adirector of Magellan Health Services, Inc., Oxford Health Plans, Inc., PetcoAnimal Supplies, Inc., Endurance Specialty and Burger King Corporation. James G. Coulter Mr. Coulter became a director in 1997. He is a founding partner of TexasPacific Group and has been Managing General Partner of Texas Pacific Group formore than eight years. He is a director of Genesis Health Ventures, Inc.,Globespan, Inc., Seagate Technology, Inc., MEMC Electronic Materials, Inc.,Evolution Global Partners and Zhone Technologies. Steven Grand-Jean Mr. Grand-Jean became a director in 2003. He has been President ofGrand-Jean Capital Management for more than five years. Thomas W. Scott Mr. Scott became a director in January 2002. He is a founding partner ofNantucket Allserve Inc. (beverage supplier) and has been Co-Chairman thereofsince 1989 and Co-Chairman and Co-Chief Executive Officer from 1989 to S-242000. He has also been Co-Chairman of Shelflink (supply chain software company)since 2000. Mr. Scott is married to Emily Woods, the Chairperson of the Board ofDirectors of Holdings. Josh S. Weston Mr. Weston became a director in 1998. He has been Honorary Chairman of theBoard of Directors of Automatic Data Processing (computing services business)since 1998. He was Chairman of the Board of Automatic Data Processing from 1996until 1998, and Chairman and Chief Executive Officer for more than five yearsprior thereto. He is also a director of Gentiva Health Services, Inc., AegisCommunications Group, Inc. and Russ Berrie & Company, Inc. Emily Woods Ms. Woods resigned as Chairperson of the Board of Directors of Holdings inMarch 2003 but continues to serve as director. She co-founded the J. Crew brandin 1983 and has served as Chief Executive Officer and Vice Chairperson ofHoldings and as Chief Executive Officer of Operating Corp. She is also adirector of Yankee Candle Company, Inc. Ms. Woods is married to Thomas Scott, adirector of Holdings. S-25ITEM 11. EXECUTIVE COMPENSATION The following table sets forth compensation paid by Holdings for fiscal2002, 2001, and 2000: . to each individual serving as our chief executive officer during fiscal 2002; . to each of the four other most highly compensated executive officers as of the end of fiscal 2002; and . to two additional executive officers who were not employed as of the end of fiscal 2002. Long-Term Compensation Annual Compensation Awards Payouts ------------------- ------ ------- Numbers of Restricted Securities Name Stock Underlying LTIP All Other And Fiscal Salary Bonus Other Award(s) Options/ Payouts Compensation -------- Principal Position Year ($) ($) ($) (1) SARS (1) ($) ($) (2) ------------------ ---- --- --- --- --- -------- --- ------- Millard S. Drexler ............... 2002 -- -- -- (4) 2,231,704 -- -- Chief Executive Officer And Chairman (3)Kenneth S. Pilot ................. 2002 201,900 520,000(5) -- 105,000 150,000 -- 3,341,900 Chief Executive Officer (6)Mark A. Sarvary .................. 2002 247,700 -- -- -- -- -- 1,407,500 Chief Executive Officer (7) 2001 675,000 -- -- -- -- -- 5,250 2000 675,000 502,500 -- -- -- -- 5,250Emily Woods ...................... 2002 886,900 -- -- -- -- -- 7,600 Director (8) 2001 1,000,000 -- -- -- -- -- 5,250 2000 1,000,000 1,000,000 -- -- -- -- 5,250Blair Gordon (9) ................. 2002 400,000 -- -- -- 30,000 -- -- Executive Vice President, Creative DirectorScott D. Hyatt ................... 2002 364,000 -- -- -- -- -- 9,700 Senior Vice President, 2001 364,000 -- -- -- 10,000 -- 5,250 Manufacturing 2000 350,000 183,800 -- -- -- -- 5,250Walter Killough (10) ............. 2002 390,000 -- -- -- -- -- 7,400 Executive Vice President, 2001 390,000 -- -- -- 25,000 -- 5,250 Direct and Supply Chain 2000 390,000 429,400 -- -- 18,600 -- 5,250Scott M. Rosen ................... 2002 365,000 -- -- -- -- -- 7,400 Executive Vice President, 2001 365,000 -- -- -- -- -- 5,250 Chief Financial Officer 2000 357,000 298,800 -- -- 18,600 -- 5,250Michael Scandiffio (11) .......... 2002 402,000 -- -- -- -- 157,900 Executive Vice President, Mens 2001 262,800 100,000(5) -- -- 40,000 -- 223,600-----------------(1) There is no established public market for shares of Holdings common stock. Holders of restricted stock have the same right to receive dividends as other holders of Holdings common stock. Holdings has not paid any cash dividends on its common stock. dividends on its common stock.(2) For Mr. Pilot, this includes $2,494,500 in severance compensation paid upon the termination of his employment and $847,400 in relocation compensation. For Mr. Sarvary, this includes $1,400,000 in severance compensation paid upon the termination of his employment. For Mr. Scandiffio, this includes $293,900 in relocation compensation and $85,000 in severance compensation. The remaining amounts represent Holdings' matching contributions to its 401(k) plan.(3) Mr. Drexler became Chief Executive Officer in January 2003 and Chairman of the Board of Directors in March 2003.(4) Mr. Drexler was granted 725,303 shares of Holdings common stock on February 12, 2003, of which 181,326 shares will vest on each January 27 of 2004, 2005 and 2006 and 181,325 shares will vest on January 27, 2007. Mr. Drexler paid $800,000 to Holdings for these shares, which was in excess of their fair market value at the time of grant. A corporation of which Mr. Drexler is a principal was also granted 55,793 shares of Holdings common stock on February 12, 2003, all of which vested immediately upon grant.(5) Represents sign-on bonus.(6) Mr. Pilot was Chief Executive Officer from September 2002 to January 2003.(7) Mr. Sarvary's employment terminated in April 2002.(8) Ms. Woods was granted 661,600 shares of Holdings common stock on October 17, 1997, all of which are currently vested. Ms. Woods was Chairperson of the Board until her resignation from this position in March 2003.(9) Mr. Gordon's employment commenced in January 2002 and terminated in January 2003.(10) Mr. Killough's employment terminated in March 2003. S-26(11) Mr. Scandiffio's employment commenced in June 2001 and terminated in October 2002.The following table shows information concerning stock options to purchaseshares of Holdings common stock granted to any of the named executive officersduring fiscal 2002. Potential Realizable Value at Assumed Annual Rates of Stock Price Appreciation for Individual Grants Option Term (2) ----------------- --------------- Number of Percent of Securities Total Options Underlying Granted to Options Employees in Exercise ExpirationName Granted (1) Fiscal Year Price($/Sh) Date 5%($) 10% ($)---- ----------- ----------- ----------- ---- ----- ------- Blair Gordon (2) ...... 30,000 7% $10.00 2/28/2012 -- --(1) Holdings has not granted any SARs.(2) Mr. Gordon's employment terminated in January 2003, at which time all of these options were forfeited automatically pursuant to Holdings' Stock Option Plan. As a result, the potential realizable value for these options is zero.The following table shows the number of stock options held to purchase shares ofHoldings common stock by the named executive officers at the end of fiscal 2002.The named executive officers did not exercise any stock options in fiscal 2002. Value of Unexercised Number of Securities In-the-Money Options/ Underlying Unexercised SARs at Fiscal Year End Options at Fiscal Year End ($) (1)Name Exercisable/Unexercisable Exercisable/Unexercisable---- ------------------------------ ----------------------------- Millard S. Drexler (2) ..................................... 0/2,231,704 0/0Kenneth S. Pilot (3) ....................................... 0/0 0/0Mark A. Sarvary (4) ........................................ 163,200/0 0/0Scott D. Hyatt ............................................. 22,000/13,000 0/0Walter Killough (5) ........................................ 47,560/27,440 0/0Scott M. Rosen ............................................. 47,560/27,440 0/0Emily Woods ................................................ 164,000/328,200 0/0Blair Gordon (6) ........................................... 0/0 0/0Michael Scandiffio (7) ..................................... 0/0 0/0------------(1) There is no established public market for shares of Holdings common stock.(2) Mr. Drexler became Chief Executive Officer in January 2003.(3) Mr. Pilot was Chief Executive Officer from September 2002 to January 2003.(4) Mr. Sarvary resigned as Chief Executive Officer in April 2002.(5) Mr. Killough's employment terminated in March 2003.(6) Mr. Gordon's employment terminated in January 2003.(7) Mr. Scandiffio's employment terminated in October 2002.Employment Agreements and Other Compensation Arrangements Employment Agreements Emily Woods. Ms. Woods had an employment agreement with Holdings andOperating Corp. pursuant to which she served as Chairperson of the Board ofDirectors of Holdings for five years beginning on October 17, 1997. Theagreement provided for a minimum annual base salary of $1.0 million, an annualbonus of up to $1.0 million based on achievement of earnings objectives to bedetermined each year, the grant of 661,600 shares of Holdings Common Stock,which we refer to as the "Woods Restricted Shares", the reimbursement of incometaxes incurred by Ms. Woods in connection with such grant, and various executivebenefits and perquisites. The employment agreement expired by its terms onOctober 17, 2002. Ms. Woods currently receives an annual base salary of$200,000. S-27 Under the terms of stock options awarded to Ms. Woods under Holdings'stock option plan, all unvested options shall become exercisable (1) if Ms.Woods' employment is terminated by Holdings without cause, by Ms. Woods for goodreason or by reason of death or disability or (2) in the event of a change incontrol of Holdings. Millard S. Drexler. Mr. Drexler has a services agreement with Holdingsand Operating Corp. pursuant to which he will serve as Chief Executive Officerfor five years beginning on January 27, 2003, provided that Mr. Drexler can stepdown as Chief Executive Officer after January 2006 and serve only as ExecutiveChairman. The agreement provides for a minimum annual base salary of $200,000,an annual bonus based on the achievement of earnings objectives to be determinedeach year, and reimbursement of business expenses, provided that such totalcompensation not exceed $700,000 per year. The agreement also provides for thegrant of options to purchase 557,926 shares of Holdings common stock, which werefer to as initial options, and the grant of premium options to purchase anadditional 1,673,778 shares of Holdings common stock, which we refer to aspremium options. The agreement also provides for the grant of 55,793 immediatelyvested shares of Holdings common stock and the grant of 725,303 shares ofHoldings common stock, which we refer to as the "Drexler Restricted Shares". Werefer you to footnote 4 to the Executive Compensation Table for information onthe vesting of the Drexler Restricted Shares. Mr. Drexler paid Holdings $200,000for the Initial Options and $800,000 for the Drexler Restricted Shares. If Mr. Drexler's employment is terminated without "cause" or for "goodreason" (each as defined in the services agreement), Mr. Drexler will beentitled to receive his base salary for one year, the immediate vesting of anyunvested Drexler Restricted Shares and the immediate vesting of that portion ofthe initial options and the premium options that would have become vested andexercisable on the anniversary of the grant date immediately following thetermination date. If such termination occurs after a "change in control" (asdefined in the services agreement), all of the unvested initial options andpremium options will immediately vest and become exercisable. Kenneth S. Pilot. Mr. Pilot had an employment agreement with Holdingsand Operating Corp. pursuant to which he would serve as Chief Executive Officerfor five years commencing on September 9, 2002. Holdings would also cause Mr.Pilot to be elected as a director. The agreement provided for a minimum annualbase salary of $700,000, a signing bonus of $520,000, two additional payments of$60,000 payable in September 2003 and 2004, and certain relocation benefits. Theagreement also provided for an annual bonus based on the achievement of earningsobjectives to be determined each year, provided that he was guaranteed proratedbonuses for fiscal 2002 equal to 85% of his base salary and 42.5% of his basesalary for fiscal 2003. He also received a grant of 105,000 shares of Holdingscommon stock, which we refer to as the "Pilot Restricted Shares", of which35,000 shares would vest over time and 70,000 shares vested immediately, and agrant of options to purchase 150,000 shares of Holdings common stock. If Mr.Pilot was terminated without "cause" or for "good reason" (as defined in theemployment agreement), he was entitled to receive any accrued bonus and alump-sum payment equal to two times his base salary. Mr. Pilot resigned effective January 29, 2003. Pursuant to hisseparation agreement, Mr. Pilot was entitled to $2,494,500 in severancecompensation, the immediate vesting of 35,000 Pilot Restricted Shares, thecontinuation of his medical benefits for the eighteen month period following hisresignation and certain outplacement benefits. In addition, Holdings waived thecall rights it had in respect of such Pilot Restricted Shares. Mark A. Sarvary. Mr. Sarvary had an employment agreement with Holdingsand Operating Corp. pursuant to which he would serve as Chief Executive Officerfor a period of five years commencing on May 10, 1999. Holdings would also causeMr. Sarvary to be elected as a director. The agreement provided for a minimum annual base salary of $670,000, a$1,000,000 signing bonus, and an annual target bonus of 50% of his annual basesalary based on achievement of earnings objectives to be determined each year.The agreement also provided for the grant of options to purchase 272,000 sharesof Holdings common stock and the grant of additional options to purchase 68,000shares on the earlier of the date of an initial public offering of Holdingscommon stock or May 10, 2004. In the event of a change in Mr. Sarvary's dutiesand responsibilities, upon the termination of Mr. Sarvary's employment, he wasentitled to receive severance and other benefits described in the January 15,2002 amendment to his employment agreement. These included a lump-sum paymentequal to two times his base salary and the continuation of medical and lifeinsurance benefits for a period of time after the termination date. In addition,all of his vested options will remain exercisable for three years. Mr. Sarvary resigned effective April 30, 2002. Pursuant to hisseparation agreement, he is entitled to $1,400,000 S-28in severance compensation and the continuation of medical benefits for two yearsand life insurance benefits for 21 months. In addition, the portion of his stockoptions scheduled to vest on the anniversary of their grant date following thetermination date was permitted to vest and become exercisable. Blair Gordon. Mr. Gordon had an employment agreement with Holdings andOperating Corp. pursuant to which he would serve as Executive Vice-President andCreative Director for three years commencing on January 7, 2002. The agreementprovided for a minimum annual base salary of $400,000, an annual bonus based onachievement of earnings objectives to be determined each year, and the grant ofoptions to purchase 30,000 shares of Holdings common stock. The agreement alsoprovided for the continuation of Mr. Gordon's base salary and medical benefitsfor one year if he was terminated without "cause" (as defined in the employmentagreement). Mr. Gordon's employment terminated effective January 30, 2003.Pursuant to his separation agreement, he is entitled to these payments andbenefits. Walter Killough. Mr. Killough had a severance agreement with Holdingsand Operating Corp. which provided that, in the event of a termination for anyreason other than death, disability or cause, as defined in the severanceagreement, he will receive a continuation of his base salary and certain expensereimbursement for a period of one year, subject to offset if he obtains newfull-time employment during that period. Mr. Killough's employment terminatedeffective March 14, 2003. Pursuant to his agreement, he is entitled to thesepayments and benefits. Michael Scandiffio. Mr. Scandiffio had an employment agreement withHoldings and Operating Corp. pursuant to which he would serve as ExecutiveVice-President of Mens for three years commencing June 12, 2001. The agreementprovided for a minimum annual base salary of $480,000, a $100,000 signing bonus,an annual bonus based on achievement of earnings objectives to be determinedeach year, and the grant of options to purchase 40,000 shares of Holdings commonstock. The agreement also provided for relocation benefits and the continuationof base salary and medical benefits for one year if Mr. Scandiffio is terminatedwithout "cause" (as defined in the employment agreement). Mr. Scandiffio'semployment terminated effective October 17, 2002 as a result of which he isentitled to these payments and benefits. Executive Severance Arrangements Messrs. Hyatt and Rosen each have an agreement with Holdings andOperating Corp. which provides that, in the event of a termination without"cause" (as defined in the agreement), he will receive a continuation of hisbase salary and medical benefits for a period of one year after the terminationdate and the payment of any bonus that he would otherwise have received for thefiscal year ending before the termination date. Shareholders Agreements The Woods Restricted Shares, the Pilot Restricted Shares, and theDrexler Restricted Shares and any shares of Holdings common stock acquired byany of the named executive officers described above pursuant to the exercise ofoptions are subject to a shareholders' agreement providing for certain transferrestrictions, registration rights and customary tag-along and drag-along rights. In addition, Mr. Drexler's shareholders' agreement provides him withcertain rights to appoint three directors by himself and three additionaldirectors by mutual agreement with Texas Pacific Group, consent to ouroperating/capital budgets, and antidilution and co-investment rights. Pursuantto this right, Mr. Drexler appointed Steven Grand-Jean as a director in March2003. The agreement also requires Mr. Drexler to pay $1.0 million to us ifJeffrey Pfeifle, current President of Holdings and Operating Corp. is terminatedfor cause or resigns without good reason, or if Mr. Pfeifle is terminatedwithout cause with Mr. Drexler's consent or for good reason as a result ofactions approved by Mr. Drexler before February 1, 2005. Mr. Drexler is alsorequired to pay the excess of $480,000 over Mr. Pfeifle's pro-rata bonus if suchtermination is without cause or for good reason. If such termination occursbetween February 1, 2004 and February 1, 2005, Mr. Drexler is also required topay us the amount of any long-term incentive paid to Mr. Pfeifle, not to exceed$400,000. S-29 Compensation Committee Interlocks and Insider Participation Ms. Woods, a director, and Mr. Boyce, a director and former ChiefExecutive Officer, are members of the Compensation Committee of Holdings. Compensation of DirectorsAn attendance fee of $10,000 for each Board of Directors meeting (up to amaximum of $40,000 per year) is paid to each director who is neither an employeeof Holdings nor a representative of Texas Pacific Group. Directors have theoption to receive all or a portion of that fee paid in cash or in shares ofHoldings common stock at a per share purchase price equal to the fair marketvalue.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 April 1, 2003 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 ofTitle of Class of Beneficial Owner Beneficial Ownership Class-------------- ------------------- -------------------- ----- Common stock .............. TPG Partners II, L.P. 8,780,073 shares (1) (4) 59% 301 Commerce Street, Suite 3300 Fort Worth, TX 76102Common stock .............. Emily Woods 2,429,177 shares (2) 16% J. Crew Group, Inc. 770 Broadway New York, NY 10003Common stock .............. Millard S. Drexler 1,522,249 shares (3) (4) 10% J. Crew Group, Inc. 770 Broadway New York, NY 10003---------------(1) These shares of common stock are beneficially owned by Texas Pacific Group and the following affiliates of Texas Pacific Group (collectively, "TPG Affiliates"): TPG Parallel II L.P., TPG Partners II L.P., TPG Investors II, L.P., and TPG Bacchus II, LLC.(2) Includes 164,000 shares not currently owned but which are issuable upon the exercise of stock options awarded under stock option plan that are currently exercisable.(3) These shares of common stock are beneficially owned by a company of which Mr. Drexler is a principal.(4) Includes 1,466,276 shares not currently owned but which are issuable to each of TPG Bacchus II, LLC and Mr. Drexler's company upon the exercise by each of them of an exchange right. We refer you to "Certain Relationships and Related Transactions" for more information.The following table sets forth information regarding the beneficial ownership ofeach class of equity securities of Holdings as of April 1, 2003 for (a) eachdirector, (b) each of the executive officers identified in the table set forthunder Management and (c) all directors and executive officers as a group. Theholders listed have sole voting power and investment power over the shares heldby them, except as indicated by the notes following the table. S-30 Number of Shares and Nature of Percent ofTitle of Class Name of Beneficial Owner Beneficial Ownership Class-------------- ------------------------ -------------------- ----- Common stock ..................... Richard W. Boyce 55,200 (1) *Common stock ..................... Jonathan J. Coslet 8,780,073 (2) 59%Common stock ..................... James G. Coulter 8,780,073 (2) 59%Common stock ..................... Millard S. Drexler 1,522,249 (3) 10%Common stock ..................... Scott D. Hyatt 22,000 (1)Common stock ..................... Steven Grand-JeanCommon stock ..................... Walter Killough (4) 47,560 (1) *Common stock ..................... Kenneth S. Pilot (5) 105,000Common stock ..................... Scott M. Rosen 47,560 (1)Common stock ..................... Mark A. Sarvary (6) 163,200 (1) *Common stock ..................... Thomas W. Scott 0 *Common stock ..................... Josh S. Weston 25,478 *Common stock ..................... Emily Woods 2,429,177 (7) 16%Common stock ..................... All directors and executive 13,197,497 (1)(2)(3)(7) 89% officers as a groupSeries A preferred stock ......... Jonathan J. Coslet 73,475 (2) 79%Series A preferred stock ......... James G. Coulter 73,475 (2) 79%Series A preferred stock ......... Josh S. Weston 60 *Series A preferred stock ......... Emily Woods 2,979 3%Series A preferred stock ......... All directors and executive 76,514 (2) 83% officers as a group-------------* Represents less than 1% of the class.(1) These are shares not currently owned but which are issuable upon the exercise of stock options awarded under the stock option plan that are currently exercisable or become exercisable within 60 days.(2) Attributes ownership of the shares beneficially owned by TPG Affiliates to Messrs. Coslet and Coulter, who are partners of Texas Pacific Group. Includes 1,466,276 shares not currently owned but which are issuable to TPG Bacchus II, LLC upon the exercise of an exchange right. We refer you to "Certain Relationships and Related Transactions" for more information. Messrs. Coslet and Coulter disclaim beneficial ownership of the shares owned by TPG Affiliates.(3) Attributes ownership of the shares beneficially owned by Mr. Drexler's company to Mr. Drexler. Includes 1,466,276 shares not currently owned but which are issuable to Mr. Drexler's company upon the exercise of an exchange right. We refer you to "Certain Relationships and Related Transactions" for more information.(4) Mr. Killough's employment terminated in March 2003.(5) Mr. Pilot was Chief Executive Officer from September 2002 to January 2003.(6) Mr. Sarvary resigned as Chief Executive Officer in April 2002.(7) Includes 164,000 shares not currently owned but which are issuable upon the exercise of stock options awarded under the stock option plan that are currently exercisable.ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONSMark Sarvary Loan In connection with Mr. Sarvary's relocation to our headquarters,Holdings loaned Mr. Sarvary $1.0 million on an interest-free basis to purchase aresidence, which loan was secured by a mortgage on that residence. The largestamount outstanding in fiscal 2002 was $850,000. As part of Mr. Sarvary'sseparation from Holdings in April 2002, Mr. Sarvary agreed to repay the loan onthe earlier of (a) June 1, 2005, (b) the sale of his residence and (c) the firstanniversary of his employment with a new employer. In October 2002, Mr. Sarvarypaid $782,000 to Holdings in full satisfaction of the loan in exchange for a$68,000 present value discount granted by us in consideration of his earlyrepayment.Tax Sharing Arrangement 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 on a "separate return" basis.TPG-MD Investment Notes Payable On February 4, 2003, Operating Corp. entered into a credit agreementwith TPG-MD Investment, LLC, an entity controlled by Texas Pacific Group andMillard S. Drexler, which provides for: S-31 . Tranche A loan in an aggregate principal amount of $10.0 million; and . Tranche B loan in an aggregate principal amount of $10.0 million. The loans are due in February 2008 and bear interest at 5.0% per annumpayable semi-annually in arrears on January 31 and July 31, commencing on July31, 2003. Interest will compound and be capitalized and added to the principalamount on each interest payment date. Payment of the loans is subordinated inright of payment to the prior payment of all senior debt and on the same termsas Operating Corp.'s senior subordinated notes. The loans are guaranteed bycertain subsidiaries of Operating Corp. The lender has the right, exercisable at anytime prior to the maturitydate, to exchange the principal amount of and accrued and unpaid interest on theloans into shares of common stock of Holdings at an exercise price of $6.82 pershare. The lender also has the right to require Operating Corp. to prepay theTranche B loan without premium or penalty under certain circumstances.ITEM 14. CONTROLS AND PROCEDURESWithin the 90 days prior to the date of this Annual Report on Form 10-K, theCompany's management, including the Chief Executive Officer and Chief FinancialOfficer, conducted an evaluation of the effectiveness of disclosure controls andprocedures as provided in Rule 13a-14 under the Securities Exchange Act of 1934,as amended. There are inherent limitations on the effectiveness of any system ofdisclosure controls and procedures, including the possibility of human error andthe circumvention or overriding of the controls and procedures. Accordingly,even effective disclosure controls and procedures can only provide reasonableassurance of achieving their control objectives. Based on that evaluation, theChief Executive Officer and Chief Financial Officer concluded that thedisclosure controls and procedures are effective in ensuring that all materialinformation required to be filed in this annual report has been made known tothem in a timely fashion. There have been no significant changes in internalcontrols, or in factors that could significantly affect internal controls,subsequent to the date the Chief Executive Officer and Chief Financial Officercompleted their evaluation, including any corrective actions with regard tosignificant deficiencies and material weaknesses. S-32 PART IVITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-KJ. Crew Group, Inc.(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 February 1, 2003 and February 2, 2002 (iii) Consolidated Statements of Operations - Years ended February 1, 2003, February 2, 2002 and February 3, 2001 (iv) Consolidated Statements of changes in Stockholders' Deficit - Years ended February 1, 2003, February 2, 2002 and February 3, 2001 (v) Consolidated Statements of Cash Flows - Years ended February 1, 2003, February 2, 2002 and February 3, 2001 (vi) Notes to consolidated financial statements 2. Financial Statement 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 filed the following reports on Form 8-K during the quarter ended February 1, 2003: Date of Report Item(s) Reported -------------- ---------------- Dec. 27, 2002 Item 5 Jan. 27, 2003 Item 5(c) Exhibits See Item 15(a) 3 above.(d) Financial Statement Schedules See Item 15(a) 1 and 15(a) 2 above. S-33J. Crew Operating Corp.(a) 1. Financial Statements The following financial statements of J. Crew Operating Corp. and subsidiaries are included in Item 8: (i) Report of KPMG LLP, Independent Auditors (ii) Consolidated Balance Sheets as of February 1, 2003 and February 2, 2002 (iii) Consolidated Statements of Operations - Years ended February 1, 2003, February 2, 2002 and February 3, 2001 (iv) Consolidated Statements of Cash Flows - Years ended February 1, 2003, February 2, 2002 and February 3, 2001 (v) Notes to consolidated financial statements 2. Financial Statement Schedules Schedule II Valuation and Qualifying Accounts. S-34SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the SecuritiesExchange Act of 1934, each registrant has duly caused this report to be signedon its behalf by the undersigned, thereunto duly authorized. J. CREW GROUP, INC.Date: April 21, 2003 J. CREW OPERATING CORP. By: /s/ Millard S. Drexler ------------------------ Millard S. Drexler Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934,this report has been signed below by the following persons on behalf of eachregistrant and in the capacities indicated, on April 21, 2003. Signature Title --------- ----- /s/ Millard S. Drexler Chairman of the Board, Chief Executive Officer --------------------------- and a Director (Principal Executive Officer) Millard S. Drexler /s/ Scott M. Rosen Executive Vice President, Chief Financial --------------------------- Officer (Principal Financial Officer) Scott M. Rosen /s/ Nicholas Lamberti Vice President, Corporate Controller --------------------------- (Principal Accounting Officer) Nicholas Lamberti /s/ Richard W. Boyce Director --------------------------- Richard W. Boyce /s/ Jonathan J. Coslet Director --------------------------- Jonathan J. Coslet /s/ James G. Coulter Director --------------------------- James G. Coulter /s/ Steven Grand-Jean Director --------------------------- Steven Grand-Jean /s/ Thomas W. Scott Director --------------------------- Thomas W. Scott /s/ Josh Weston Director --------------------------- Josh Weston /s/ Emily Woods Director --------------------------- Emily Woods S-35CERTIFICATIONI, Millard S. Drexler, certify that:1. I have reviewed this annual report on Form 10-K of J. Crew Group, Inc. and J. Crew Operating Corp.;2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of each registrant as of, and for, the periods presented in this annual report.4. Each registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for such registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to such registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of such registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Report"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;5. Each registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to such registrant's auditors and the audit committee of such registrant's board of directors (or persons performing the equivalent function); a) all significant deficiencies in the design or operation of internal controls which could adversely affect such registrant's ability to record, process, summarize and report financial data and have identified for such registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in such registrant's internal controls; and6. Each registrant's other certifying officers and I have indicated in this annual report whether or not there were any significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.April 21, 2003 /s/ Millard S. Drexler ---------------------- Millard S. Drexler Chief Executive Officer S-36CERTIFICATIONI, Scott M. Rosen, certify that:1. I have reviewed this annual report on Form 10-K of J. Crew Group, Inc. and J. Crew Operating Corp.;2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of each registrant as of, and for, the periods presented in this annual report.4. Each registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for such registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to such registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of such registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Report"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;5. Each registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to such registrant's auditors and the audit committee of such registrant's board of directors (or persons performing the equivalent function); a) all significant deficiencies in the design or operation of internal controls which could adversely affect such registrant's ability to record, process, summarize and report financial data and have identified for such registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in such registrant's internal controls; and6. Each registrant's other certifying officers and I have indicated in this annual report whether or not there were any significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.April 21, 2003 /s/ Scott M. Rosen ------------------ Scott M. Rosen Executive Vice-President and Chief Financial Officer S-37Independent 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 auditing standards generally acceptedin the United States of America. Those standards require that we plan andperform the audit to obtain reasonable assurance about whether the financialstatements are free of material misstatement. An audit includes examining, on atest basis, evidence supporting the amounts and disclosures in the financialstatements. An audit also includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallfinancial statement presentation. We believe that our audits provide areasonable 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 February 1, 2003 and February 2, 2002 and the results oftheir operations and their cash flows for each of the years in the three-yearperiod ended February 1, 2003, in conformity with accounting principlesgenerally accepted in the United States of America. Also, in our opinion, therelated financial statement schedule when considered in relation to the basicconsolidated financial statements taken as a whole, presents fairly, in allmaterial respects the information set forth therein. KPMG LLPMarch 25, 2003,except as to note 17, which is as ofApril 4, 2003 F-1 J. CREW GROUP, INC. AND SUBSIDIARIES Consolidated Balance Sheets February 1, February 2, Assets 2003 2002 ------ ---- ---- (in thousands) Current assets: Cash and cash equivalents $ 18,895 $ 16,201 Merchandise inventories 107,318 138,918 Prepaid expenses and other current assets 24,886 27,026 Refundable income taxes 6,278 - --------- --------- Total current assets 157,377 182,145 --------- ---------Property and equipment - at cost: Land 1,710 1,610 Buildings and improvements 11,705 11,700 Furniture, fixtures and equipment 102,108 105,292 Leasehold improvements 182,226 170,195 Construction in progress 3,161 4,903 --------- --------- 300,910 293,700 Less accumulated depreciation and amortization 129,363 106,427 --------- --------- 171,547 187,273 --------- ---------Deferred income tax assets 5,000 18,071Other assets 14,954 13,831 --------- --------- Total assets $ 348,878 $ 401,320 ========= ========= Liabilities and Stockholders' Deficit -------------------------------------Current liabilities: Accounts payable $ 54,921 $ 66,703 Other current liabilities 61,463 61,788 Income taxes payable 2,978 8,840 Deferred income tax liabilities - 5,650 --------- --------- Total current liabilities 119,362 142,981 --------- ---------Deferred credits and other long-term liabilities 65,141 67,235 --------- ---------Long-term debt 292,000 279,687 --------- ---------Redeemable preferred stock 264,038 230,460 --------- ---------Stockholders' deficit (391,663) (319,043) --------- --------- Total liabilities and stockholders' deficit $ 348,878 $ 401,320 ========= =========See accompanying notes to consolidated financial statements. F-2 J. CREW GROUP, INC. AND SUBSIDIARIES Consolidated Statements of Operations Years ended ----------- February 1, February 2, February 3, ----------- ----------- ----------- 2003 2002 2001 ---- ---- ---- (in thousands) Revenues: Net sales $ 732,279 $ 741,280 $ 787,658 Other 34,103 36,660 38,317 --------- --------- --------- 766,382 777,940 825,975Operating costs and expenses: Cost of goods sold, including buying and occupancy costs 478,700 462,371 463,909 Selling, general and administrative expenses 291,518 295,568 301,865 Write down of assets and other charges in connection with discontinuance of Clifford & Wills -- -- 4,130 --------- --------- --------- 770,218 757,939 769,904 --------- --------- --------- Income/(loss) from operations (3,836) 20,001 56,071Interest expense - net 40,954 36,512 36,642 Income/(loss) before income taxes (44,790) (16,511) 19,429(Provision) benefit for income taxes 4,200 5,500 (7,500) --------- --------- --------- Net income/(loss) $ (40,590) $ (11,011) $ 11,929 ========= ========= =========See accompanying notes to consolidated financial statements. F-3 J. CREW GROUP, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows Years ended ----------- February 1, February 2, February 3, ----------- ----------- ----------- 2003 2002 2001 ---- ---- ---- (in thousands) Cash flows from operating activities:Net income/(loss) $ (40,590) $ (11,011) $ 11,929Adjustments to reconcile net income/(loss) to net cash provided by operating activities: Depreciation and amortization 34,451 31,718 22,600 Amortization of deferred financing costs 4,435 1,997 2,793 Non-cash interest expense 12,313 15,395 13,608 Deferred income taxes 7,421 (3,460) 27 Non-cash compensation expense (589) 1,574 649 Write down of assets and other charges in connection with discontinued catalog -- -- 4,130Changes in operating assets and liabilities: Merchandise inventories 31,600 1,749 (10,739) Prepaid expenses and other current assets 2,140 (3,286) 6,343 Other assets (2,470) (3,416) (2,788) Net assets held for disposal -- -- 4,797 Accounts payable (11,782) 16,998 8,754 Other liabilities 495 (13,767) 5,263 Income taxes payable (12,140) (8,741) 2,894 --------- --------- --------- Net cash provided by operating activities 25,284 25,750 70,260 --------- --------- ---------Cash flows from investing activities: Capital expenditures (26,920) (61,862) (55,694) Proceeds from construction allowances 6,502 19,287 13,519 --------- --------- --------- Net cash used in investing activities (20,418) (42,575) (42,175) --------- --------- ---------Cash flows from financing activities: Costs incurred in refinancing Credit Facility (3,256) -- -- Repayment of long-term debt -- -- (34,000) Proceeds from the issuance of common stock 1,084 96 178 Repurchase of common stock -- -- (26) --------- --------- --------- Net cash provided by/(used in) financing activities (2,172) 96 (33,848) --------- --------- --------- Increase (decrease) in cash and cash equivalents 2,694 (16,729) (5,763)Cash and cash equivalents at beginning of year 16,201 32,930 38,693 --------- --------- ---------Cash and cash equivalents at end of year $ 18,895 $ 16,201 $ 32,930 ========= ========= =========Supplementary cash flow information: Income taxes paid $ 453 $ 6,442 $ 4,279 ========= ========= ========= Interest paid $ 19,380 $ 19,389 $ 20,513 ========= ========= =========Noncash financing activities: Dividends on redeemable preferred stock $ 33,578 $ 30,442 $ 26,484 ========= ========= =========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) Common stock Additional Retained Deferred Stock- ------------ paid-in earnings Treasury compen- holders' Shares Amount capital (deficit) stock sation deficit ------ ------ ------- --------- ----- ------ ------- Balance at January 29, 2000 12,214,265 $ 1 $ 70,537 $ (331,178) $ (2,325) $ (1,628) $ (264,593) === ======== =========== ========= ========= ==========Net loss -- -- -- 11,929 -- -- 11,929Preferred stock dividends -- -- -- (26,484) -- -- (26,484)Issuance of common stock 18,400 -- 178 -- -- -- 178Amortization of restricted stock -- -- -- -- -- 649 649Repurchase of common stock -- -- -- -- (26) -- (26) ---------- --- -------- ----------- --------- ------- -----------Balance at February 3, 2001 12,232,665 1 70,715 (345,733) (2,351) (979) (278,347) === ======== =========== ========= ========= ==========Net loss -- -- -- (11,011) -- -- (11,011)Preferred stock dividends -- -- -- (30,442) -- -- (30,442)Issuance of common stock 5,524 -- 96 -- -- -- 96Amortization of restricted stock -- -- -- -- -- 661 661 ---------- --- -------- ----------- --------- ------- -----------Balance at February 2, 2002 12,238,189 1 70,811 (387,186) (2,351) (318) (319,043) ========== === ======== =========== ========= ========= ==========Net loss -- -- -- (40,590) -- -- (40,590)Preferred stock dividends -- -- -- (33,578) -- -- (33,578)Issuance of common stock 737,621 -- 1,084 -- -- -- 1,084Issuance of restricted stock 383,963 -- 311 -- -- (311) --Amortization of restricted stock -- -- -- -- -- 464 464 ---------- --- -------- ----------- --------- ------- -----------Balance at February 1, 2003 13,359,773 1 72,206 (461,354) (2,351) (165) (391,663) ========== === ======== =========== ========= ========= ==========See accompanying notes to consolidated financial statements. F-5 J. CREW GROUP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended February 1, 2003, February 2, 2002 and February 3, 2001(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, shoes and accessories under the J.Crew brand name. The Company's products are marketed, primarily in the United States, through various channels of distribution, including retail and factory 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) Segment Information The Company operates in one reportable business segment. All of the Company's identifiable assets are located in the United States. Export sales are not significant. (d) Fiscal Year The Company's fiscal year ends on the Saturday closest to January 31. The fiscal years 2002, 2001, and 2000 ended on February 1, 2003 (52 weeks), February 2, 2002 (52 weeks), and February 3, 2001 (53 weeks). (e) 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 $11,224,000 and $7,895,000 at February 1, 2003 and February 2, 2002, are stated at cost, which approximates market value. F-6 J. CREW GROUP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended February 1, 2003, February 2, 2002 and February 3, 2001 (f) Merchandise Inventories Merchandise inventories are stated at the lower of average cost or market. The Company capitalizes certain design, purchasing and warehousing costs in inventory. (g) 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 February 1, 2003 and February 2, 2002 were $6,197,000 and $7,959,000. Catalog costs, which are reflected in selling and administrative expenses, for the fiscal years 2002, 2001, and 2000 were $56,695,000 $65,477,000 and $69,000,000. All other advertising costs, which are not significant, are expensed as incurred. (h) Property and Equipment Property and equipment are stated at cost and are depreciated over the estimated useful lives by the straight-line method. Buildings and improvements are depreciated over estimated useful lives of twenty years. Furniture, fixtures and equipment are depreciated over 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 million and $8.5 million of system development costs were capitalized in fiscal years 2002 and 2001. 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. (i) Debt Issuance Costs Debt issuance costs (included in other assets) of $6,743,000 and $6,906,000 at February 1, 2003 and February 2, 2002 are amortized over the term of the related debt agreements. (j) Income Taxes The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes". This statement requires the use of the asset and liability method of accounting for income taxes. Under the asset and 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. 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. F-7 J. CREW GROUP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended February 1, 2003, February 2, 2002 and February 3, 2001 (k) 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. Amounts billed to customers for shipping and handling fees related to catalog and internet sales are included in other revenues at the time of shipment. (l) Store Preopening Costs Costs associated with the opening of new retail and outlet stores are expensed as incurred. (m) Derivative Financial Instruments Derivative financial instruments are used by the Company from time to time 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. (n) 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. (o) Impairment of Long-Lived Assets 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. (p) 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 or in excess of the fair market price at the date of grant. If the Company had adopted the fair value recognition provisions of SFAS No. 123, the effect on net income would not be material. Restricted stock awards which are granted at less than fair market value result in the recognition of deferred compensation, which is charged to expense over the vesting period of the awards. Deferred compensation is shown as a reduction of stockholders' equity. F-8 J. CREW GROUP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended February 1, 2003, February 2, 2002 and February 3, 2001(2) Events of September 11, 2001 The terrorist events of September 11, 2001 resulted in the destruction of the Company's retail store located at the World Trade Center in New York City, resulting in the loss of inventories and store fixtures, equipment and leasehold improvements. These losses and the resulting business interruption are covered by insurance policies maintained by the Company. The statement of operations for the year ended February 2, 2002 included losses of $1.9 million relating to inventories and stores fixtures, equipment and leasehold improvements. Insurance recoveries in fiscal 2001 were recorded to the extent of the losses recognized. The statement of operations for the year ended February 1, 2003 includes a gain of $1,420,000, as a result of additional insurance recoveries during fiscal 2002. This gain was classified as a reduction of selling, general and administrative expenses. Additional insurance recoveries, which may be received in the future including recoveries for business interruption, will be recorded at the time of settlement.(3) Disposal of a Business In 1998, management of the Company made a decision to exit the catalog and outlet store operations of Clifford & Wills ("C&W"). Revenues and expenses of C&W for fiscal 2000 were not material and as a result have been netted in the accompanying consolidated statements of operations. 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 C&W outlet stores and conduct other liquidation sales of inventories through December 31, 2000. After consideration of the proceeds from the sale of assets and other terms of the agreement the Company provided $4,000,000 to write down inventories to net realizable value as of January 29, 2000. At February 3, 2001, the Company determined that the realizable value of the remaining net assets of C&W, primarily inventories, was less than their carrying amounts and an additional charge of $4,130,000 was taken.(4) Other Current Liabilities Other current liabilities consist of: February 1, February 2, 2003 2002 ---- ---- Customer liabilities $9,993,000 $11,381,000 Accrued catalog and marketing costs 2,536,000 3,655,000 Taxes, other than income taxes 2,670,000 2,930,000 Accrued interest 9,598,000 4,690,000 Accrued occupancy 1,024,000 1,036,000 Reserve for sales returns 5,313,000 6,475,000 Accrued compensation 7,475,000 1,697,000 Other 22,854,000 29,924,000 ----------- ----------- $61,463,000 $61,788,000 ----------- ----------- F-9 J. CREW GROUP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended February 1, 2003, February 2, 2002 and February 3, 2001(5) Lines of Credit On December 23, 2002 the Company entered into a Loan and Security Agreement with Wachovia Bank, N.A., as arranger, Congress Financial Corporation, as administrative and collateral agent, and a syndicate of lenders which provides for a maximum credit availability of up to $180.0 million (the "Congress Credit Facility"). The Congress Credit Facility replaced a revolving credit facility which was scheduled to expire in October 2003. The Congress Credit Facility provides for revolving loans of up to $160.0 million; supplemental loans of up to $20.0 million each year during the period from April 15 to September 15; and letter of credit accommodations. The Congress Credit Facility expires in December 2005. The total amount of availability is subject to limitations based on specified percentages of eligible receivables, inventories and real property. Real property availability is limited to $5.8 million and will be reduced at a rate of $97,000 per month commencing June 1, 2003. Borrowings are secured by a perfected first priority security interest in all the assets of the Company's subsidiaries and bear interest, at the Company's option, at the prime rate plus 0.5% or the Eurodollar rate plus 2.5%. Supplemental loans bear interest at the prime rate plus 3.0%. The Congress Credit Facility includes restrictions, including the incurrence of additional indebtedness, the payment of dividends and other distributions, the making of investments, the granting of loans and the making of capital expenditures. The Company is required to maintain minimum levels of earnings before interest, taxes, depreciation, amortization and certain non-cash items, ("EBITDA") if excess availability is less than $15.0 million for any 30 consecutive day period. The Congress Credit Facility was amended on February 7, 2003 to provide for an exclusion from the definition of consolidated net income of severance and other one-time employment-related charges of up to $6.7 million in the last quarter of fiscal 2002 and $3.0 million in the first quarter of fiscal 2003. Maximum borrowings under revolving credit agreements were $63,000,000, $95,000,000 and $34,000,000 during fiscal years 2002, 2001 and 2000 and average borrowings were $40,400,000, $43,100,000 and $9,800,000. There were no borrowings outstanding at February 1, 2003 and February 2, 2002. Outstanding letters of credit established primarily to facilitate international merchandise purchases at February 1, 2003 and February 2, 2002 amounted to $45,900,000 and $46,300,000.(6) Long-Term Debt Long term debt consists of: February 1, February 2, 2003 2002 ---- ---- 10-3/8% senior subordinated notes (a) $150,000,000 $150,000,000 13-1/8% senior discount debentures (b) 142,000,000 129,687,000 ------------ ------------ Total $292,000,000 $279,687,000 ============ ============ F-10 J. CREW GROUP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended February 1, 2003, February 2, 2002 and February 3, 2001 (a) 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% of principal in 2002 to 100% in 2005 and thereafter. (b) 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 did not accrue prior to October 15, 2002. However, the Company recorded 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% of principal to 100% in 2005 and thereafter. Long term debt of $150,000,000 matures in fiscal 2007.(7) 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. At February 1, 2003, 92,800 shares of Series A Preferred Stock and 32,500 shares of Series B Preferred Stock were outstanding. 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 $138,738,000 at February 1, 2003. Dividends are recorded as an increase to redeemable preferred stock and a reduction of retained earnings.(8) Common Stock The restated certificate of incorporation authorizes Holdings to issue up to 100,000,000 shares of common stock; par value $.01per share. At February 1, 2003, shares issued were 13,359,773 and shares outstanding were 12,870,373. During 2000, 2001 and 2002 directors converted fees into 18,400, 5,524 and 12,318 shares of Holdings common stock. F-11 J. CREW GROUP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended February 1, 2003, February 2, 2002 and February 3, 2001(9) Commitments and Contingencies (a) Operating Leases As of February 1, 2003, 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 through 2014. At February 1, 2003 aggregate minimum rentals in future periods are, as follows: Fiscal year Amount ----------- ------ 2003 52,372,000 2004 49,867,000 2005 47,396,000 2006 45,192,000 2007 43,636,000 Thereafter 143,875,000 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 2002, 2001, and 2000 was $50,403,000, $46,573,000 and $45,138,000 including contingent rent based on store sales of $1,187,000, $1,023,000, and $1,974,000. (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.(10) 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 $1,834,000, $1,334,000 and $1,241,000 for fiscal 2002, 2001 and 2000.(11) License Agreement The Company has a licensing agreement through January 2005 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 2002, 2001, and 2000 was $2,280,000, $2,560,000 and $3,020,000. F-12 J. CREW GROUP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended February 1, 2003, February 2, 2002 and February 3, 2001(12) Interest Expense - Net Interest expense, net consists of the following: 2002 2001 2000 ---- ---- ---- Interest expense $36,548,000 $34,810,000 $34,390,000 Amortization of deferred financing costs 4,435,000 1,997,000 2,793,000 Interest income (29,000) (295,000) (541,000) ----------- ----------- ----------- Interest expense, net $40,954,000 $36,512,000 $36,642,000 ----------- ----------- ----------- Deferred financing costs of $1,800,000 were written off in connection with the refinancing of our revolving credit facility in December 2002.(13) Other Revenues Other revenues consist of the following: 2002 2001 2000 ---- ---- ---- Shipping and handling fees $31,823,000 $34,100,000 $35,297,000 Royalties 2,280,000 2,560,000 3,020,000 ----------- ----------- ----------- $34,103,000 $36,660,000 $38,317,000 =========== =========== ===========(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 $238,692,000 and $187,191,000 at February 1, 2003 and February 2, 2002, and is based on dealer quotes or quoted market prices of the same or similar instruments. The carrying amounts of long-term debt were $292,000,000 and 279,687,000 at February 1, 2003 and February 2, 2002. 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.(15) Income Taxes The income tax provision/benefit consists of: 2002 2001 2000 ---- ---- ---- Current: Foreign $ 193,000 $ 260,000 $ 300,000 Federal (12,014,000) (2,400,000) 6,253,000 State and local 200,000 100,000 920,000 ------------- ------------ ----------- (11,621,000) (2,040,000) 7,473,000 ------------- ------------ ----------- Deferred 7,421,000 (3,460,000) 27,000 ------------- ------------ ----------- Total $ (4,200,000) $ (5,500,000) $ 7,500,000 ============= ============ =========== F-13 J. CREW GROUP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended February 1, 2003, February 2, 2002 and February 3, 2001 A reconciliation between the provision/(benefit) for income taxes based on the U.S. Federal statutory rate and the Company's effective rate is as follows. 2002 2001 2000 ---- ---- ---- Federal income tax rate (35.0)% (35.0)% 35.0% State and local income taxes, net of federal benefit - (2.3) 7.6 Valuation allowance 47.0 - - Reversal of prior tax accruals (20.9) - - Nondeductible expenses and other (.5) 4.0 (4.0) ------- ------ ----- Effective tax rate (9.4)% (33.3)% 38.6% ======= ======= ===== The tax effect of temporary differences which give rise to deferred tax assets and liabilities are: February 1, February 2, 2003 2002 ---- ---- Deferred tax assets: Original issue discount $ 24,896,000 $ 20,836,000 Federal NOL carryforwards 7,100,000 - State and local NOL carryforwards 1,400,000 1,900,000 Reserve for sales returns 2,202,000 2,603,000 Other 3,873,000 3,826,000 ------------ ------------- 39,471,000 29,165,000 ------------ ------------- Valuation allowance (21,046,000) -- ------------ ------------- 18,425,000 29,165,000 Deferred tax liabilities: Prepaid catalog and other prepaid expenses (9,872,000) (8,841,000) Difference in book and tax basis for property and equipment (3,553,000) (7,903,000) ------------ ------------- (13,425,000) (16,744,000) ------------ ------------- Net deferred income tax asset $ 5,000,000 $ 12,421,000 ============ ============= The Company has significant deferred tax assets resulting from net operating loss carryforwards and deductible temporary differences, which will reduce taxable income in future periods. SFAS No. 109 "Accounting for Income Taxes" states that a valuation allowance is required when it is more likely than not that all or a portion of a deferred tax asset will not be realized. A review of all available positive and negative evidence needs to be considered, including a company's current and past performance, the market environment in which a company operates, length of carryback and carryforward periods, existing contracts or sales backlog that will result in future profits, etc. Forming a conclusion that a valuation allowance is not needed is difficult when there is negative evidence such as cumulative losses in recent years. Cumulative losses weigh heavily in the overall assessment. As a result of our assessment, we established a valuation allowance for the net deferred tax F-14 J. CREW GROUP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended February 1, 2003, February 2, 2002 and February 3, 2001 assets at February 1, 2003. The Company does not expect to recognize any tax benefits in future results of operations until an appropriate level of profitability is sustained. The Company has state and local income tax net operating loss carryforwards of varying amounts.(16) Stock Compensation Plans 1997 Stock Option Plan Under the terms of the 1997 Stock Option Plan, an aggregate of 1,910,000 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 1997 Plan was, as follows: 2002 2001 2000 ---- ---- ---- Weighted Weighted Weighted -------- -------- -------- average average average ------- ------- ------- Shares exercise price Shares exercise price Shares exercise price ------ -------------- ------ -------------- ------ -------------- Outstanding, beginning of year 1,808,790 $ 9.97 1,788,750 $ 9.15 1,532,800 $ 8.87 Granted 395,500 7.64 283,000 14.53 374,700 10.17 Exercised -- -- -- -- (2,000) 6.82 Cancelled (597,560) 10.29 (262,960) 9.31 (116,750) 8.72 --------- ------ --------- ------ --------- ------ Outstanding, end of year 1,606,730 $ 9.27 1,808,790 $ 9.97 1,788,750 $ 9.15 --------- ------ --------- ------ ========= ====== Options exercisable at end of year 842,340 $ 9.81 728,950 $ 9.21 583,000 $ 9.24 ========== ====== ========= ====== ========= ====== 2003 Equity Incentive Plan In January 2003, the Board of Directors of Holdings approved the adoption of the 2003 Equity Incentive Plan. Under the terms of the 2003 Plan, an aggregate of 4,798,160 shares of common stock are available for award to key employees and consultants in the form of non-qualified stock options and restricted shares as follows: . 1,115,812 shares are reserved for the issuance of stock options at an exercise price of $6.82 of fair market value, whichever is greater; . 1,115,812 shares are reserved for the issuance of stock options at an exercise price of $25.00 or fair market value, whichever is greater; . 1,115,812 shares are reserved for the issuance of stock options at an exercise price of $35.00 or fair market value, whichever is greater; . 1,450,724 shares are reserved for the issuance of restricted shares. F-15 J. CREW GROUP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended February 1, 2003, February 2, 2002 and February 3, 2001 The options have terms of ten years and become exercisable over the period provided in each grant agreement. During fiscal 2002, Holdings granted 836,889 options with an exercise price of $6.82, 1,015,425 options with an exercise price of $25.00 and 1,015,425 options with an exercise price of $35.00, and issued 1,004,266 restricted shares under the 2003 plan.(17) Subsequent Events TPG - MD Investment Loans On February 4, 2003, Operating Corp. entered into a credit agreement with TPG-MD Investment, LLC, a related party, which provides for a Tranche A loan to Operating Corp. in an aggregate principal amount of $10.0 million and a Tranche B loan to Operating Corp. in an aggregate principal amount of $10.0 million. The loans are due in February 2008 and bear interest at 5.0% per annum payable semi-annually in arrears on January 31 and July 31, commencing on July 31, 2003. Interest will compound and be capitalized and added to the principal amount on each interest payment date. Payment of the loans is subordinated in right of payment to the prior payment of all senior debt and on the same terms as Operating Corp's 10-3/8% senior subordinated notes due 2008. Exchange Offer On April 4, 2003, Holdings commenced through J. Crew Intermediate LLC, its newly formed wholly-owned subsidiary ("Intermediate"), an offer to exchange the outstanding 13 1/8% Senior Discount Debentures due 2008 issued by Holdings for Intermediate's unissued 16.0% Senior Discount Contingent Principal Notes due 2008. Holdings will not pay accrued and unpaid interest on the existing debentures on the scheduled interest payment date of April 15, 2003. Rather, Holdings will pay such interest on the settlement date of the exchange offer (which is expected to occur on or about May 6, 2003) together with interest thereon at a rate of 13 1/8% per annum from April 15, 2003 to the settlement date, to the holders of the existing debentures who do not tender their existing debentures in the exchange offer. Congress Credit Facility The Congress Credit Facility was amended on April 4, 2003 to (a) consent to the formation of J.Crew Intermediate LLC and the Exchange Offer; (b) carve-out a $9.0 million one-time charge for non-current inventory from the EBITDA covenant; (c) modify required EBITDA covenant levels and (d) eliminate the supplemental loan availability in fiscal 2003.(18) Recent Accounting Pronouncements In June 2001, the Financial Accounting Standards Board, ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 143, "Accounting for Asset Retirement Obligations". SFAS No. 143 requires the Company to record the fair value of an asset retirement obligation as a liability in the period in which it incurs a legal obligation associated with the retirement of tangible long-lived assets and a corresponding asset which is depreciated over the life of the asset. Subsequent to the initial measurement of the asset retirement obligation, the obligation will be adjusted at the end of each period to reflect the passage of time and changes in the estimated future cash flows underlying the obligation. SFAS No. 143 is effective for fiscal years beginning after F-16 J. CREW GROUP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended February 1, 2003, February 2, 2002 and February 3, 2001 June 15, 2002. Management does not believe that the adoption of SFAS No. 143 will have a significant impact on the Company's financial statements. In July 2001, the FASB issued SFAS No. 141, "Business Combinations" and SFAS No. 142., "Goodwill and Other Intangible Assets". SFAS No. 141 eliminates the pooling-of-interests method of accounting for business combinations initiated after June 30, 2001 and modifies the application of the purchase accounting method effective for transactions that are completed after June 30, 2001. SFAS No. 142 eliminated the requirement to amortize goodwill and intangible assets having indefinite useful lives but requires testing at least annually for impairment. Intangible assets that have finite lives will continue to be amortized over their useful lives. SFAS No. 142 applies to goodwill and intangible assets arising from transactions completed before and after the statement's effective dated of January 1, 2002. The adoption of these statements in fiscal 2002 did not have any effect on the Company's financial statements. In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". SFAS No. 144 addresses financial accounting and reporting for the impairment of disposal of long-lived assets and requires companies to separately report discontinued operations and extends that reporting to a component of an entity that either has been disposed of or is classified as held for sale. This statement requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. SFAS No. 144 was effective for fiscal years beginning after December 15, 2001. The adoption of SFAS No. 144 did not have a significant impact on the Company's financial statements. EITF Issue No. 01-9 "Accounting for Consideration Given to a Customer or a Reseller of the Vendor's Products" (formerly EITF Issue 00-14) became effective in the first quarter of fiscal 2002. This EITF addresses the accounting for and classification of consideration given to a customer from a vendor in connection with the purchase or promotion of the vendor's product. The adoption of the EITF did not have a significant effect on the Company's financial statements. In June 2002, the FASB issued SFAS No. 146 - "Accounting for Costs Associated with Exit or Disposal Activities". SFAS No. 146 addresses accounting and reporting for costs associated with exit or disposal activities. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized and measured initially at fair value when the liability is incurred. SFAS No. 146 is effective for exit or disposal activities that are initiated after December 31, 2002. The adoption of SFAS No. 146 in the fourth quarter of 2002 did not have an impact on the Company's financial statements. In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB statements No. 4, 44, and 64, Amendment of FASB Statement No 13, and Technical Corrections". SFAS No. 145 primarily affects the reporting requirements and classification of gains and losses from the extinguishment of debt, rescinds the transitional accounting requirement for intangible assets of motor carriers, and requires that certain lease modifications with economic effects similar to sale-leaseback transactions be accounted for in the same manner as sale-leaseback transactions. SFAS No. 145 is effective for financial statements issued after April 2003, with the exception of the provisions affecting the accounting for lease transactions, which should be applied for transactions entered into after May 15, 2002, and the provisions affecting classification of gains and losses from the extinguishment of debt, which should be applied in fiscal years after May 15, 2002. Management has classified the loss from the refinancing of its credit facility in December 2002 as a component of interest expense in the Company's financial statements. F-17 J. CREW GROUP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended February 1, 2003, February 2, 2002 and February 3, 2001 In November 2002, the FASB issued FASB interpretation ("FIN") No. 45 - "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others". This interpretation elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued and requires that they be recorded at fair value. The initial recognition and measurement provisions of this interpretation are to be applied on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosure requirements of this interpretation are effective for periods ending after December 15, 2002. In December 2002, the FASB issued SFAS No. 148, - "Accounting for Stock-Based Compensation - Transition and Disclosure, an amendment of FASB Statement No. 123". This Statement amends SFAS No. 123, Accounting for Stock-Based Compensation, to provide alternate methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. This Statement also amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The amendments to SFAS 123 regarding disclosure are effective for fiscal years ending after December 15, 2002. The Company applies APB Opinion No. 25 in accounting for its employee stock option plans. In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable Interest Entities - and Interpretation of Accounting Research Bulletin No. 51". FIN No. 46 requires unconsolidated variable interest entities to be consolidated by their primary beneficiaries if the entities do not effectively disperse the risks and rewards of ownership among their owners and other parties involved. The provisions of FIN No. 46 are applicable immediately to all variable interest entities created after January 31, 2003 and variable interest entities in which a company obtains an interest after that date. For variable interest entities created before January 31, 2003, the provisions of this interpretation are effective July 1, 2003. The adoption of FIN No. 46 is not expected to have any effect on the Company's financial statements. F-18 J. CREW GROUP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended February 1, 2003, February 2, 2002 and February 3, 2001(19) Quarterly Financial Information (Unaudited) ($ in millions) 13 weeks 13 weeks 13 weeks 13 weeks 52 weeks ended ended ended ended ended 5/4/02 (a) 8/3/02 11/2/02 2/1/03 (b) 2/1/03 ------ ------ ------- ------ ------ Net sales $ 157.9 $160.9 $181.9 $ 231.6 $ 732.3Gross profit 67.0 61.0 75.9 83.8 287.7Net income (loss) $ (12.1) $ (7.1) $ (.7) $ (20.7) $ (40.6) 13 weeks 13 weeks 13 weeks 14 weeks 53 weeks ended ended ended ended ended 5/5/01 8/4/01 11/3/01 2/2/02 2/2/02 ------ ------ ------- ------ ------ Net sales $ 158.9 $160.5 $187.1 $ 234.8 $ 741.3Gross profit 68.2 60.5 82.8 104.1 315.6Net income (loss) $ (9.3) $ (8.6) $ .3 $ 6.6 $ (11.0)(a) Net income (loss) includes a pre-tax charge of $4.6 million for severance charges.(b) Net income (loss) includes (a) pre-tax charges of $7.7 million for severance and other one-time employment related charges, (b) $1.8 million to write-off deferred financing charges in connection with the refinancing of our credit facility (c) a $9,000,000 inventory writedown as a result of the Company's decision to modify its strategy on the disposition of inventory to accelerate inventory clearing at the end of each selling season and (d) a tax provision of $6.5 million on a pre-tax loss of $14.2 million as a result of providing a valuation allowance against deferred tax assets at February 1, 2003. F-19SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS beginning charged to cost charged to other ending balance and expenses accounts deductions balance ($ in thousands) Inventory reserve----------------- (deducted from inventories)fiscal year ended:February 1, 2003 $8,367 $4,053 (a) $ -- $ -- $12,420February 2, 2002 7,360 1,007 (a) -- -- 8,367February 3, 2001 4,447 2,913 (a) -- -- 7,360Allowance for sales returns--------------------------- (included in other current liabilities)fiscal year ended:February 1, 2003 $6,475 $(1,162)(a) $ -- $ -- $5,313February 2, 2002 6,530 (55)(a) -- -- 6,475February 3, 2001 5,011 1,519(a) -- -- 6,530(a) 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. F-20Independent Auditors' ReportThe Board of Directors and StockholdersJ. Crew Operating Corp. and Subsidiaries:We have audited the consolidated financial statements of J. Crew Operating Corp.and subsidiaries (the "Company") as listed in the accompanying Index. Inconnection with our audits of the consolidated financial statements, we alsohave audited the financial statement schedule listed in the accompanying index.These consolidated 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 auditing standards generally acceptedin the United States of America. Those standards require that we plan andperform the audit to obtain reasonable assurance about whether the financialstatements are free of material misstatement. An audit includes examining, on atest basis, evidence supporting the amounts and disclosures in the financialstatements. An audit also includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallfinancial statement presentation. We believe that our audits provide areasonable 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 OperatingCorp. and subsidiaries as of February 1, 2003 and February 2, 2002 and theresults of their operations and their cash flows for each of the years in thethree-year period ended February 1, 2003, in conformity with accountingprinciples generally accepted in the United States of America. Also, in ouropinion, the related financial statement schedule, when considered in relationto the basic consolidated financial statements taken as a whole, presentsfairly, in all material respects, the information set forth therein. KPMG LLPMarch 25, 2003,except as to note 15, the date of which isApril 4, 2003 F-21 J. CREW OPERATING CORP. AND SUBSIDIARIES Consolidated Balance Sheets February 1, February 2, Assets 2003 2002 ------ ---- ---- (in thousands) Current assets: Cash and cash equivalents $ 18,895 $ 16,201 Merchandise inventories 107,318 138,918 Prepaid expenses and other current assets 24,886 27,026 Refundable income taxes 6,278 -- ---------- -------- Total current assets 157,377 182,145 ---------- --------Property and equipment - at cost: Land 1,710 1,610 Buildings and improvements 11,705 11,700 Furniture, fixtures and equipment 102,108 105,292 Leasehold improvements 182,226 170,195 Construction in progress 3,161 4,903 ---------- -------- 300,910 293,700 Less accumulated depreciation and amortization 129,363 106,427 ---------- -------- 171,547 187,273 ---------- --------Other assets 13,646 12,310 ---------- -------- Total assets $ 342,570 $381,728 ========== ======== Liabilities and Stockholder's Equity ------------------------------------Current liabilities: Accounts payable $ 54,921 $ 66,703 Other current liabilities 56,255 61,788 Income taxes payable 2,978 10,109 Deferred income taxes 910 5,604 ---------- -------- Total current liabilities 115,064 144,204 ---------- --------Long-term debt 150,000 150,000 ---------- --------Deferred credits and other long-term liabilities 65,141 67,235 ---------- --------Due to J.Crew Group, Inc. 2,040 1,142 ---------- --------Stockholder's equity 10,325 19,147 ---------- -------- Total liabilities and stockholder's equity $ 342,570 $381,728 ========== ========See accompanying notes to consolidated financial statements. F-22 J. CREW OPERATING CORP. AND SUBSIDIARIES Consolidated Statements of Operations Years ended ----------- February 1, February 2, February 3, ----------- ---------- ----------- 2003 2002 2001 ---- ---- ---- (in thousands) Revenues: Net sales $732,279 $741,280 $ 787,658 Other 34,103 36,660 38,317 -------- -------- --------- 766,382 777,940 825,975Operating costs and expenses: Cost of goods sold, including buying and occupancy costs 478,700 462,371 463,909 Selling, general and administrative expenses 291,054 294,907 301,216 Write down of assets and other charges in connection with discontinuance of Clifford & Wills -- - 4,130 -------- -------- --------- 769,754 757,278 769,255 -------- -------- --------- Income/(loss) from operations (3,372) 20,662 56,720Interest expense - net 23,200 20,890 22,787 Income/(loss) before income taxes (26,572) (228) 33,933(Provision) benefit for income taxes 17,750 167 (12,180) -------- -------- --------- Net income/(loss) $ (8,822) $ (61) $ 21,753 ======== ======== =========See accompanying notes to consolidated financial statements. F-23 J. CREW OPERATING CORP. AND SUBSIDIARIES Consolidated Statements of Cash Flows Years ended ----------- February 1, February 2, February 3, ----------- ----------- ----------- 2003 2002 2001 ---- ---- ---- (in thousands) Cash flows from operating activities:Net income/(loss) $ (8,822) $ (61) $ 21,753Adjustments to reconcile net income/(loss) to net cash provided by operating activities: Depreciation and amortization 34,451 31,718 22,600 Amortization of deferred financing costs 4,202 1,770 2,548 Deferred income taxes (4,694) 1,873 4,706 Non-cash compensation expense (1,053) 913 -- Write down of assets and other charges in connection with discontinued catalog -- -- 4,130Changes in operating assets and liabilities: Merchandise inventories 31,600 1,749 (10,739) Prepaid expenses and other current assets 2,140 (3,286) 6,343 Other assets (2,470) (3,416) (2,781) Net assets held for disposal -- -- 4,797 Accounts payable (11,782) 16,998 8,754 Other liabilities (3,835) (13,671) 5,407 Income taxes payable (13,409) (8,741) 2,894 --------- -------- --------- Net cash provided by operating activities 26,368 25,846 70,412 --------- -------- ---------Cash flows from investing activities: Capital expenditures (26,920) (61,862) (55,694) Proceeds from construction allowances 6,502 19,287 13,519 --------- -------- --------- Net cash used in investing activities (20,418) (42,575) (42,175) --------- -------- ---------Cash flows from financing activities: Costs incurred in refinancing Credit Facility (3,256) -- -- Repayment of long-term debt -- -- (34,000) --------- -------- --------- Net cash used in financing activities (3,256) -- (34,000) --------- -------- --------- Increase (decrease) in cash and cash equivalents 2,694 (16,729) (5,763)Cash and cash equivalents at beginning of year 16,201 32,930 38,693 --------- -------- ---------Cash and cash equivalents at end of year $ 18,895 $ 16,201 $ 32,930 ========= ======== =========See accompanying notes to consolidated financial statements. F-24 J. CREW OPERATING CORP. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended February 1, 2003, February 2, 2002 and February 3, 2001(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 Operating Corp. ("Operating Corp.") and its wholly-owned subsidiaries (collectively, the "Company"). Operating Corp. is a wholly owned subsidiary of J.Crew Group, Inc. ("Holdings"). 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, shoes and accessories under the J.Crew brand name. The Company's products are marketed, primarily in the United States, through various channels of distribution, including retail and factory 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) Segment Information The Company operates in one reportable business segment. All of the Company's identifiable assets are located in the United States. Export sales are not significant. (d) Fiscal Year The Company's fiscal year ends on the Saturday closest to January 31. The fiscal years 2002, 2001, and 2000 ended on February 1, 2003 (52 weeks), February 2, 2002 (52 weeks), and February 3, 2001 (53 weeks). (e) 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 $11,224,000 and $7,895,000 at February 1, 2003 and February 2, 2002, are stated at cost, which approximates market value. (f) Merchandise Inventories Merchandise inventories are stated at the lower of average cost or market. The Company capitalizes certain design, purchasing and warehousing costs in inventory. F-25 J. CREW OPERATING CORP. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended February 1, 2003, February 2, 2002 and February 3, 2001 (g) 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 February 1, 2003 and February 2, 2002 were $6,197,000 and $7,959,000. Catalog costs, which are reflected in selling and administrative expenses, for the fiscal years 2002, 2001, and 2000 were $56,695,000, $65,477,000 and $69,000,000. All other advertising costs, which are not significant, are expensed as incurred. (h) Property and Equipment Property and equipment are stated at cost and are depreciated over the estimated useful lives by the straight-line method. Buildings and improvements are depreciated over estimated useful lives of twenty years. Furniture, fixtures and equipment are depreciated over 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 million and $8.5 million of system development costs were capitalized in fiscal years 2002 and 2001. 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. (i) Debt Issuance Costs Debt issuance costs (included in other assets) of $5,435,000 and $5,195,000 at February 1, 2003 and February 2, 2002 are amortized over the term of the related debt agreements. (j) Income Taxes The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes". This statement requires the use of the asset and liability method of accounting for income taxes. Under the asset and 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. 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. (k) 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 F-26 J. CREW OPERATING CORP. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended February 1, 2003, February 2, 2002 and February 3, 2001 subsequent to the balance sheet date that relate to sales prior to the balance sheet date. Amounts billed to customers for shipping and handling fees related to catalog and internet sales are included in other revenues at the time of shipment. (l) Store Preopening Costs Costs associated with the opening of new retail and outlet stores are expensed as incurred. (m) Derivative Financial Instruments Derivative financial instruments are used by the Company from time to time 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. (n) 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. (o) Impairment of Long-Lived Assets 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. (p) 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 or in excess of the fair market price at the date of grant. If the Company had adopted the fair value recognition provisions of SFAS No. 123, the effect on net income would not be material. F-27 J. CREW OPERATING CORP. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended February 1, 2003, February 2, 2002 and February 3, 2001(2) Events of September 11, 2001 The terrorist events of September 11, 2001 resulted in the destruction of the Company's retail store located at the World Trade Center in New York City, resulting in the loss of inventories and store fixtures, equipment and leasehold improvements. These losses and the resulting business interruption are covered by insurance policies maintained by the Company. The statement of operations for the year ended February 2, 2002 included losses of $1.9 million relating to inventories and stores fixtures, equipment and leasehold improvements. Insurance recoveries in fiscal 2001 were recorded to the extent of the losses recognized. The statement of operations for the year ended February 1, 2003 includes a gain of $1,420,000, as a result of additional insurance recoveries during fiscal 2002. This gain was classified as a reduction of selling, general and administrative expenses. Additional insurance recoveries, which may be received in the future including recoveries for business interruption, will be recorded at the time of settlement.(3) Disposal of a Business In 1998, management of the Company made a decision to exit the catalog and outlet store operations of Clifford & Wills ("C&W"). Revenues and expenses of C&W for fiscal 2000 were not material and as a result have been netted in the accompanying consolidated statements of operations. 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 C&W outlet stores and conduct other liquidation sales of inventories through December 31, 2000. After consideration of the proceeds from the sale of assets and other terms of the agreement the Company provided $4,000,000 to write down inventories to net realizable value as of January 29, 2000. At February 3, 2001, the Company determined that the realizable value of the remaining net assets of C&W, primarily inventories, was less than their carrying amounts and an additional charge of $4,130,000 was taken.(4) Other Current Liabilities Other current liabilities consist of: February 1, February 2, 2003 2002 ---- ---- Customer liabilities $ 9,993,000 $11,381,000 Accrued catalog and marketing costs 2,536,000 3,655,000 Taxes, other than income taxes 2,670,000 2,930,000 Accrued interest 4,390,000 4,690,000 Accrued occupancy 1,024,000 1,036,000 Reserve for sales returns 5,313,000 6,475,000 Accrued compensation 7,475,000 1,697,000 Other 22,854,000 29,924,000 ------------ ------------ $56,255,000 $61,788,000 ------------ ------------ F-28 J. CREW OPERATING CORP. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended February 1, 2003, February 2, 2002 and February 3, 2001(5) Lines of Credit On December 23, 2002 the Company entered into a Loan and Security Agreement with Wachovia Bank, N.A., as arranger, Congress Financial Corporation, as administrative and collateral agent, and a syndicate of lenders which provides for a maximum credit availability of up to $180.0 million (the "Congress Credit Facility"). The Congress Credit Facility replaced a revolving credit facility which was scheduled to expire in October 2003. The Congress Credit Facility provides for revolving loans of up to $160.0 million; supplemental loans of up to $20.0 million each year during the period from April 15 to September 15; and letter of credit accommodations. The Congress Credit Facility expires in December 2005. The total amount of availability is subject to limitations based on specified percentages of eligible receivables, inventories and real property. Real property availability is limited to $5.8 million and will be reduced at a rate of $97,000 per month commencing June 1, 2003. Borrowings are secured by a perfected first priority security interest in all the assets of the Company's subsidiaries and bear interest, at the Company's option, at the prime rate plus 0.5% or the Eurodollar rate plus 2.5%. Supplemental loans bear interest at the prime rate plus 3.0%. The Congress Credit Facility includes restrictions, including the incurrence of additional indebtedness, the payment of dividends and other distributions, the making of investments, the granting of loans and the making of capital expenditures. The Company is required to maintain minimum levels of earnings before interest, taxes, depreciation, amortization and certain non-cash items, ("EBITDA") if excess availability is less than $15.0 million for any 30 consecutive day period. The Congress Credit Facility was amended on February 7, 2003 to provide for an exclusion from the definition of consolidated net income of severance and other one-time employment-related charges of up to $6.7 million in the last quarter of fiscal 2002 and $3.0 million in the first quarter of fiscal 2003. Maximum borrowings under revolving credit agreements were $63,000,000, $95,000,000 and $34,000,000 during fiscal years 2002, 2001 and 2000 and average borrowings were $40,400,000, $43,100,000 and $9,800,000. There were no borrowings outstanding at February 1, 2003 and February 2, 2002. Outstanding letters of credit established primarily to facilitate international merchandise purchases at February 1, 2003 and February 2, 2002 amounted to $45,900,000 and $46,300,000.(6) Long-Term Debt Long term debt consists of: February 1, February 2, 2003 2002 ---- ---- 10-3/8% senior subordinated notes $150,000,000 $150,000,000 ============ ============ 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% of principal in 2002 to 100% in 2005 and thereafter. F-29 J. CREW OPERATING CORP. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended February 1, 2003, February 2, 2002 and February 3, 2001(7) Commitments and Contingencies (a) Operating Leases As of February 1, 2003, 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 through 2014. At February 1, 2003 aggregate minimum rentals in future periods are, as follows: Fiscal year Amount ----------- ------ 2003 52,372,000 2004 49,867,000 2005 47,396,000 2006 45,192,000 2007 43,636,000 Thereafter 143,875,000 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 2002, 2001, and 2000 was $50,403,000, $46,573,000 and $45,138,000 including contingent rent based on store sales of $1,187,000, $1,023,000, and $1,974,000. (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.(8) 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 $1,834,000, $1,334,000 and $1,241,000 for fiscal 2002, 2001 and 2000.(9) License Agreement The Company has a licensing agreement through January 2005 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 2002, 2001, and 2000 was $2,280,000, $2,560,000 and $3,020,000. F-30 J. CREW OPERATING CORP. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended February 1, 2003, February 2, 2002 and February 3, 2001(10) Interest Expense - Net Interest expense, net consists of the following: 2002 2001 2000 ---- ---- ----- Interest expense $19,027,000 $19,415,000 $20,780,000 Amortization of deferred financing costs 4,202,000 1,770,000 2,548,000 Interest income (29,000) (295,000) (541,000) ------------ ------------ ------------ Interest expense, net $23,200,000 $20,890,000 $22,787,000 ------------ ------------ ------------ Deferred financing costs of $1,800,000 were written off in connection with the refinancing of our revolving credit facility in December 2002.(11) Other Revenues Other revenues consist of the following: 2002 2001 2000 ---- ---- ---- Shipping and handling fees $ 31,823,000 $ 34,100,000 $ 35,297,000 Royalties 2,280,000 2,560,000 3,020,000 ------------ ------------ ------------ $ 34,103,000 $ 36,660,000 $ 38,317,000 ============ ============ ============(12) 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 $138,110,000 and $119,754,000 at February 1, 2003 and February 2, 2002, and is based on dealer quotes or quoted market prices of the same or similar instruments. The carrying amount of long-term debt was $150,000,000 at February 1, 2003 and February 2, 2002. The carrying amount 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.(13) Income Taxes The income tax provision/benefit consists of: 2002 2001 2000 ---- ---- ---- Current: Foreign $ 193,000 $ 260,000 $ 300,000 Federal (13,449,000) (2,400,000) 6,253,000 State and local 200,000 100,000 920,000 -------------- ------------ ------------ (13,056,000) (2,040,000) 7,473,000 -------------- ------------ ------------ Deferred (4,694,000) 1,873,000 4,707,000 -------------- ------------ ------------ Total $ (17,750,000) $ (167,000) $ 12,180,000 ============== ============ ============ F-31 J. CREW OPERATING CORP. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended February 1, 2003, February 2, 2002 and February 3, 2001 A reconciliation between the provision/(benefit) for income taxes based on the U.S. Federal statutory rate and the Company's effective rate is as follows. 2002 2001 2000 -------- -------- -------- Federal income tax rate (35.0)% (35.0)% 35.0% State and local income taxes, net of federal benefit -- 134.6 3.2 Reversal of prior year tax accruals (38.6) -- -- Nondeductible expenses and other 6.8 (172.8) (2.3) -------- -------- -------- Effective tax rate (66.8)% (73.2)% 35.9% ======== ======== ======== The tax effect of temporary differences which give rise to deferred tax assets and liabilities are: February 1, February 2, 2003 2002 ------------ ------------ Deferred tax assets: Federal NOL carryforwards $ 5,040,000 $ -- State and local NOL carryforwards 1,400,000 1,900,000 Reserve for sales returns 2,202,000 2,603,000 Other 3,873,000 6,637,000 ------------ ------------ 12,515,000 11,140,000 ------------ ------------ Deferred tax liabilities: Prepaid catalog and other prepaid expenses (9,872,000) (8,841,000) Difference in book and tax basis for property and equipment (3,553,000) (7,903,000) ------------ ------------ (13,425,000) (16,744,000) ------------ ------------ Net deferred income tax liabilities $ (910,000) $ (5,604,000) ============ ============ The Company has state and local income tax net operating loss carryforwards of varying amounts.(14) Stock Compensation Plans 1997 Stock Option Plan Under the terms of the 1997 Stock Option Plan, an aggregate of 1,910,000 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. F-32 J. CREW OPERATING CORP. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended February 1, 2003, February 2, 2002 and February 3, 2001 A summary of stock option activity for the 1997 Plan was, as follows: 2002 2001 2000 ---- ---- ---- Weighted Weighted Weighted -------- -------- -------- average average average ------- ------- ------- exercise exercise exercise -------- -------- -------- Shares price Shares price Shares price ---------- ------- ---------- ------- --------- -------- Outstanding, beginning of year 1,808,790 $ 9.97 1,788,750 $ 9.15 1,532,800 $ 8.87 Granted 395,500 7.64 283,000 14.53 374,700 10.17 Exercised -- -- -- -- (2,000) 6.82 Cancelled (597,560) 10.29 (262,960) 9.31 (116,750) 8.72 ---------- ------- ---------- ------- --------- -------- Outstanding, end of year 1,606,730 $ 9.27 1,808,790 $ 9.97 1,788,750 $ 9.15 ---------- ------- ---------- ------- ========= ======== Options exercisable at end of year 842,340 $ 9.81 728,950 $ 9.21 583,000 $ 9.24 ========== ======= ========== ======= ========= ======== 2003 Equity Incentive Plan In January 2003, the Board of Directors of Holdings approved the adoption of the 2003 Equity Incentive Plan. Under the terms of the 2003 Plan, an aggregate of 4,798,160 shares of common stock are available for award to key employees and consultants in the form of non-qualified stock options and restricted shares as follows: . 1,115,812 shares are reserved for the issuance of stock options at an exercise price of $6.82 of fair market value, whichever is greater; . 1,115,812 shares are reserved for the issuance of stock options at an exercise price of $25.00 or fair market value, whichever is greater; . 1,115,812 shares are reserved for the issuance of stock options at an exercise price of $35.00 or fair market value, whichever is greater; . 1,450,724 shares are reserved for the issuance of restricted shares. The options have terms of ten years and become exercisable over the period provided in each grant agreement. During fiscal 2002, Holdings granted 836,889 options with an exercise price of $6.82, 1,015,425 options with an exercise price of $25.00 and 1,015,425 options with an exercise price of $35.00, and issued 1,004,266 restricted shares under the 2003 plan.(15) Stockholder's Equity The Company has authorized 100 shares of common stock par value $1 per share, all of which was issued and outstanding at February 1, 2003 and February 2, 2002. A reconciliation of stockholder's equity is, as follows: Year ended February 1, February 2, 2003 2002 ------------- ----------- Balance, beginning of year $ 19,147,000 $ 19,208,000Net loss (8,822,000) (61,000) ------------- ------------Balance, end of year $ 10,325,000 $ 19,147,000 ============ ============(16) Subsequent Events TPG - MD Investment Loans On February 4, 2003, Operating Corp. entered into a credit agreement with TPG-MD Investment, LLC, a related party, which provides for a Tranche A loan to Operating Corp. in an aggregate principal amount of $10.0 million and a Tranche B loan to Operating Corp. in an aggregate principal amount of $10.0 million. The loans are due in February 2008 and bear interest at 5.0% per annum payable semi-annually in arrears on January 31 and July 31, commencing on July 31, 2003. Interest will compound and be capitalized and added to the principal amount on each interest payment date. Payment of the loans is subordinated in right of payment to the prior payment of all senior debt and on the same terms as Operating Corp's 10-3/8% senior subordinated notes due 2008. F-33 J. CREW OPERATING CORP. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended February 1, 2003, February 2, 2002 and February 3, 2001 Exchange Offer On April 4, 2003, Holdings commenced through J. Crew Intermediate LLC, its newly formed wholly-owned subsidiary ("Intermediate"), an offer to exchange the outstanding 13 1/8% Senior Discount Debentures due 2008 issued by Holdings for Intermediate's unissued 16.0% Senior Discount Contingent Principal Notes due 2008. Holdings will not pay accrued and unpaid interest on the existing debentures on the scheduled interest payment date of April 15, 2003. Rather, Holdings will pay such interest on the settlement date of the exchange offer (which is expected to occur on or about May 6, 2003) together with interest thereon at a rate of 13 1/8% per annum from April 15, 2003 to the settlement date, to the holders of the existing debentures who do not tender their existing debentures in the exchange offer. Congress Credit Facility The Congress Credit Facility was amended on April 4, 2003 to (a) consent to the formation of J.Crew Intermediate LLC and the Exchange Offer; (b) carve-out a $9.0 million one-time charge for non-current inventory from the EBITDA covenant; (c) modify required EBITDA covenant levels and (d) eliminate the supplemental loan availability in fiscal 2003.(17) Recent Accounting Pronouncements In June 2001, the Financial Accounting Standards Board, ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 143, "Accounting for Asset Retirement Obligations". SFAS No. 143 requires the Company to record the fair value of an asset retirement obligation as a liability in the period in which it incurs a legal obligation associated with the retirement of tangible long-lived assets and a corresponding asset which is depreciated over the life of the asset. Subsequent to the initial measurement of the asset retirement obligation, the obligation will be adjusted at the end of each period to reflect the passage of time and changes in the estimated future cash flows underlying the obligation. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. Management does not believe that the adoption of SFAS No. 143 will have a significant impact on the Company's financial statements. In July 2001, the FASB issued SFAS No. 141, "Business Combinations" and SFAS No. 142., "Goodwill and Other Intangible Assets". SFAS No. 141 eliminates the pooling-of-interests method of accounting for business combinations initiated after June 30, 2001 and modifies the application of the purchase accounting method effective for transactions that are completed after June 30, 2001. SFAS No. 142 eliminated the requirement to amortize goodwill and intangible assets having indefinite useful lives but requires testing at least annually for impairment. Intangible assets that have finite lives will continue to be amortized over their useful lives. SFAS No. 142 applies to goodwill and intangible assets arising from transactions completed before and after the statement's effective dated of January 1, 2002. The adoption of these statements in fiscal 2002 did not have any effect on the Company's financial statements. In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". SFAS No. 144 addresses financial accounting and reporting for the impairment of disposal of long-lived assets and requires companies to separately report discontinued operations and extends that reporting to a component of an entity that either has been disposed of or is classified as held for sale. This statement requires F-34 J. CREW OPERATING CORP. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended February 1, 2003, February 2, 2002 and February 3, 2001 that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. SFAS No. 144 was effective for fiscal years beginning after December 15, 2001. The adoption of SFAS No. 144 did not have a significant impact on the Company's financial statements. EITF Issue No. 01-9 "Accounting for Consideration Given to a Customer or a Reseller of the Vendor's Products" (formerly EITF Issue 00-14) became effective in the first quarter of fiscal 2002. This EITF addresses the accounting for and classification of consideration given to a customer from a vendor in connection with the purchase or promotion of the vendor's product. The adoption of the EITF did not have a significant effect on the Company's financial statements. In June 2002, the FASB issued SFAS No. 146 - "Accounting for Costs Associated with Exit or Disposal Activities". SFAS No. 146 addresses accounting and reporting for costs associated with exit or disposal activities. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized and measured initially at fair value when the liability is incurred. SFAS No. 146 is effective for exit or disposal activities that are initiated after December 31, 2002. The adoption of SFAS No. 146 in the fourth quarter of 2002 did not have an impact on the Company's financial statements. In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB statements No. 4, 44, and 64, Amendment of FASB Statement No 13, and Technical Corrections". SFAS No. 145 primarily affects the reporting requirements and classification of gains and losses from the extinguishment of debt, rescinds the transitional accounting requirement for intangible assets of motor carriers, and requires that certain lease modifications with economic effects similar to sale-leaseback transactions be accounted for in the same manner as sale-leaseback transactions. SFAS No. 145 is effective for financial statements issued after April 2003, with the exception of the provisions affecting the accounting for lease transactions, which should be applied for transactions entered into after May 15, 2002, and the provisions affecting classification of gains and losses from the extinguishment of debt, which should be applied in fiscal years after May 15, 2002. Management has classified the loss from the refinancing of its credit facility in December 2002 as a component of interest expense in the Company's financial statements. In November, 2002, the FASB issued FASB interpretation ("FIN") No. 45 - "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others". This interpretation elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued and requires that they be recorded at fair value. The initial recognition and measurement provisions of this interpretation are to be applied on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosure requirements of this interpretation are effective for periods ending after December 15, 2002. In December 2002, the FASB issued No. 148, - "Accounting for Stock-Based Compensation - Transition and Disclosure, an amendment of FASB Statement No. 123" ("SFAS 148"). This Statement amends FASB Statement No. 123, Accounting for Stock-Based Compensation, to provide alternate methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. This Statement also amends the disclosure requirements of Statement 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The amendments to Statement 123 regarding disclosure are effective for fiscal years ending after December 15, 2002. The Company applies APB Opinion No. 25 in accounting for its employee stock option plans. In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable Interest Entities - an Interpretation of Accounting Research Bulletin No. 51". FIN No. 46 requires unconsolidated variable interest entities to be F-35 J. CREW OPERATING CORP. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended February 1, 2003, February 2, 2002 and February 3, 2001 consolidated by their primary beneficiaries if the entities do not effectively disperse the risks and rewards of ownership among their owners and other parties involved. The provisions of FIN No. 46 are applicable immediately to all variable interest entities created after January 31, 2003 and variable interest entities in which a company obtains an interest after that date. For variable interest entities created before January 31, 2003, the provisions of this interpretation are effective July 1, 2003. The adoption of FIN No. 46 is not expected to have any effect on the Company's financial statements.(17) Quarterly Financial Information (Unaudited) ($ in millions) 13 weeks 13 weeks 13 weeks 13 weeks 52 weeks ended ended ended ended ended 5/4/02 (a) 8/3/02 11/2/02 2/1/03 (b) 2/1/03 ------ ------ ------- ------ ------ Net sales $ 157.9 $ 160.9 $ 181.9 $ 231.6 $ 732.3Gross profit 67.0 61.0 75.9 83.8 287.7Net income (loss) $ (9.1) $ (4.1) $ 2.1 $ 2.3 $ (8.8) 13 weeks 13 weeks 13 weeks 14 weeks 53 weeks ended ended ended ended ended 5/5/01 8/4/01 11/3/01 2/2/02 2/2/02 ------ ------ ------- ------ ------ Net sales $ 158.9 $ 160.5 $ 187.1 $ 234.8 $ 741.3Gross profit 68.2 60.5 82.8 104.1 315.6Net income (loss) $ (7.1) $ (6.1) $ 2.7 $ 10.4 $ (.1)(a) Net income (loss) includes a pre-tax charge of $4.6 million for severance charges.(b) Net income (loss) includes pre-tax charges of (a) $7.7 million for severance and other one-time employment related charges, (b) $1.8 million to write-off deferred financing charges in connection with the refinancing of our credit facility and (c) a $9,000,000 inventory writedown as a result of the Company's decision to modify its strategy on the disposition of inventory to accelerate inventory clearing at the end of each selling season and (d) a tax benefit of $11.8 million on a pre-tax loss of $9.5 million as a result of the reversal of $10.3 million of prior year tax accruals at February 1, 2003. F-36SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS beginning charged to cost charged to other ending balance and expenses accounts deductions balance ($ in thousands) Inventory reserve----------------- (deducted from inventories)fiscal year ended:February 1, 2003 $ 8,367 $ 4,053 (a) $ -- $ -- $ 12,420February 2, 2002 7,360 1,007 (a) -- -- 8,367February 3, 2001 4,447 2,913 (a) -- -- 7,360Allowance for sales returns--------------------------- (included in other current liabilities)fiscal year ended:February 1, 2003 $ 6,475 $(1,162)(a) $ -- $ -- $ 5,313February 2, 2002 6,530 (55)(a) -- -- 6,475February 3, 2001 5,011 1,519 (a) -- -- 6,530(a) 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. F-37 EXHIBIT INDEX Articles of Incorporation and By-Laws3.1 Restated Certificate of Incorporation of J. Crew Group, Inc. Incorporated by reference to Exhibit 3.1 to the Company's Registration Statement on Form S-4, File No. 333-42427, filed December 16, 1997 (the "Group Registration Statement").3.2 By-laws of J. Crew Group, Inc., as amended. Incorporated by reference to Exhibit 3.2 to the Company's Annual Report on Form 10-K for the fiscal year ended February 3, 2001.3.3 Certificate of Incorporation of J.Crew Operating Corp., as amended. Incorporated by reference to Exhibits 3.1 and 3.2 to the Company's Registration Statement on Form S-4, File No. 333-4243, filed December 16, 1997 (the "Operating Registration Statement").3.4 By-laws of J.Crew Operating Corp., as amended. Incorporated by reference to Exhibit 3 to the Company's Quarterly Report on Form 10-Q for the period ended October 31, 1998 and Exhibit 3.14 to the Operating Registration Statement. Instruments Defining the Rights of Security Holders, Including Indentures4.1 Indenture, dated as of October 17, 1997, between J.Crew Group, Inc. and State Street Bank and Trust Company. Incorporated by reference to Exhibit 4.3 to the Group Registration Statement.4.2 Indenture, dated as of October 17, 1997, between J.Crew Operating Corp. and State Street Bank and Trust Company. Incorporated by reference to Exhibit 4.1 to the Operating Registration Statement.4.3 Registration Rights Agreement, dated as of October 17, 1997, by and among the Company, Donaldson, Lufkin & Jenrette Securities Corporation and Chase Securities Inc. Incorporated by reference to Exhibit 4.10 to the Group Registration Statement.4.4 Stockholders' Agreement, dated as of October 17, 1997, between the Company and the Stockholder signatories thereto. Incorporated by reference to Exhibit 4.1 to the Group Registration Statement.4.5(a) Stockholders' Agreement, dated as of October 17, 1997, among the Company, TPG Partners II, L.P. and Emily Woods. Incorporated by reference to Exhibit 10.1 to the Group Registration Statement.4.5(b) Amendment to Stockholders' Agreement, dated as of February 3, 2003, among the Company, TPG Partners II, L.P. and Emily Woods. Incorporated by reference to Exhibit 4.1 of the Company's Form 8-K filed on February 7, 2003.4.6* Stockholders' Agreement, dated as of September 9, 2002, between the Company, TPG Partners II, L.P. and Kenneth Pilot.4.7 Stockholders' Agreement, dated as of January 24, 2003, among the Company, TPG Partners II, L.P. and Millard S. Drexler. Incorporated by reference to Exhibit 4.1 of the Company's Form 8-K filed on February 3, 2003.4.8 Stockholders' Agreement, dated as of February 20, 2003, among the Company, TPG Partners II, L.P. and Jeffrey A. Pfeifle. Incorporated by reference to Exhibit 4.1 of the Company's Form 8-K filed on February 26, 2003.4.9 Stockholders' Agreement, dated as of February 12, 2003, among the Company, TPG Partners II, L.P. and Scott Gilbertson. Incorporated by reference to Exhibit 4.1 of the Company's Form 8-K filed on February 14, 2003. Material Contracts10.1(a) Loan and Security Agreement, dated as of December 23, 2002, by and among J. Crew Operating Corp., J. Crew Inc., Grace Holmes, Inc. and H.F.D. No. 55, Inc. as Borrowers, J. Crew Group, Inc. and J. Crew International, Inc. as Guarantors, Wachovia Bank, National Association as Arranger, Congress Financial Corporation as Administrative and I-1 Collateral Agent, and the Lenders. Incorporated by reference to Exhibit 10.1 of the Company's Form 8-K filed on December 27, 2002.10.1(b) Amendment No. 1, dated as of February 7, 2003, to the Loan and Security Agreement. Incorporated by reference to Exhibit 10.1 of the Company's Form 8-K filed on February 14, 2003.10.1(c) Amendment No. 2, dated as of April 4, 2003, to the Loan and Security Agreement. Incorporated by reference to Exhibit 10.1 of the Company's Form 8-K filed on April 8, 2003.10.2 Credit Agreement, dated as of February 4, 2003, by and between J. Crew Group, Inc., J. Crew Operating Corp., and certain subsidiaries thereof, and TPG-MD Investment, LLC. Incorporated by reference to Exhibit 10.1 of the Company's Form 8-K filed on February 7, 2003. Management Contracts and Compensatory Plans and Arrangements10.3 Amended and Restated J. Crew Group, Inc. 1997 Stock Option Plan. Incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the period ended August 3, 2002.10.4* J. Crew Group, Inc. 2003 Equity Incentive Plan.10.5(a) Employment Agreement, dated May 3, 1999, between the Company and Mark Sarvary. Incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the period ended May 1, 1999.10.5(b) Letter Agreement, dated August 9, 1999, between the Company and Mark Sarvary. Incorporated by reference to Exhibit 10.5(b) to the Company's Annual Report on Form 10-K for the fiscal year ended January 29, 2000.10.5(c) Letter Agreement, dated January 15, 2002, between the Company and Mark Sarvary. Incorporated by reference to Exhibit 10.5(c) of the Company's Annual Report on Form 10-K for the fiscal year ended February 2, 2002.10.5(d)* Separation Agreement, dated April 29, 2002, between the Company and Mark Sarvary.10.6(a) Employment Agreement, dated May 17, 2001, between the Company and Michael Scandiffio. Incorporated by reference to Exhibit 10.12 of the Company's Annual Report on Form 10-K for the fiscal year ended February 2, 2002.10.6(b)* Separation Agreement, dated October 17, 2002, between the Company and Michael Scandiffio.10.7(a) Employment Agreement, dated December 12, 2001, between the Company and Blair Gordon. Incorporated by reference to Exhibit 10.13 of the Company's Annual Report on Form 10-K for the fiscal year ended February 2, 2002.10.7(b)* Separation Agreement, dated January 30, 2003, between the Company and Blair Gordon.10.8(a) Employment Agreement, dated August 26, 2002, between the Company and Kenneth Pilot. Incorporated by reference to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the period ended August 3, 2002.10.8(b)* Separation Agreement, dated January 29, 2003, between the Company and Kenneth Pilot.10.9* Services Agreement, dated January 24, 2003, between the Company, Millard S. Drexler, Inc. and Millard S. Drexler. I-210.10* Employment Agreement, dated January 24, 2003, between the Company and Jeffrey A. Pfeifle.10.11* Employment Agreement, dated January 27, 2003, between the Company and Scott Gilbertson.10.12* Separation Agreement, dated March 7, 2003, between the Company and Walter Killough. Other Exhibits21.1* Subsidiaries of J. Crew Group, Inc.23.1* Consent of KPMG LLP, Independent Auditors.99.1* Certification of Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes - Oxley Act of 2002.99.2* Certification of Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes - Oxley Act of 2002._____________* Filed herewith I-3 Exhibit 4.6 STOCKHOLDERS' AGREEMENT STOCKHOLDERS' AGREEMENT (this "Agreement"), dated as of September 9,2002, between J. Crew Group, Inc. (the "Company"), TPG Partners II, L.P. ("TPG")and Kenneth S. Pilot (the "Stockholder"). WHEREAS, the Stockholder is an employee of the Company and J. CrewOperating Corp., a wholly-owned subsidiary of the Company (the "Subsidiary"), insuch capacity is on the date hereof being, and may in the future be, grantedcertain options (the "Options") to purchase shares of common stock, $.01 parvalue per share, of the Company ("Common Stock") pursuant to the Company's 1997Stock Option Plan (the "Option Plan") or the Employment Agreement, dated August26, 2002, among the Stockholder, the Company and the Subsidiary (the "EmploymentAgreement"), and is being granted pursuant to the Employment Agreement certainGranted Shares and Restricted Shares (each as defined therein) and may begranted additional shares of Common Stock or rights to purchase Common Stock inthe future in connection with his employment; and WHEREAS, the Stockholder and the Company desire to enter into thisAgreement and to have this Agreement apply to the shares of Common Stock to bepurchased or granted pursuant to the Option Plan or the Employment Agreement,and to any shares of Common Stock acquired after the date hereof by theStockholder from whatever source, subject to any future agreement between theCompany and the Stockholder to the contrary (in the aggregate, the "Shares"). NOW THEREFORE, in consideration of the premises hereinafter set forth,and other good and valuable consideration, the receipt of which is herebyacknowledged, the parties hereto agree as follows. 1. Investment. The Stockholder represents that the Shares are beingacquired for investment and not with a view toward the distribution thereof. 2. Issuance of Shares. The Stockholder acknowledges and agrees that thecertificate for the Shares shall bear the following legends (except that thesecond paragraph of this legend shall not be required after the Shares have beenregistered and except that the first paragraph of this legend shall not berequired after the termination of this Agreement): The shares represented by this certificate are subject to the terms and conditions of a Stockholders' Agreement dated as of September 9, 2002 and may not be sold, transferred, hypothecated, assigned or encumbered, except as may be permitted by the aforesaid Agreement. A copy of the Stockholders' Agreement may be obtained from the Secretary of the Company. The shares represented by this certificate have not been registered under the Securities Act of 1933. The shares have been acquired for investment and may not be sold, transferred, pledged or hypothecated in the absence of an effective registration statement for the shares under the Securities Act of 1933 or an opinion of counsel for the Company that registration is not required under said Act. Upon the termination of this Agreement, or upon registration of theShares under the Securities Act of 1933 (the "Securities Act"), the Stockholdershall have the right to exchange any Shares containing the above legend (i) inthe case of the registration of the Shares, for Shares legended only with thefirst paragraph described above and (ii) in the case of the termination of thisAgreement, for Shares legended only with the second paragraph described above. 3. Transfer of Shares; Call Rights. (a) The Stockholder agrees that he will not cause or permit the Sharesor his interest in the Shares to be sold, transferred, hypothecated, assigned orencumbered except as expressly permitted by this Section 3; provided, however,that the Shares or any such interest may be transferred (i) on the Stockholder'sdeath by bequest or inheritance to the Stockholder's executors, administrators,testamentary trustees, legatees or beneficiaries, (ii) to a trust orcustodianship the beneficiaries of which may include only the Stockholder, theStockholder's spouse, or the Stockholder's lineal descendants (by blood oradoption) and (iii) in accordance with Section 4 of this Agreement, subject inany such case to the agreement by each transferee (other than the Company) inwriting to be bound by the terms of this Agreement and provided in any such casethat no such transfer that would cause the Company to be required to registerthe Common Stock under Section 12(g) of the Securities Exchange Act of 1934, asamended (the "Exchange Act"), shall be permitted. (b) The Company (or its designated assignee) shall have the right,during the ninety-day period commencing on the later of (x) the termination ofthe Stockholder's employment with the Company for any reason and (y)one-hundred-eighty-one (181) days following the date of the acquisition by theStockholder of any Shares, to purchase from the Stockholder, and upon theexercise of such right the Stockholder shall sell to the Company (or itsdesignated assignee), all or any portion of the Shares held by the Stockholderas of the date as of which such right, is exercised at a per Share price equalto the Fair Market Value (as defined in the Option Plan) of a share of CommonStock determined as of the date as of which such right is exercised. The Company(or its designated assignee) shall exercise such right by delivering to theStockholder a written notice specifying its intent to purchase Shares held bythe Stockholder, the date as of which such right is to be exercised and thenumber of Shares to be purchased. Such purchase and sale shall occur on suchdate as the Company (or its designated assignee) shall specify which date shallnot be later than ninety (90) days after the fiscal quarter-end immediatelyfollowing the date as of which the Company's right is exercised. 4. Certain Rights. (a) Drag Along Rights. If TPG desires to sell all or substantially allof its shares of Common Stock to a good faith independent purchaser (a"Purchaser") (other than any other investment partnership, limited liabilitycompany or other entity established for investment purposes and controlled bythe principals of TPG or any of its affiliates and other than any employees ofTPG or any of its affiliates, hereinafter referred to as a "PermittedTransferee") and said Purchaser desires to acquire all or substantially all ofthe issued and outstanding shares of Common Stock (or all or substantially allof the assets of the Company) upon such terms and conditions as agreed to withTPG, the Stockholder agrees to sell all of his Shares to said 2Purchaser (or to vote all of his Shares in favor of any merger or othertransaction which would effect a sale of such shares of Common Stock or assetsof the Company) at the same price per share of Common Stock and pursuant to thesame terms and conditions with respect to payment for the shares of Common Stockas agreed to by TPG. In such case, TPG shall give written notice of such sale tothe Stockholder at least 30 days prior to the consummation of such sale, settingforth (i) the consideration to be received by the holders of shares of CommonStock, (ii) the identity of the Purchaser, (iii) any other material items andconditions of the proposed transfer and (iv) the date of the proposed transfer. (b) Tag Along Rights. (i) Subject to paragraph ( iv) of this Section4(b), if TPG or its affiliates proposes to transfer any of its shares of CommonStock to a Purchaser (other than a Permitted Transferee), then TPG or suchPermitted Transferee (hereinafter referred to as a "Selling Stockholder") shallgive written notice of such proposed transfer to the Stockholder (the "SellingStockholder's Notice") at least 30 days prior to the consummation of suchproposed transfer, and shall provide notice to all other stockholders of theCompany to whom TPG has granted similar "tag-along" rights (such stockholderstogether with the Stockholder, referred to herein as the "Other Stockholders")setting forth (A) the number of shares of Common Stock offered, (B) theconsideration to be received by such Selling Stockholder, (C) the identity ofthe Purchaser, (D) any other material items and conditions of the proposedtransfer and (E) the date of the proposed transfer. (ii) Upon delivery of the Selling Stockholder's Notice, theStockholder may elect to sell up to the sum of (A) the Pro Rata Portion (ashereinafter defined) and (B) the Excess Pro Rata Portion (as hereinafterdefined) of his Shares, at the same price per share of Common Stock and pursuantto the same terms and conditions with respect to payment for the shares ofCommon Stock as agreed to by the Selling Stockholder, by sending written noticeto the Selling Stockholder within 15 days of the date of the SellingStockholder's Notice, indicating his election to sell up to the sum of the ProRata Portion plus the Excess Pro Rata Portion of his Shares in the sametransaction. Following such 15 day period, the Selling Stockholder and eachOther Stockholder shall be permitted to sell to the Purchaser on the terms andconditions set forth in the Selling Stockholder's Notice the sum of (X) the ProRata Portion and (Y) the Excess Pro Rata Portion of its Shares. (iii) For purposes of Section 4(b) and 4(c) hereof, "Pro Rata Portion"shall mean, with respect to shares of Common Stock held by the Stockholder orSelling Stockholder, as the case may be, a number equal to the product of (x)the total number of such shares then owned by the Stockholder or the SellingStockholder, as the case may be, and (y) a fraction, the numerator of whichshall be the total number of such shares proposed to be sold to the Purchaser asset forth in the Selling Stockholder's Notice or initially proposed to beregistered by the Selling Stockholder, as the case may be, and the denominatorof which shall be the total number of such shares then outstanding (includingsuch shares proposed to be sold or registered by the Selling Stockholder);provided, however, that any fraction of a share resulting from such calculationshall be disregarded for purposes of determining the Pro Rata Portion. Forpurposes of Sections 4(b) and 4(c), "Excess Pro Rata Portion" shall mean, withrespect to shares of Common Stock held by the Stockholder or the SellingStockholder, as the case may be, a number equal to the product of (x) the numberof Non-Elected Shares (as defined below) and (y) a fraction, the numerator ofwhich shall be such Stockholder's Pro Rata Portion with respect to 3such shares, and the denominator of which shall be the sum of (1) the aggregatePro Rata Portions with respect to the shares of Common Stock of all of the OtherStockholders that have elected to exercise in full their rights to sell theirPro Rata Portion of shares of Common Stock, and (2) the Selling Stockholder'sPro Rata Portion of shares of Common Stock (the aggregate amount of suchdenominator is hereinafter referred to as the "Elected Shares"). For purposes ofthis Agreement, "Non-Elected Shares" shall mean the excess, if any, of the totalnumber of shares of Common Stock, proposed to be sold to a Purchaser as setforth in a Selling Stockholder's Notice or initially proposed to be registeredby the Selling Stockholder, as the case may be, less the amount of ElectedShares. (iv) Notwithstanding anything to the contrary contained herein, theprovisions of this Section 4(b) shall not apply to any sale or transfer by TPGof shares of Common Stock unless and until TPG, after giving effect to theproposed sale or transfer, shall have sold or transferred in the aggregate(other than to Permitted Transferees) shares of Common Stock, representing 7.5%of shares of Common Stock owned by TPG on the date hereof. (c) Piggyback Registration Rights. (i) Notice to Stockholder. If the Company determines that it will filea registration statement under the Securities Act, other than a registrationstatement on Form S-4 or Form S-8 or any successor form, for an offering whichincludes shares of Common Stock held by TPG or its affiliates (hereinafter inthis paragraph (c) of Section 4 referred to as a "Selling Stockholder"), thenthe Company shall give prompt written notice to the Stockholder that such filingis expected to be made (but in no event less than 30 days nor more than 60 daysin advance of filing such registration statement), the jurisdiction orjurisdictions in which such offering is expected to be made, and the underwriteror underwriters (if any) that the Company (or the person requesting suchregistration) intends to designate for such offering. If the Company, within 15days after giving such notice, receives a written request for registration ofany Shares from the Stockholder, then the Company shall include in the sameregistration statement the number of Shares to be sold by the Stockholder asshall have been specified in his request, except that the Stockholder shall notbe permitted to register more than the Pro Rata Portion plus the Excess Pro Rataportion of his Shares. The Company shall bear all costs of preparing and filingthe registration statement, and shall indemnify and hold harmless, to the extentcustomary and reasonable, pursuant to indemnification and contributionprovisions to be entered into by the Company at the time of filing of theregistration statement, the seller of any shares of Common Stock covered by suchregistration statement. Notwithstanding anything herein to the contrary, the Company, on priornotice to the participating Stockholder, may abandon its intention to file aregistration statement under this Section 4(c) at any time prior to such filing. (ii) Allocation. If the managing underwriter shall inform the Companyin writing that the number of shares of Common Stock requested to be included insuch registration exceeds the number which can be sold in (or during the timeof) such offering within a price range acceptable to TPG, then the Company shallinclude in such registration such number of shares of Common Stock which theCompany is so advised can be sold in (or during the time of) such offering. Allholders of shares of Common Stock proposing to sell shares of Common 4Stock shall share pro rata in the number of shares of Common Stock to beexcluded from such offering, such sharing to be based on the respective numbersof shares of Common Stock as to which registration has been requested by suchholders. (iii) Permitted Transfer. Notwithstanding anything to the contrarycontained herein, sales of Shares pursuant to a registration statement filed bythe Company may be made without compliance with any other provision of thisAgreement. 5. Termination. This Agreement shall terminate immediately followingthe existence of a Public Market for the Common Stock except that (i) therequirements contained in Section 2 hereof shall survive the termination of thisAgreement and (ii) the provisions contained in Section 3 hereof shall continuewith respect to each Share during such period of time, if any, as theStockholder is precluded from selling such Shares pursuant to Rule 144 of theSecurities Act. For this purpose, a "Public Market" for the Common Stock shallbe deemed to exist if the Common Stock is registered under Section 12(b) or12(g) of the Exchange Act and trading regularly occurs in such Common Stock in,on or through the facilities of securities exchanges and/or inter-dealerquotation systems in the United States (within the meaning of Section 902(n) ofthe Securities Act) or any designated offshore securities market (within themeaning of Rule 902(a) of the Securities Act). 6. Distributions With Respect To Shares. As used herein, the term"Shares" includes securities of any kind whatsoever distributed with respect tothe Common Stock acquired by the Stockholder pursuant to the Option Plan or anysuch securities resulting from a stock split or consolidation involving suchCommon Stock. 7. Amendment; Assignment. This Agreement may be amended, superseded,canceled, renewed or extended, and the terms hereof may be waived, only by awritten instrument signed by authorized representatives of the parties or, inthe case of a waiver, by an authorized representative of the party waivingcompliance. No such written instrument shall be effective unless it expresslyrecites that it is intended to amend, supersede, cancel, renew or extend thisAgreement or to waive compliance with one or more of the terms hereof, as thecase may be. Except for the Stockholder's right to assign his or her rightsunder Section 3(a) or the Company's right to assign its rights under Section3(b), no party to this Agreement may assign any of its rights or obligationsunder this Agreement without the prior written consent of the other partieshereto. 8. Notices. All notices and other communications hereunder shall bein writing, shall be deemed to have been given if delivered in person or bycertified mail, return receipt requested, and shall be deemed to have been givenwhen personally delivered or three (3) days after mailing to the followingaddress: If to the Company: J. Crew Group, Inc. 770 Broadway, Twelfth Floor New York, New York 10003 Attention: Board of Directors and Secretary 5 with a copy to: Paul Shim, Esq. Cleary, Gottlieb, Steen & Hamilton One Liberty Plaza New York, New York 10006 If to TPG: 301 Commerce Street, Suite 3300 Fort Worth, Texas 76102 Attention: John E. Viola If to the Stockholder, to the address on record with the Company; orfor any party, to such other address as any party may have furnished to theothers in writing in accordance herewith, except that notices of change ofaddress shall only be effective upon receipt. 9. Counterparts. This Agreement may be executed in two or morecounterparts, each of which shall be deemed to be an original, but each of whichtogether shall constitute one and the same document. 10. Governing Law. This Agreement shall be governed by and construed inaccordance with the laws of the State of NEW YORK, without reference to itsprinciples of conflicts of law. 11. Binding Effect. This Agreement shall be binding upon, inure to thebenefit of, and be enforceable by the heirs, personal representatives,successors and permitted assigns of the parties hereto. Nothing expressed orreferred to in this Agreement is intended or shall be construed to give anyperson other than the parties to this Agreement, or their respective heirs,personal representatives, successors or assigns, any legal or equitable rights,remedy or claim under or in respect of this Agreement or any provision containedherein. 12. Entire Agreement. This Agreement constitutes the entire agreementbetween the parties hereto with respect to the subject matter hereof. 13. Severability. If any term, provision, covenant or restriction ofthis Agreement, is held by a court of competent jurisdiction to be invalid, voidor unenforceable, the remainder of the terms, provisions, covenants andrestrictions of this Agreement shall remain in full force and effect and shallin no way be affected, impaired or invalidated. 14. Miscellaneous. The headings contained in this Agreement are forreference purposes only and shall not affect in any way the meaning orinterpretation of this Agreement. * * * * * * 6 IN WITNESS WHEREOF, the parties hereto have caused thisAgreement to be duly executed as of the day and year first above written. ___________________________ Kenneth S. Pilot J. CREW GROUP, INC. ____________________________ By: Title: TPG PARTNERS II, L.P. ____________________________ By: Title: 7 Exhibit 10.4 J. CREW GROUP, INC. 2003 EQUITY INCENTIVE PLAN1. Purpose of the Plan The purpose of the J. Crew Group, Inc. 2003 Equity Incentive Plan (the"Plan") is to promote the interests of the Company and its stockholders byproviding the Company's key employees and consultants with an appropriateincentive to encourage them to continue in the employ of the Company and toimprove the growth and profitability of the Company.2. Definitions As used in this Plan, the following capitalized terms shall have thefollowing meanings: (a) "Affiliate" shall mean the Company and any of its direct orindirect subsidiaries. (b) "Award" shall mean an Option or shares of Restricted Stock grantedto a Participant pursuant to the terms of the Plan and as evidenced by a GrantAgreement. (c) "Board" shall mean the Board of Directors of the Company. (d) "Cause" shall mean, when used in connection with the termination ofa Participant's Employment, unless otherwise provided in the Participant's GrantAgreement, the termination of the Participant's Employment by the Company or anAffiliate on account of (i) the willful violation by the Participant of anyfederal or state law or any rule of the Company or any Affiliate, (ii) a breachby a Participant of the Participant's duty of loyalty to the Company and itsAffiliates in contemplation of the Participant's termination of Employment, suchas the Participant's pre-termination of Employment solicitation of customers oremployees of the Company or an Affiliate, (iii) the Participant's unauthorizedremoval from the premises of the Company or Affiliate of any document (in anymedium or form) relating to the Company or an Affiliate or the customers of theCompany or an Affiliate, or (iv) any gross negligence in connection with theperformance of the Participant's duties as an Employee. Any rights the Companyor an Affiliate may have hereunder in respect of the events giving rise to Causeshall be in addition to the rights the Company or Affiliate may have under anyother agreement with the Employee or at law or in equity. If, subsequent to aParticipant's termination of Employment, it is discovered that suchParticipant's Employment could have been terminated for Cause, the Participant'sEmployment shall, at the election of the Committee, in its sole discretion, bedeemed to have been terminated for Cause retroactively to the date the eventsgiving rise to Cause occurred. (e) "Change in Control" shall mean the occurrence of any of thefollowing events: (i) any sale, lease, exchange or other transfer (in onetransaction or a series of related transactions) of all or substantially all ofthe assets of the Company or JCC to any Person or group of related persons forpurposes of Section 13(d) of the Exchange Act (a "Group"), together with anyaffiliates thereof other than to TPG Partnership II, L.P. or any of itsaffiliates (hereinafter "TPG II") or Millard S. Drexler or any entity that isdirectly or indirectly controlled by Millard S. 1Drexler (hereinafter "MD" and together with TPG II, "TPG Group"); (ii) theapproval by the holders of capital stock of the Company or JCC of any plan orproposal for the liquidation or dissolution of the Company or JCC, as the casemay be; (iii) (A) any Person or Group (other than TPG Group) shall become thebeneficial owner (within the meaning of Section 13(d) of the Exchange Act),directly or indirectly, of shares representing more than 40% of the aggregatevoting power of the issued and outstanding stock entitled to vote in theelection of directors, managers or trustees (the "Voting Stock") of the Companyor JCC and (B) TPG Group beneficially owns, directly or indirectly, in theaggregate a lesser percentage of the Voting Stock of the Company than such otherPerson or Group; (iv) the replacement of a majority of the Board of Directors ofthe Company or JCC over a two-year period from the directors who constituted theBoard of Directors of the Company or JCC, as the case may be, at the beginningof such period, and such replacement shall not have been approved either by TPGGroup or by a vote of at least a majority of the Board of Directors of theCompany or JCC, as the case may be, then still in office who either were membersof such Board of Directors at the beginning of such period or whose election asa member of such Board of Directors was previously so approved or who werenominated by, or designees of, TPG Group; (v) any Person or Group other than TPGGroup shall have acquired the power to elect a majority of the members of theBoard of Directors of the Company; or (vi) a merger or consolidation of theCompany with another entity in which holders of the Common Stock of the Companyimmediately prior to the consummation of the transaction hold, directly orindirectly, immediately following the consummation of the transaction, 50% orless of the common equity interest in the surviving corporation in suchtransaction. (f) "Code" shall mean the Internal Revenue Code of 1986, as amended. (g) "Commission" shall mean the U.S. Securities and ExchangeCommission. (h) "Committee" shall mean the Committee appointed by the Boardpursuant to Section 3 of the Plan. (i) "Common Stock" shall mean the common stock of the Company. (j) "Company" shall mean J. Crew Group, Inc. (k) "Disability" shall mean a permanent disability as defined in theCompany's or an Affiliate's disability plans, or as defined from time to time bythe Company, in its discretion, or as specified in the Participant's GrantAgreement. (l) "EBITDA" shall mean, for any period, the consolidated earnings(losses) of the Company and its affiliates before extraordinary items and thecumulative effect of accounting changes, as determined by the Company inaccordance with U.S. generally accepted accounting principles, and beforeinterest (expense or income), taxes, depreciation, amortization, non-cash gainsand losses from sales of assets other than in the ordinary course of business,Transaction Costs and Valuation Adjustments. For purposes of clarification, indetermining EBITDA, consolidated earnings shall be reduced (or, with respect tolosses, increased), but only once, by compensation expenses attributable to thisPlan and any other compensation plan, program or 2arrangement of the Company or any of its affiliates, to the extent such expensesare recorded in accordance with U.S. generally accepted accounting principles.In the event of the occurrence of any business combination transaction affectingthe earnings or indebtedness of the Company, including (without limitation) anytransaction accounted for as a pooling or as a recapitalization, the Committeeshall adjust EBITDA as the Committee shall in good faith consider necessary orappropriate, including (without limitation) to reflect transaction-related costsattributable to such accounting method ("Transaction Costs"). (m) "Eligible Employee" shall mean (i) any Employee who is a keyexecutive of the Company or an Affiliate, or (ii) certain other Employees,directors or consultants who, in the judgment of the Committee, should beeligible to participate in the Plan due to the services they perform on behalfof the Company or an Affiliate. (n) "Employment" shall mean employment with the Company or anyAffiliate and shall include the provision of services as a director orconsultant for the Company or any Affiliate. "Employee" and "Employed" shallhave correlative meanings. (o) "Exercise Date" shall have the meaning set forth in Section 5.10herein. (p) "Exercise Notice" shall have the meaning set forth in Section 5.10herein. (q) "Exercise Price" shall mean the price that the Participant must payunder the Option for each share of Common Stock as determined by the Committeefor each Grant and specified in the Stock Option Grant Agreements. (r) "Fair Market Value" shall mean, as of any date: (1) prior to the existence of a Public Market for the Common Stock, thequotient obtained by dividing (i) the excess of (x) the product of (A) 9 (assuch number may be changed as provided below, the "Multiple") and (B) EBITDA forthe twelve month period ending on the fiscal quarter-end immediately precedingsuch date over (y) the sum of (I) the weighted arithmetic average indebtedness(net of all cash and cash equivalents) during such period of the Company and itsconsolidated direct and indirect wholly-owned subsidiaries and (II) for eachless than wholly-owned direct or indirect subsidiary of the Company the earningsof which are either consolidated with those of the Company or accounted for onan equity basis, the weighted arithmetic average indebtedness (net of all cashand cash equivalents) during such period of such subsidiary multiplied by theproportion of the total earnings (determined on the same basis as, and excludingthe same items as in the determination of, EBITDA) of such subsidiary includedin EBITDA (excluding earnings attributable to dividends received from suchsubsidiary), by (ii) the total number of shares of Common Stock on the last dayof such period, determined on a fully diluted basis. For purposes of determiningthe indebtedness of an entity, all preferred stock of the entity, other thanpreferred stock convertible into Common Stock, shall be considered indebtednessin the amount of the liquidation value thereof plus accumulated but unpaiddividends thereon. Notwithstanding the foregoing provisions of this paragraph(1), for the ten (10) day period immediately following the occurrence of aChange in Control, Fair Market Value shall not be less than the price per share,if any, paid to any member of the Initial Ownership 3Group or the public tender offer price paid in connection with such Change inControl. The Committee shall review the Multiple then in effect following theaudit of the Company's financial statements each fiscal year, and shall makesuch increases or decreases in the Multiple as shall be determined by theCommittee in good faith to reflect market conditions and Company performance. (2) on which a Public Market for the Common Stock exists, (i) theaverage of the high and low sales prices on such day of a share of Common Stockas reported on the principal securities exchange on which shares of Common Stockare then listed or admitted to trading or (ii) if not so reported, the averageof the closing bid and ask prices on such day as reported on the NationalAssociation of Securities Dealers Automated Quotation System or (iii) if not soreported, as furnished by any member of the National Association of SecuritiesDealers, Inc. selected by the Committee. The Fair Market Value of a share ofCommon Stock as of any such date on which the applicable exchange orinter-dealer quotation system through which trading in the Common Stockregularly occurs is closed shall be the Fair Market Value determined pursuant tothe preceding sentence as of the immediately preceding date on which the CommonStock is traded, a bid and ask price is reported or a trading price is reportedby any member of NASD selected by the Committee. In the event that the price ofa share of Common Stock shall not be so reported or furnished, the Fair MarketValue shall be determined by the Committee in good faith to reflect the fairmarket value of a share of Common Stock. (s) "Good Reason" shall mean, unless otherwise provided in aParticipant's Grant Agreement, (i) a material diminution in a Participant'sduties and responsibilities other than a change in such Participant's duties andresponsibilities that directly results from a Change in Control, (ii) a decreasein a Participant's base salary, bonus opportunity or benefits other than adecrease in benefits that applies to all employees of the Company or itsAffiliates otherwise eligible to participate in the applicable benefit plan, or(iii) a relocation following a Change in Control of a Participant's primary worklocation more than 50 miles from the work location immediately prior to theChange in Control, in each case without the Participant's written consent andafter the Participant has provided the Committee with written notice specifyingthe circumstances that the Participant believes constitute Good Reason and theCompany fails to cure such circumstances within a reasonable period of time (notto exceed 30 days) after receipt of such notice. (t) "Grant" shall mean a grant of (or to grant) an Option under thePlan evidenced by a Stock Option Grant Agreement or a Grant of (or to grant)Restricted Stock under the Plan evidenced by a Restricted Stock Grant Agreement,provided, that in either case, such grant may or may not be made in exchange forconsideration paid in accordance with the terms of the relevant Stock OptionGrant Agreement or Restricted Stock Grant Agreement. (u) "Grant Agreement" shall mean, in the case of the Grant of anOption, an Option Grant Agreement, and in the case of a Grant of RestrictedStock, a Restricted Stock Grant Agreement. (v) "Grant Date" with respect to an Award, shall mean the date as ofwhich such Award is granted to a Participant and set forth in the GrantAgreement evidencing such Award. 4 (w) "JCC" shall mean J. Crew Operating Corp., a wholly ownedsubsidiary of the Company. (x) "Non-Qualified Stock Option" shall mean an Option that is not an"incentive stock option" within the meaning of Section 422 of the Code. (y) "Option" shall mean the option to purchase Common Stock granted toany Participant under the Plan. Each Option granted hereunder shall be aNon-Qualified Stock Option and shall be identified as such in the Stock OptionGrant Agreement by which it is evidenced. (z) "Option Spread" shall mean, with respect to an Option, the excess,if any, of the Fair Market Value of a share of Common Stock as of the applicableValuation Date over the Exercise Price. (aa) "Participant" shall mean an Eligible Employee to whom a Grant ofan Option and/or Restricted Stock under the Plan has been made, and, whereapplicable, shall include Permitted Transferees. (bb) "Permitted Transferee" shall have the meaning set forth in Section5.6. (cc) "Person" means an individual, partnership, corporation, limitedliability company, unincorporated organization, trust or joint venture, or agovernmental agency or political subdivision thereof. (dd) A "Public Market" for the Common Stock shall be deemed to existfor purposes of the Plan if the Common Stock is registered under Section 12(b)or 12(g) of the Exchange Act and trading regularly occurs in such Common Stockin, on or through the facilities of securities exchanges and/or inter-dealerquotation systems in the United States (within the meaning of Rule 902(j) of theSecurities Act). (ee) "Restricted Stock" shall mean a share of Common Stock that isgranted to a Participant pursuant to Section 6 herein. (ff) "Restricted Stock Grant Agreement" shall mean an agreement enteredinto by the Participant and the Company evidencing the Grant of Restricted Stockpursuant to the Plan (a sample of which is attached hereto as Exhibit A). (gg) "Retirement" shall mean, when used in connection with thetermination of a Participant's Employment, a Participant who is at least age 60and has been Employed for at least five years at the time of such termination. (hh) "Securities Act" shall mean the Securities Act of 1933, asamended. (ii) "Stock Option Grant Agreement" shall mean an agreement enteredinto by each Participant and the Company evidencing the Grant of each Optionpursuant to the Plan (a sample of which is attached hereto as Exhibit B). 5 (jj) "Stockholders' Agreement" shall mean the Stockholders' Agreement,attached hereto as Exhibit C or such other stockholders' agreement as may beentered into between the Company and any Participant. (kk) "Transfer" shall mean any transfer, sale, assignment, gift,testamentary transfer, pledge, hypothecation or other disposition of anyinterest. "Transferee" and "Transferor" shall have correlative meanings. (ll) "Valuation Adjustments" shall mean that amount of non-cash expensecharged against earnings for any period resulting from the application ofaccounting for business combinations in accordance with Statement of FinancialAccounting Standards No. 141. These charges may include, but are not limited to,amounts such as inventory revaluations, property, plant and equipmentrevaluations, goodwill amortization and finance fee amortization. (mm) "Valuation Date" shall mean (i) prior to the existence of a PublicMarket for the Common Stock, the last day of each fiscal quarter, (ii) on orafter the existence of a Public Market for the Common Stock, the trading dateimmediately preceding the date of the relevant transaction, or (iii) in theevent of a Change in Control, the date of the consummation of such Change inControl. (nn) "Vesting Date" shall mean, in the case of an Option, the date anOption becomes exercisable pursuant to Section 5.4 herein, and, in the case ofRestricted Stock, the date a share of Restricted Stock vests pursuant to Section6.3 herein. (oo) "Withholding Request" shall have the meaning set forth in Section5.10 herein.3. Administration of the Plan The Committee shall be appointed by the Board and shall administer thePlan. In the absence of a Committee, the Board shall administer the Plan and allreferences herein to Committee shall include the Board. No member of theCommittee shall participate in any decision that specifically affects suchmember's interest in the Plan. 3.1 Powers of the Committee. In addition to the other powers grantedto the Committee under the Plan, the Committee shall have the power: (a) todetermine to which of the Eligible Employees Grants shall be made; (b) todetermine the time or times when Grants shall be made and to determine the typeof Award and the number of shares of Common Stock subject to each such Grant;(c) to prescribe the form of any instrument evidencing a Grant; (d) to adopt,amend and rescind such rules and regulations as, in its opinion, may beadvisable for the administration of the Plan; (e) to construe and interpret thePlan, such rules and regulations and the instruments evidencing Grants; and (f)to make all other determinations necessary or advisable for the administrationof the Plan. 3.2 Determinations of the Committee. Any Grant, determination,prescription or other act of the Committee shall be final and conclusivelybinding upon all persons. 6 3.3 Indemnification of the Committee. No member of the Committee or theBoard shall be liable for any action or determination made in good faith withrespect to the Plan or any Grant. To the full extent permitted by law, theCompany shall indemnify and hold harmless each person made or threatened to bemade a party to any civil or criminal action or proceeding by reason of the factthat such person, or such person's testator or intestate, is or was a member ofthe Committee. 3.4 Compliance with Applicable Law. Notwithstanding anything herein tothe contrary, the Company shall not be required to issue or deliver anycertificates evidencing shares of Common Stock pursuant to any Award, unless anduntil the Committee has determined, with advice of counsel, that the issuanceand delivery of such certificates is in compliance with all applicable laws,regulations of governmental authorities and, if applicable, the requirements ofany exchange on which the shares of Common Stock are listed or traded. Inaddition to the terms and conditions provided herein, the Committee may requirethat a Participant make such reasonable covenants, agreements andrepresentations as the Committee, in its sole discretion, deems advisable inorder to comply with any such laws, regulations or requirements. 3.5 Inconsistent Terms. Except as specifically provided herein or inany Participant's Grant Agreement, in the event of a conflict between the termsof the Plan and the terms of any Grant Agreement, the terms of the Plan shallgovern.4. Shares Subject to the Plan Subject to the adjustments provided in Section 7 herein, the maximumnumber of shares of Common Stock available for Awards under the Plan shall be4,798,160 shares. To the extent that any Option or Restricted Stock grantedunder the Plan is forfeited, terminates, expires or is canceled without havingbeen exercised, the shares of Common Stock covered by such Option or RestrictedStock shall again be available for Grant under the Plan. Unless the Board determines otherwise, of the maximum number of sharesof Common Stock: (a) 1,115,812 shares of Common Stock shall be reserved for the issuanceof Options with an Exercise Price of $6.82, provided that if the Fair MarketValue of a share of Common Stock is greater than $6.82, such Exercise Price maybe greater than $6.82; (b) 1,115,812 shares of Common Stock shall be reserved for the issuanceof Options with an Exercise Price of $25.00, provided that if the Fair MarketValue of a share of Common Stock is greater than $25.00, such Exercise Price maybe greater than $25.00; (c) 1,115,812 shares of Common Stock shall be reserved for the issuanceof Options with an Exercise Price of $35.00, provided that if the Fair MarketValue of a share of Common Stock is greater than $35.00, such Exercise Price maybe greater than $35.00; and (d) 1,450,724 shares of Common Stock shall be reserved for the issuanceof shares of Restricted Stock. 75. Options 5.1 Identification of Options. The Options granted under the Plan shallbe clearly identified in the Stock Option Grant Agreement as Non-Qualified StockOptions. 5.2 Exercise Price. The Exercise Price of any Option granted under thePlan shall be such price as the Committee shall determine (which may be equalto, less than or greater than the Fair Market Value of a share of Common Stockon the Grant Date for such Options) and which shall be specified in the StockOption Grant Agreement; provided that such price may not be less than theminimum price required by law or provided in Section 4 herein. 5.3 Grant Date. The Grant Date of the Options shall be the datedesignated by the Committee and specified in the Stock Option Grant Agreement asthe date the Option is granted. 5.4 Vesting Date of Options. Each Stock Option Grant Agreement shallindicate the date or conditions under which such Option shall becomeexercisable; provided, however, that, unless otherwise provided in aParticipant's Stock Option Grant Agreement, if during the one-year period aftera Change in Control the Participant's Employment is terminated by the Company orits Affiliate without Cause or by the Participant for Good Reason, alloutstanding Options held by such Participant shall become immediatelyexercisable as of the effective date of the termination of such Participant'sEmployment. 5.5 Expiration of Options. With respect to each Participant, suchParticipant's Option(s), or portion thereof, which have not become exercisableshall expire on the date such Participant's Employment is terminated for anyreason. With respect to each Participant, each Participant's Option(s), or anyportion thereof, which have become exercisable shall expire on the earlier of(i) the commencement of business on the date the Participant's Employment isterminated for Cause; (ii) 90 days after the date the Participant's Employmentis terminated for any reason other than Cause, Retirement, death or Disability;(iii) one year after the date the Participant's Employment is terminated byreason of death, Retirement or Disability; or (iv) the 10th anniversary of theGrant Date for such Option(s). Notwithstanding the foregoing, the Committee mayspecify in the Stock Option Grant Agreement a different expiration date orperiod for any Option granted hereunder, and such expiration date or periodshall supersede the foregoing expiration period. 5.6 Limitation on Transfer. During the lifetime of a Participant, eachOption shall be exercisable only by such Participant unless the Participantobtains written consent from the Company to Transfer such Option to a specifiedTransferee (a "Permitted Transferee") or the Participant's Stock Option GrantAgreement provides otherwise. 5.7 Condition Precedent to Transfer of Any Option. It shall be acondition precedent to any Transfer of any Option by any Participant that theTransferee, if not already a Participant in the Plan, shall agree prior to theTransfer in writing with the Company to be bound by the terms of the Plan andthe Stock Option Grant Agreement as if he had been an original signatorythereto. 8 5.8 Effect of Void Transfers. In the event of any purported Transferof any Options in violation of the provisions of the Plan, such purportedTransfer shall, to the extent permitted by applicable law, be void and of noeffect. 5.9 Exercise of Options. A Participant may exercise any or all of hisvested Options by serving an Exercise Notice on the Company as provided inSection 5.10 herein. 5.10 Method of Exercise. The Option shall be exercised by delivery ofwritten notice to the Company's principal office (the "Exercise Notice"), to theattention of its Secretary, no less than five business days in advance of theeffective date of the proposed exercise (the "Exercise Date"). Such notice shall(a) specify the number of shares of Common Stock with respect to which theOption is being exercised, the Grant Date of such Option and the Exercise Date,(b) be signed by the Participant, and (c) prior to the existence of a PublicMarket for the Common Stock, indicate in writing that the Participant agrees tobe bound by the Stockholders' Agreement, and (d) if the Option is beingexercised by the Participant's Permitted Transferee(s), such PermittedTransferee(s) shall indicate in writing that they agree to and shall be bound bythe Plan and Stock Option Grant Agreement as if they had been originalsignatories thereto. The Exercise Notice shall include (i) payment in cash foran amount equal to the Exercise Price multiplied by the number of shares ofCommon Stock specified in such Exercise Notice, (ii) a certificate representingthe number of shares of Common Stock with a Fair Market Value equal to theExercise Price (provided the Participant has owned such shares at least sixmonths prior to the Exercise Date) multiplied by the number of shares of CommonStock specified in such Exercise Notice, or (iii) a combination of (i) and (ii)or any method otherwise approved by the Committee. In addition, the ExerciseNotice shall include payment either in cash or previously-owned shares of CommonStock in an amount equal to the applicable withholding taxes based on the OptionSpread for each share of Common Stock specified in the Exercise Notice as of themost recent Valuation Date unless the Participant requests, in writing, that theCompany withhold a portion of the shares that are to be distributed to theParticipant to satisfy the minimum applicable federal, state and localwithholding taxes incurred in connection with the exercise of the Option (the"Withholding Request"). The Committee, in its sole discretion, will either grantor deny the Withholding Request and shall notify the Participant of itsdetermination prior to the Exercise Date. If the Withholding Request is denied,the Participant shall pay an amount equal to the applicable withholding taxesbased on the Option Spread for each share of Common Stock specified in theExercise Notice as of the most recent Valuation Date on or before such ExerciseDate. The partial exercise of the Option, alone, shall not cause the expiration,termination or cancellation of the remaining Options. 5.11 Certificates of Shares. Upon the exercise of the Options inaccordance with Section 5.10 and, prior to the existence of a Public Market forthe Common Stock, execution of the Stockholders' Agreement, certificates ofshares of Common Stock shall be issued in the name of the Participant anddelivered to such Participant as soon as practicable following the ExerciseDate. Each certificate shall contain such legends as the Committee deemsappropriate. Prior to the existence of a Public Market, no shares of CommonStock shall be issued to any Participant until such Participant agrees to bebound by and executes the Stockholders' Agreement. In addition, prior to theexistence of a Public Market for the Common Stock, the 9Committee may require that the certificate evidencing any shares of Common Stockbe held in custody by the Company. 5.12 Termination of the Options. The Committee may, at any time, in itsabsolute discretion, without amendment to the Plan or any relevant Stock OptionGrant Agreement, terminate the Options then outstanding, whether or notexercisable, provided, however, that the Company, in full consideration of suchtermination, shall pay (a) with respect to any Option, or portion thereof, thenoutstanding, an amount equal to the Option Spread determined as of the ValuationDate coincident with or next succeeding the date of termination. Such paymentshall be made as soon as practicable after the payment amounts are determined,provided, however, that the Company shall have the option to make payments tothe Participants by issuing a note to the Participant bearing a reasonable rateof interest as determined by the Committee in its absolute discretion.6. Restricted Stock 6.1 Grant of Restricted Stock. The Committee may, in its solediscretion, Grant Awards of Restricted Stock to Eligible Employees at suchtimes, in such amounts and subject to such terms and conditions as the Committeemay determine, but not inconsistent with the Plan. The Committee shall sendwritten notice to each Eligible Employee selected to receive an Award ofRestricted Stock, which shall include a Restricted Stock Grant Agreement. Inorder to accept the Award of Restricted Stock, such Eligible Employee mustexecute the Restricted Stock Grant Agreement and, prior to the existence of aPublic Market for the Common Stock, such Eligible Employee must also execute theStockholders' Agreement. 6.2 Grant Date. The Grant Date of a share of Restricted Stock shall bethe date designated by the Committee and specified in the Restricted Stock GrantAgreement as the date the share of Restricted Stock is granted. 6.3 Vesting Date of Restricted Stock. Each Restricted Stock GrantAgreement shall indicate the date or dates under which such the shares ofRestricted Stock shall become vested; provided, however, that, unless otherwiseprovided in a Participant's Restricted Stock Grant Agreement, if during theone-year period after a Change in Control the Participant's Employment isterminated by the Company or its Affiliate without Cause or by the Participantfor Good Reason, all unvested shares of Restricted Stock held by suchParticipant shall become immediately vested as of the effective date of thetermination of such Participant's Employment. 6.4 Limitation of Transfer of Restricted Stock. Prior to the existenceof a Public Market for Common Shares, each share of Restricted Stock shall notbe Transferred unless the Participant obtains written consent from the Companyto Transfer such share of Restricted Stock to a specified Permitted Transfereeor the Participant's Restricted Stock Grant Agreement provides otherwise. Itshall be a condition precedent to any Transfer of any share of Restricted Stockby any Participant that the Transferee, if not already a Participant in thePlan, shall agree prior to the Transfer in writing with the Company to be boundby the terms of the Plan and the Restricted Stock Grant Agreement as if he hadbeen an original signatory thereto. In the event of 10any purported Transfer of any share of Restricted Stock in violation of theprovisions of the Plan, such purported Transfer shall, to the extent permittedby applicable law, be void and of no effect. 6.5 Issuance of Certificates. Reasonably promptly after the receipt bythe Company of the Restricted Stock Grant Agreement and Stockholders' Agreementexecuted by the Participant with respect to the shares of Restricted Stockgranted by the Restricted Stock Grant Agreement, the Company shall cause to beissued stock certificates, registered in the name of the Participant, evidencingthe shares of Common Stock granted by the Restricted Stock Grant Agreement. Eachcertificate shall contain such legends as the Committee deems appropriate. Priorto the existence of a Public Market for the Common Stock, the Committee mayrequire that the certificate evidencing any shares of Common Stock be held incustody by the Company, and that, as a condition of any Award, the Committee mayrequire that the Participant deliver to the Company a stock power, endorsed inblank, relating to the share of Restricted Stock covered by such Award. 6.6 Termination of Restricted Stock. The Committee may, at any time, inits sole discretion, terminate any Award of shares of Restricted Stock thenoutstanding, whether vested or not, provided, however, that the Company, in fullconsideration of such termination shall pay with respect to each share of CommonStock, whether or not vested on the date of such termination, an amount equal tothe Fair Market Value of a share of Common Stock, determined as of the ValuationDate coincident with or next succeeding the date of termination. Such paymentshall be made as soon as practicable after the payment amounts are determined. 6.7 Expiration of Restricted Stock. Subject to Section 6.3 above, withrespect to each Participant, such Participant's shares of Restricted Stock whichhave not become vested on the date such Participant's Employment is terminatedfor any reason shall be immediately forfeited unless otherwise specified in theRestricted Stock Grant Agreement. 6.8 Other Restrictions. At the time of an Award, the Committee mayimpose such additional restrictions on the Restricted Stock awarded as it, inits sole discretion, deems appropriate. 6.9 Rights as Shareholders. (a) Dividends. Unless otherwise provided in the Restricted StockGrant Agreement, ordinary and routine dividends paid in cash with respect toshares of Restricted Stock that are outstanding as of the relevant record datefor such dividends shall be distributed to the Participant at such time and inthe manner paid to holders of shares of Common Stock. Stock dividends issuedwith respect to shares of Restricted Stock covered by the Award shall be treatedas additional shares under the Award and shall be subject to the samerestrictions and terms and conditions that apply to the shares of RestrictedStock with respect to which such dividends are issued. (b) Voting. To the extent that the holders of shares of CommonStock are entitled to vote, the Participant shall be entitled to vote his sharesof Common Stock, or in the 11case of Restricted Stock held in custody by the Company, direct the Company asto the manner as to which the shares of Common Stock underlying the Award shallbe voted.7. Adjustment Upon Changes in Company Stock. 7.1 Increase or Decrease in Issued Shares Without Consideration.Subject to any required action by the stockholders of the Company, in the eventof any increase or decrease in the number of issued shares of Common Stockresulting from a subdivision or consolidation of shares of Common Stock or thepayment of a stock dividend (but only on the shares of Common Stock), or anyother increase or decrease in the number of such shares effected without receiptof consideration by the Company, the Committee shall, make such adjustments withrespect to the number of shares of Common Stock subject to the Awards, or in thecase of Options, the exercise price per share of Common Stock of each suchOption, as the Committee may consider appropriate to prevent the enlargement ordilution of rights. 7.2 Certain Mergers. Subject to any required action by the stockholdersof the Company, in the event that the Company shall be the surviving corporationin any merger or consolidation (except a merger or consolidation as a result ofwhich the holders of shares of Common Stock receive securities of anothercorporation), the Awards outstanding on the date of such merger or consolidationshall pertain to and apply to the securities which a holder of the number ofshares of Common Stock subject to any such Award would have received in suchmerger or consolidation (it being understood that if, in connection with suchtransaction, the stockholders of the Company retain their shares of Common Stockand are not entitled to any additional or other consideration, the Awards shallnot be affected by such transaction). 7.3 Certain Other Transactions. In the event of (i) a dissolution orliquidation of the Company, (ii) a sale of all or substantially all of theCompany's assets, (iii) a merger or consolidation involving the Company in whichthe Company is not the surviving corporation or (iv) a merger or consolidationinvolving the Company in which the Company is the surviving corporation but theholders of shares of Common Stock receive securities of another corporationand/or other property, including cash, the Committee shall, in its absolutediscretion, have the power to: (a) provide for the exchange of any Award outstanding immediatelyprior to such event (whether or not then exercisable or vested) for an awardwith respect to, as appropriate, some or all of the property for which the stockunderlying such Award is exchanged and, incident thereto, make an equitableadjustment, as determined by the Committee, in the Exercise Price of theOptions, if applicable, or the number of shares or amount of property subject tothe Award or, if appropriate, provide a cash payment to the Participants inpartial consideration for the exchange of Awards as the Committee may considerappropriate to prevent dilution or enlargement of rights; (b) cancel, effective immediately prior to the occurrence of suchevent, any Award outstanding immediately prior to such event (whether or notthen exercisable or vested), and in full consideration of such cancellation, payto the Participant to whom such Award was granted an amount in cash, for eachshare of Common Stock subject to such Award, equal to (A) 12with respect to an Option, the excess of (x) the value, as determined by theCommittee in its sole discretion, of securities and property (including cash)received by the holders of shares of Common Stock as a result of such event over(y) the Exercise Price of such Option or (B) with respect to Restricted Stock ,the value, as determined by the Committee in its sole discretion, of securitiesand property (including cash) received by the holders of the shares of CommonStock as a result of such event; or (c) provide for any combination of (a) or (b). 7.4 Other Changes. In the event of any change in the capitalization ofthe Company or a corporate change other than those specifically referred to inSections 7.1, 7.2 or 7.3 hereof, the Committee may make such adjustments in thenumber and class of shares subject to the Awards outstanding on the date onwhich such change occurs and, in the case of Options, in the per-share ExercisePrice of each such Option, as the Committee may consider appropriate to preventdilution or enlargement of rights. 7.5 Consideration Received on Unvested Restricted Stock.Notwithstanding the foregoing and unless otherwise determined by the Committeeor provided in a Restricted Stock Grant Agreement, in respect of any unvestedshares of Restricted Stock underlying an Award, in the event of a Change inControl in connection with which the holders of shares of Common Stock receivecash or any other property as consideration, the Company shall hold suchconsideration paid (cash or otherwise) in respect of such shares in escrow andsuch consideration shall be subject to the same restrictions and terms andconditions, including vesting schedule, that applied to the shares of RestrictedStock with respect to which such consideration was paid and except with respectto cash consideration, the terms and conditions of the Plan and Restricted StockGrant Agreement shall apply to such consideration in the same manner as itapplies to the Restricted Stock. With respect to any cash consideration, withina reasonable time following any applicable Vesting Date, the Company shallrelease to the Participant that portion of the cash consideration paid inrespect of his shares of Restricted Stock, provided, that the Participant iscontinuously Employed by the Company or any of its Affiliates through suchVesting Date. 7.6 No Other Rights. Except as expressly provided in the Plan or theGrant Agreements evidencing the Awards, the Participants shall not have anyrights by reason of any subdivision or consolidation of shares of Common Stockor shares of stock of any class, the payment of any dividend, any increase ordecrease in the number of shares of Common Stock or shares of stock of any classor any dissolution, liquidation, merger or consolidation of the Company or anyother corporation. Except as expressly provided in the Plan or the GrantAgreements evidencing the Awards, no issuance by the Company of shares of CommonStock or shares of stock of any class, or securities convertible into shares ofCommon Stock or shares of stock of any class, shall affect, and no adjustment byreason thereof shall be made with respect to, the number of shares of CommonStock subject to the Awards or, in the case of Options, the Exercise Price ofsuch Options. 138. Amendment of the Plan or Awards The Committee may, in its absolute discretion, amend the Plan or termsof any Award, provided, however, that any such amendment shall not impair oradversely affect the Participants' rights under the Plan or such Award withoutsuch Participant's written consent.9. Miscellaneous 9.1 Rights as Stockholders. The Participants shall not have any rightsas stockholders with respect to any shares of Common Stock covered by orrelating to the Awards granted pursuant to the Plan until the date theParticipants become the registered owners of such shares. Except as otherwiseexpressly provided herein, no adjustment to the Awards shall be made fordividends or other rights for which the record date occurs prior to the datesuch stock certificate is issued. 9.2 No Special Employment Rights. Nothing contained in the Plan shallconfer upon the Participants any right with respect to the continuation of theirEmployment or interfere in any way with the right of the Company or anAffiliate, subject to the terms of any separate Employment agreements to thecontrary, at any time to terminate such Employment or to increase or decreasethe compensation of the Participants from the rate in existence at the time ofthe Grant of any Award. 9.3 No Obligation to Exercise. The Grant to the Participants of theOptions shall impose no obligation upon the Participants to exercise suchOptions. 9.4 Restrictions on Common Stock. Prior to the existence of a PublicMarket for the Common Stock, the rights and obligations of the Participants withrespect to Common Stock obtained through the Grant of Restricted Stock or uponthe exercise of any Option provided in the Plan shall be governed by the termsand conditions of the Stockholders' Agreement. 9.5 Withholding Taxes. Whenever shares of Restricted Stock are to beissued hereunder or shares of Common Stock are to be issued upon the exercise ofan Option, the Company shall have the right to require the Participant to remitto the Company in cash an amount sufficient to satisfy federal, state and localwithholding tax requirements, if any, attributable to such issuance prior to thedelivery of any certificate or certificates for such shares. 9.5 Notices. All notices and other communications hereunder shall be inwriting and shall be given and shall be deemed to have been duly given ifdelivered in person, by cable, telegram, telex or facsimile transmission, to theparties as follows: If to the Participant: To the address shown on the Grant Agreement. If to the Company: 14 J. Crew Group Inc. 770 Broadway, 12th Floor New York, NY 10003 Attention: General Counsel or to such other address as any party may have furnished to the otherin writing in accordance herewith, except that notices of change of addressshall only be effective upon receipt. 9.6 Descriptive Headings. The headings in the Plan are for convenienceof reference only and shall not limit or otherwise affect the meaning of theterms contained herein. 9.7 Severability. In the event that any one or more of the provisions,subdivisions, words, clauses, phrases or sentences contained herein, or theapplication thereof in any circumstances, is held invalid, illegal orunenforceable in any respect for any reason, the validity, legality andenforceability of any such provision, subdivision, word, clause, phrase orsentence in every other respect and of the remaining provisions, subdivisions,words, clauses, phrases or sentences hereof shall not in any way be impaired, itbeing intended that all rights, powers and privileges of the Company andParticipants shall be enforceable to the fullest extent permitted by law. 9.8 Governing Law. The Plan shall be governed by and construed andenforced in accordance with the laws of the State of New York, without regard tothe provisions governing conflict of laws. 15 EXHIBIT A RESTRICTED STOCK GRANT AGREEMENT THIS AGREEMENT, made as of this [___] day of [_____], 200[__] betweenJ.CREW GROUP INC. (the "Company") and [___________] (the "Participant"). WHEREAS, the Company has adopted and maintains the J. Crew Group, Inc.2003 Equity Incentive Plan (the "Plan") to promote the interests of the Companyand its stockholders by providing the Company's key employees and others with anappropriate incentive to encourage them to continue in the employ of the Companyand to improve the growth and profitability of the Company; WHEREAS, the Plan provides for the Grant to Participants in the Plan ofrestricted shares of Common Stock of the Company. NOW, THEREFORE, in consideration of the premises and the mutualcovenants hereinafter set forth, the parties hereto hereby agree as follows: 1. Investment. The Participant represents that the shares of RestrictedStock (as defined herein) are being acquired for investment and not with a viewtoward the distribution thereof. 2. Grant of Restricted Stock. Pursuant to, and subject to, the termsand conditions set forth herein and in the Plan, the Company hereby Grants tothe Participant an Award of [______] shares of Common Stock of the Company(collectively, the "Restricted Stock"). 3. Grant Date. The Grant Date of the Restricted Stock hereby granted is[________]. 4. Incorporation of Plan. All terms, conditions and restrictions of thePlan are incorporated herein and made part hereof as if stated herein. If thereis any conflict between the terms and conditions of the Plan and this Agreement,the terms and conditions of this Agreement, as interpreted by the Committee,shall govern. All capitalized terms used herein shall have the meanings given tosuch terms in the Plan. 5. Vesting Date. The Restricted Stock shall become vested as follows:[vesting schedule]. Notwithstanding the foregoing, if within the one-year periodafter a Change in Control the Participant's Employment is terminated by theCompany or its Affiliate without Cause or by the Participant for Good Reason,all shares of Restricted Stock underlying this Award shall become immediatelyvested as of the effective date of the termination of such Participant'sEmployment. 6. Forfeiture. Subject to the provisions of the Plan, with respect tothe shares of Restricted Stock which have not become vested on the date theParticipant's Employment is terminated for any reason, the Award of RestrictedStock shall expire and such unvested shares of Restricted Stock shallimmediately be forfeited on such date. A-1 7. Delays or Omissions. No delay or omission to exercise any right,power, or remedy accruing to any party hereto upon any breach or default of anyparty under this Agreement, shall impair any such right, power or remedy of suchparty nor shall it be construed to be a waiver of any such breach or default, oran acquiescence therein, or of or in any similar breach or default thereafteroccurring nor shall any waiver of any single breach or default be deemed awaiver of any other breach or default theretofore or thereafter occurring. Anywaiver, permit, consent or approval of any kind or character on the part of anyparty of any breach or default under this Agreement, or any waiver on the partof any party or any provisions or conditions of this Agreement, shall be inwriting and shall be effective only to the extent specifically set forth in suchwriting. 8. Limitation on Transfer. All shares of Restricted Stock grantedhereunder shall be subject to the terms and conditions of the Stockholders'Agreement, dated as of __________, 200__, between the Company, the Participantand TPG Partners II, L.P. (the "Stockholders' Agreement"). Prior to theexistence of a Public Market for Common Shares, each share of Restricted Stockshall not be Transferred unless the Participant obtains written consent from theCompany to Transfer such share of Restricted Stock to a specified PermittedTransferee or the Participant's Restricted Stock Grant Agreement providesotherwise. It shall be a condition precedent to any Transfer of any share ofRestricted Stock by the Participant that the Transferee, if not already aParticipant in the Plan, shall agree prior to the Transfer in writing with theCompany to be bound by the terms of the Plan and this Agreement as if he hadbeen an original signatory thereto. In the event of any purported Transfer ofany share of Restricted Stock in violation of the provisions of the Plan andthis Agreement, such purported Transfer shall, to the extent permitted byapplicable law, be void and of no effect. 9. Integration. This Agreement, the Plan and the Stockholders'Agreement contain the entire understanding of the parties with respect to itssubject matter. There are no restrictions, agreements, promises,representations, warranties, covenants or undertakings with respect to thesubject matter hereof other than those expressly set forth herein, the Plan andthe Stockholders' Agreement. This Agreement, the Plan and the Stockholders'Agreement supersede all prior agreements and understandings between the partieswith respect to its subject matter. 10. Counterparts. This Agreement may be executed in two or morecounterparts, each of which shall be deemed an original, but all of which shallconstitute one and the same instrument. 11. Governing Law. This Agreement shall be governed by and construedand enforced in accordance with the laws of the State of NEW YORK, withoutregard to the provisions governing conflict of laws. 12. Participant Acknowledgment. The Participant hereby acknowledgesreceipt of a copy of the Plan. The Participant hereby acknowledges that alldecisions, determinations and interpretations of the Committee in respect of thePlan, this Agreement and this Award of Restricted Stock shall be final andconclusive. A-2 IN WITNESS WHEREOF, the Company has caused this Agreement to be dulyexecuted by its duly authorized officer and said Participant has hereunto signedthis Agreement on the Participant's own behalf, thereby representing that theParticipant has carefully read and understands this Agreement and the Plan as ofthe day and year first written above. J.CREW GROUP INC. ___________________________ By: [____________] Title: [____________] ___________________________ [Insert Participant's Name] A-3 EXHIBIT B STOCK OPTION GRANT AGREEMENT THIS AGREEMENT, made as of this [___] day of [_____], 200[__] betweenJ.CREW GROUP INC. (the "Company") and [___________] (the "Participant"). WHEREAS, the Company has adopted and maintains the J. Crew Group, Inc.2003 Equity Incentive Plan (the "Plan") to promote the interests of the Companyand its stockholders by providing the Company's key employees and others with anappropriate incentive to encourage them to continue in the employ of the Companyand to improve the growth and profitability of the Company; WHEREAS, the Plan provides for the Grant to Participants in the Plan ofNon-Qualified Stock Options to purchase shares of Common Stock of the Company. NOW, THEREFORE, in consideration of the premises and the mutualcovenants hereinafter set forth, the parties hereto hereby agree as follows: 1. Grant of Options. Pursuant to, and subject to, the terms andconditions set forth herein and in the Plan, the Company hereby Grants to theParticipant a NON-QUALIFIED STOCK OPTION (the "Option") with respect to[________] shares of Common Stock of the Company. 2. Grant Date. The Grant Date of the Option hereby granted is[________]. 3. Incorporation of Plan. All terms, conditions and restrictions of thePlan are incorporated herein and made part hereof as if stated herein. If thereis any conflict between the terms and conditions of the Plan and this Agreement,the terms and conditions of this Agreement, as interpreted by the Committee,shall govern. All capitalized terms used herein shall have the meanings given tosuch terms in the Plan. 4. Exercise Price. The exercise price of each share underlying theOption hereby granted is [____________]. 5. Vesting Date. The Option shall become exercisable as follows:[vesting schedule]. Notwithstanding the foregoing, if within the one-year periodafter a Change in Control the Participant's Employment is terminated by theCompany or its Affiliate without Cause or by the Participant for Good Reason,all outstanding Options held by such Participant shall become immediatelyexercisable as of the effective date of the termination of such Participant'sEmployment. 6. Expiration Date. Subject to the provisions of the Plan, with respectto the Option or any portion thereof which has not become exercisable, theOption shall expire on the date the Participant's Employment is terminated forany reason, and with respect to any Option or any portion thereof which hasbecome exercisable, the Option shall expire on the earlier of (i) 90 B-1days after the Participant's termination of Employment other than for Cause,Retirement, death, or Disability; (ii) one year after termination of theParticipant's Employment by reason of death, Retirement or Disability; (iii) thecommencement of business on the date the Participant's Employment is, or isdeemed to have been, terminated for Cause; or (iv) the tenth anniversary of theGrant Date. 7. Delays or Omissions. No delay or omission to exercise any right,power, or remedy accruing to any party hereto upon any breach or default of anyparty under this Agreement, shall impair any such right, power or remedy of suchparty nor shall it be construed to be a waiver of any such breach or default, oran acquiescence therein, or of or in any similar breach or default thereafteroccurring nor shall any waiver of any single breach or default be deemed awaiver of any other breach or default theretofore or thereafter occurring. Anywaiver, permit, consent or approval of any kind or character on the part of anyparty of any breach or default under this Agreement, or any waiver on the partof any party or any provisions or conditions of this Agreement, shall be inwriting and shall be effective only to the extent specifically set forth in suchwriting. 8. Limitation on Transfer. During the lifetime of the Participant, theOption shall be exercisable only by the Participant. The Option shall not beassignable or transferable otherwise than by will or by the laws of descent anddistribution. Notwithstanding the foregoing, the Participant may requestauthorization from the Committee to assign the Participant's rights with respectto the Option granted herein to a trust or custodianship, the beneficiaries ofwhich may include only the Participant, the Participant's spouse or theParticipant's lineal descendants (by blood or adoption), and, if the CommitteeGrants such authorization, the Participant may assign the Participant's rightsaccordingly. In the event of any such assignment, such trust or custodianshipshall be subject to all the restrictions, obligations, and responsibilities asapply to the Participant under the Plan and this Stock Option Grant Agreementand shall be entitled to all the rights of the Participant under the Plan. Allshares of Common Stock obtained pursuant to the Option granted herein shall notbe transferred except as provided in the Plan and, where applicable, theStockholders' Agreement. 9. Integration. This Agreement, the Plan and the Stockholders'Agreement contain the entire understanding of the parties with respect to itssubject matter. There are no restrictions, agreements, promises,representations, warranties, covenants or undertakings with respect to thesubject matter hereof other than those expressly set forth herein, the Plan andthe Stockholders' Agreement. This Agreement, the Plan and the Stockholders'Agreement supersede all prior agreements and understandings between the partieswith respect to its subject matter. 10. Counterparts. This Agreement may be executed in two or morecounterparts, each of which shall be deemed an original, but all of which shallconstitute one and the same instrument. B-2 11. Governing Law. This Agreement shall be governed by and construedand enforced in accordance with the laws of the State of NEW YORK, withoutregard to the provisions governing conflict of laws. 12. Participant Acknowledgment. The Participant hereby acknowledgesreceipt of a copy of the Plan. The Participant hereby acknowledges that alldecisions, determinations and interpretations of the Committee in respect of thePlan, this Agreement and the Option shall be final and conclusive. IN WITNESS WHEREOF, the Company has caused this Agreement to be dulyexecuted by its duly authorized officer and said Participant has hereunto signedthis Agreement on the Participant's own behalf, thereby representing that theParticipant has carefully read and understands this Agreement and the Plan as ofthe day and year first written above. J.CREW GROUP INC. ___________________________ By: [____________] Title: [____________] ___________________________ [Insert Participant's Name] B-3EXHIBIT C STOCKHOLDERS' AGREEMENT STOCKHOLDERS' AGREEMENT (this "Agreement"), dated as of ________,200__, between J. Crew Group, Inc. (the "Company"), TPG Partners II, L.P.("TPG") and ___________________ (the "Stockholder"). WHEREAS, the Stockholder is an employee of the Company and in suchcapacity was granted [an option (the "Option") to purchase shares] [an Award ofrestricted shares] of common stock of the Company, $.01 par value per share("Common Stock"), pursuant to the Company's 2003 Equity Incentive Plan (the"2003 Plan"); WHEREAS, as a condition to the issuance of [shares of Common Stockpursuant to the exercise of an Option] [restricted shares of Common Stock], theStockholder is required under the 2003 Plan to execute this Agreement; [WHEREAS, the Stockholder desires to exercise the Option to purchase__________ shares of Common Stock]; and WHEREAS, the Stockholder and the Company desire to enter this Agreementand to have this Agreement apply to the shares to be acquired pursuant to the2003 Plan and to any shares of Common Stock acquired after the date hereof bythe Stockholder from whatever source, subject to any future agreement betweenthe Company and the Stockholder to the contrary (in the aggregate, the"Shares"). NOW THEREFORE, in consideration of the premises hereinafter set forth,and other good and valuable consideration, the receipt of which is herebyacknowledged, the parties hereto agree as follows. 1. Investment. The Stockholder represents that the Shares are beingacquired for investment and not with a view toward the distribution thereof. 2. Issuance of Shares. The Stockholder acknowledges and agrees that thecertificate for the Shares shall bear the following legends (except that thesecond paragraph of this legend shall not be required after the Shares have beenregistered and except that the first paragraph of this legend shall not berequired after the termination of this Agreement): The shares represented by this certificate are subject to the terms and conditions of a Stockholders' Agreement dated as of ______________, 200_ and may not be sold, transferred, hypothecated, assigned or encumbered, except as may be permitted by the aforesaid Agreement. A copy of the Stockholders' Agreement may be obtained from the Secretary of the Company. The shares represented by this certificate have not been registered under the Securities Act of 1933. The shares have been acquired for investment and may not be sold, transferred, pledged or hypothecated in the absence of an effective C-1 registration statement for the shares under the Securities Act of 1933 or an opinion of counsel for the Company that registration is not required under said Act. Upon the termination of this Agreement, or upon registration of theShares under the Securities Act of 1933 (the "Securities Act"), the Stockholdershall have the right to exchange any Shares containing the above legend (i) inthe case of the registration of the Shares, for Shares legended only with thefirst paragraph described above and (ii) in the case of the termination of thisAgreement, for Shares legended only with the second paragraph described above. 3. Transfer of Shares; Call Rights. (a) The Stockholder agrees that he will not cause or permit the Sharesor his interest in the Shares to be sold, transferred, hypothecated, assigned orencumbered except as expressly permitted by this Section 3; provided, however,that the Shares or any such interest may be transferred (i) on the Stockholder'sdeath by bequest or inheritance to the Stockholder's executors, administrators,testamentary trustees, legatees or beneficiaries, (ii) to a trust orcustodianship the beneficiaries of which may include only the Stockholder, theStockholder's spouse, or the Stockholder's lineal descendants (by blood oradoption) and (iii) in accordance with Section 4 of this Agreement, subject inany such case to the agreement by each transferee (other than the Company) inwriting to be bound by the terms of this Agreement and provided in any such casethat no such transfer that would cause the Company to be required to registerthe Common Stock under Section 12(g) of the Securities Exchange Act of 1934, asamended (the "Exchange Act"), shall be permitted. (b) The Company (or its designated assignee) shall have the rightcommencing on the later of (x) the termination of the Stockholder's employmentwith the Company for any reason and (y) one-hundred-eighty-one (181) daysfollowing the date of the acquisition by the Stockholder of any Shares, topurchase from the Stockholder, and upon the exercise of such right theStockholder shall sell to the Company (or its designated assignee), all or anyportion of the Shares held by the Stockholder as of the date as of which suchright, is exercised at a per Share price equal to the Fair Market Value (asdefined in the 2003 Plan) of a share of Common Stock determined as of the dateas of which such right is exercised. The Company (or its designated assignee)shall exercise such right by delivering to the Stockholder a written noticespecifying its intent to purchase Shares held by the Stockholder, the date as ofwhich such right is to be exercised and the number of Shares to be purchased.Such purchase and sale shall occur on such date as the Company (or itsdesignated assignee) shall specify which date shall not be later than ninety(90) days after the fiscal quarter-end immediately following the date as ofwhich the Company's right is exercised. C-2 4. Certain Rights. (a) Drag Along Rights. If TPG desires to sell all or substantiallyall of its shares of Common Stock to a good faith independent purchaser (a"Purchaser") (other than any other investment partnership, limited liabilitycompany or other entity established for investment purposes and controlled bythe principals of TPG or any of its affiliates and other than any employees ofTPG or any of its affiliates, hereinafter referred to as a "PermittedTransferee") and said Purchaser desires to acquire all or substantially all ofthe issued and outstanding shares of Common Stock (or all or substantially allof the assets of the Company) upon such terms and conditions as agreed to withTPG, the Stockholder agrees to sell all of his Shares to said Purchaser (or tovote all of his Shares in favor of any merger or other transaction which wouldeffect a sale of such shares of Common Stock or assets of the Company) at thesame price per share of Common Stock and pursuant to the same terms andconditions with respect to payment for the shares of Common Stock as agreed toby TPG. In such case, TPG shall give written notice of such sale to theStockholder at least 30 days prior to the consummation of such sale, settingforth (i) the consideration to be received by the holders of shares of CommonStock, (ii) the identity of the Purchaser, (iii) any other material items andconditions of the proposed transfer and (iv) the date of the proposed transfer. (b) Tag Along Rights. (i) Subject to paragraph ( iv) of thisSection 4(b), if TPG or its affiliates proposes to transfer any of its shares ofCommon Stock to a Purchaser (other than a Permitted Transferee), then TPG orsuch Permitted Transferee (hereinafter referred to as a "Selling Stockholder")shall give written notice of such proposed transfer to the Stockholder (the"Selling Stockholder's Notice") at least 30 days prior to the consummation ofsuch proposed transfer, and shall provide notice to all other stockholders ofthe Company to whom TPG has granted similar "tag-along" rights (suchstockholders together with the Stockholder, referred to herein as the "OtherStockholders") setting forth (A) the number of shares of Common Stock offered,(B) the consideration to be received by such Selling Stockholder, (C) theidentity of the Purchaser, (D) any other material items and conditions of theproposed transfer and (E) the date of the proposed transfer. (ii) Upon delivery of the Selling Stockholder's Notice, theStockholder may elect to sell up to the sum of (A) the Pro Rata Portion (ashereinafter defined) and (B) the Excess Pro Rata Portion (as hereinafterdefined) of his Shares, at the same price per share of Common Stock and pursuantto the same terms and conditions with respect to payment for the shares ofCommon Stock as agreed to by the Selling Stockholder, by sending written noticeto the Selling Stockholder within 15 days of the date of the SellingStockholder's Notice, indicating his election to sell up to the sum of the ProRata Portion plus the Excess Pro Rata Portion of his Shares in the sametransaction. Following such 15 day period, the Selling Stockholder and eachOther Stockholder shall be permitted to sell to the Purchaser on the terms andconditions set forth in the Selling Stockholder's Notice the sum of (X) the ProRata Portion and (Y) the Excess Pro Rata Portion of its Shares. C-3 (iii) For purposes of Section 4(b) hereof, "Pro Rata Portion" shallmean, with respect to shares of Common Stock held by the Stockholder or SellingStockholder, as the case may be, a number equal to the product of (x) the totalnumber of such shares then owned by the Stockholder or the Selling Stockholder,as the case may be, and (y) a fraction, the numerator of which shall be thetotal number of such shares proposed to be sold to the Purchaser as set forth inthe Selling Stockholder's Notice and the denominator of which shall be the totalnumber of such shares then outstanding (including such shares proposed to besold by the Selling Stockholder); provided, however, that any fraction of ashare resulting from such calculation shall be disregarded for purposes ofdetermining the Pro Rata Portion. For purposes of Section 4(b), "Excess Pro RataPortion" shall mean, with respect to shares of Common Stock held by theStockholder or the Selling Stockholder, as the case may be, a number equal tothe product of (x) the number of Non-Elected Shares (as defined below) and (y) afraction, the numerator of which shall be such Stockholder's Pro Rata Portionwith respect to such shares, and the denominator of which shall be the sum of(1) the aggregate Pro Rata Portions with respect to the shares of Common Stockof all of the Other Stockholders that have elected to exercise their rights tosell their Pro Rata Portion of shares of Common Stock, and (2) the SellingStockholder's Pro Rata Portion of shares of Common Stock (the aggregate amountof such denominator is hereinafter referred to as the "Elected Shares"). Forpurposes of this Agreement, "Non-Elected Shares" shall mean the excess, if any,of the total number of shares of Common Stock, proposed to be sold to aPurchaser as set forth in a Selling Stockholder's Notice less the amount ofElected Shares. (iv) Notwithstanding anything to the contrary contained herein, theprovisions of this Section 4(b) shall not apply to any sale or transfer by TPGof shares of Common Stock unless and until TPG, after giving effect to theproposed sale or transfer, shall have sold or transferred in the aggregate(other than to Permitted Transferees) shares of Common Stock, representing 7.5%of shares of Common Stock owned by TPG on the date hereof. 5. Termination. This Agreement shall terminate immediatelyfollowing the existence of a Public Market for the Common Stock except that (i)the requirements contained in Section 2 hereof shall survive the termination ofthis Agreement and (ii) the provisions contained in Section 3 hereof shallcontinue with respect to each Share during such period of time, if any, as theStockholder is precluded from selling such Shares pursuant to Rule 144 of theSecurities Act. For this purpose, a "Public Market" for the Common Stock shallbe deemed to exist if the Common Stock is registered under Section 12(b) or12(g) of the Exchange Act and trading regularly occurs in such Common Stock in,on or through the facilities of securities exchanges and/or inter-dealerquotation systems in the United States (within the meaning of Section 902(j) ofthe Securities Act) or any designated offshore securities market (within themeaning of Rule 902(b) of the Securities Act). 6. Distributions With Respect To Shares. As used herein, the term"Shares" includes securities of any kind whatsoever distributed with respect tothe Common Stock acquired by the Stockholder pursuant to the 2003 Plan or anysuch securities resulting from a stock split or consolidation involving suchCommon Stock. C-4 7. Amendment; Assignment. This Agreement may be amended,superseded, canceled, renewed or extended, and the terms hereof may be waived,only by a written instrument signed by authorized representatives of the partiesor, in the case of a waiver, by an authorized representative of the partywaiving compliance. No such written instrument shall be effective unless itexpressly recites that it is intended to amend, supersede, cancel, renew orextend this Agreement or to waive compliance with one or more of the termshereof, as the case may be. Except for the Stockholder's right to assign his orher rights under Section 3(a) or the Company's right to assign its rights underSection 3(b), no party to this Agreement may assign any of its rights orobligations under this Agreement without the prior written consent of the otherparties hereto. 8. Notices. All notices and other communications hereunder shall bein writing, shall be deemed to have been given if delivered in person or bycertified mail, return receipt requested, and shall be deemed to have been givenwhen personally delivered or three (3) days after mailing to the followingaddress: If to the Stockholder: If to the Company: If to TPG: or to such other address as any party may have furnished to theothers in writing in accordance herewith, except that notices of change ofaddress shall only be effective upon receipt. 9. Counterparts. This Agreement may be executed in two or morecounterparts, each of which shall be deemed to be an original, but each of whichtogether shall constitute one and the same document. 10. Governing Law. This Agreement shall be governed by and construedin accordance with the laws of the State of NEW YORK, without reference to itsprinciples of conflicts of law. 11. Binding Effect. This Agreement shall be binding upon, inure tothe benefit of, and be enforceable by the heirs, personal representatives,successors and permitted assigns of the parties hereto. Nothing expressed orreferred to in this Agreement is intended or shall be construed to give anyperson other than the parties to this Agreement, or their respective C-5heirs, personal representatives, successors or assigns, any legal or equitablerights, remedy or claim under or in respect of this Agreement or any provisioncontained herein. 12. Entire Agreement. This Agreement constitutes the entireagreement between the parties hereto with respect to the subject matter hereof. 13. Severability. If any term, provision, covenant or restriction ofthis Agreement, is held by a court of competent jurisdiction to be invalid, voidor unenforceable, the remainder of the terms, provisions, covenants andrestrictions of this Agreement shall remain in full force and effect and shallin no way be affected, impaired or invalidated. 14. Miscellaneous. The headings contained in this Agreement are forreference purposes only and shall not affect in any way the meaning orinterpretation of this Agreement. IN WITNESS WHEREOF, the parties hereto have caused this Agreement tobe duly executed as of the day and year first above written. J. CREW GROUP, INC. _____________________________ By: Title: TPG PARTNERS II, L.P. _____________________________ By: Title: ___________________________ [Stockholder] C-6 Exhibit 10.5(d) April 29, 2002Mark Sarvary7 Fox RunPurchase, NY 10577Dear Mark: This letter will confirm our understanding of the arrangements underwhich your Employment Agreement ("Employment Agreement"), dated May 3, 1999,with the Company (as modified by your letter agreement ("Letter Agreement"),dated January 15, 2002, with the Company) is terminated. The terms andconditions of the termination of your employment with the Company are set outbelow. 1. The parties hereby acknowledge and confirm that your employment with the Company is terminated effective as of April 30, 2002 (the "Termination Date") and that such termination shall constitute a Qualifying Termination (as defined in the Letter Agreement). In addition, the parties hereby acknowledge and confirm that your resignation as a Director of J. Crew Group, Inc. ("Parent") is also effective as of the Termination Date. 2. Subject to this Agreement becoming effective (as described in Paragraph 18 hereof), the Company will pay you a lump-sum amount equal to two (2) times your base salary on the Termination Date. You will also be entitled to receive the following benefits. The Company shall continue to provide medical plan coverage substantially similar to the medical plan coverage that it provides its active employees, as it may be amended from time to time, until the earlier of (i) the second anniversary of the Termination Date (i.e. April 30, 2004), (ii) the date that you become employed as a full-time employee with a new employer or (iii) the date that you become eligible to be covered by comparable plan of a subsequent employer, provided that the Company shall provide such coverage by paying your COBRA continuation coverage for the COBRA coverage period and thereafter, the Company shall only provide such coverage to the extent that the monthly cost of such coverage does not exceed the cost of your monthly COBRA premiums as in effect on the last month of your COBRA continuation period. In order to receive the foregoing medical coverage you shall cooperate with the reasonable requests of the Company, including without limitation any request to submit to medical examinations and elect COBRA continuation coverage. The Company shall also provide you with life insurance coverage equivalent to the coverage provided immediately prior to the Termination Date (namely two-times your base salary as of the Termination Date) under the same terms as it provides such coverage to its active employees under its life insurance plan, as it may be amended from time to time, until the earlier of (i) the twenty-four month anniversary of the date of the Letter Agreement (i.e. January 15, 2004), (ii) the date that you become employed as a full-time employee with a new employer or (iii) the date that you become eligible to be covered by comparable plan of a subsequent employer. The foregoing payments shall be reduced by any required tax withholdings and shall not be taken into account as compensation and no service credit shall be given after the Termination Date for purposes of determining the benefits payable under any other plan, program, agreement or arrangement of the Company. You acknowledge that, except for the foregoing payments, you are not entitled to any payment by the Company in the nature of either severance or termination pay. 3. As of the Termination Date, you have vested options to purchase 108,800 shares of Common Stock of Parent ("Common Stock") at $10.00 per share. In addition, the Company hereby agrees that options to purchase an additional 54,400 shares of Common Stock at $10.00 per share shall vest and become exercisable on May 10, 2002 (such additional options together with the options vested as of the Termination Date are collectively referred to as the "Vested Options"). Notwithstanding anything to the contrary, all of the Vested Options shall remain exercisable until the third anniversary of the Termination Date (i.e. April 30, 2005), subject in all other respects to the provisions of your stock option agreement with Parent and the J. Crew Group, Inc. 1997 Stock Option Plan ("Option Plan"). All other unvested options (totaling 108,800 options to purchase Common Stock at $10.00 per share) shall terminate effective as of the Termination Date. All shares of Common Stock acquired by you pursuant to the Vested Options shall be subject to the Stockholders' Agreement attached to the Option Plan as Exhibit B and Section 2(f) of the Employment Agreement relating to your put right. In consideration of the extension relating to the Vested Options described above and notwithstanding anything in the Stockholders' Agreement to the contrary, however, you hereby agree that the Company (or its designated assignee) shall have the right, during the 120 day period immediately following the expiration of the six month period after any shares of Common Stock are acquired by you, to purchase from you all or any portion of such shares at a per share price equal to the Fair Market Value (as defined in the Option Plan) of a share of Common Stock determined as of the date as of which such right is exercised. 4. The parties acknowledge and agree that you shall repay in full the principal amount of the Company Loan (as defined in the Letter Agreement) (currently $850,000 principal balance still outstanding) on the earliest of (i) June 1, 2005, (ii) the date that you sell or otherwise dispose of your primary residence located at 7 Fox Run, Purchase, New York, and (iii) the one year anniversary of the date that you commence full time continuous employment with any subsequent employer. Notwithstanding the foregoing, you agree that any and all proceeds generated from the sale or disposition of all or any portion of your shares of Common Stock (less the amount you paid to the Company for such shares) shall be immediately applied to the payment of the outstanding principal amount of the Company Loan. In the event of a repurchase of Common Stock by the Company, you authorize the Company to withhold any payments for such Common Stock and apply such proceeds to the repayment of the Company Loan. 2 5. By signing this Agreement, you agree that in exchange for the additional consideration set forth herein, you hereby voluntarily, fully and unconditionally release and forever discharge the Company, Parent, their present and former parent corporation(s), subsidiaries, divisions, affiliates and otherwise related entities and their respective incumbent and former employees, directors, plan administrators, officers and agents, individually and in their official capacities (collectively, the "Releasees"), from any and all charges, actions, causes of action, demands, debts, dues, bonds, accounts, covenants, contracts, liabilities, or damages of any nature whatsoever, whether now known or claimed, to whomever made, which you have or may have against any or all of the Releasees for or by reason of any cause, nature or thing whatsoever, up to the present time, arising out of or related to your employment with the Company or the termination of such employment, including, by way of examples and without limiting the broadest application of the foregoing, any actions, causes of action, or claims under any contract or federal, state or local decisional law, statues, regulations or constitutions, any claims for notice, pay in lieu of notice, wrongful dismissal, breach of contract, defamation or other tortious conduct, discrimination on the basis of actual or perceived disability, age, sex, race or any other factor (including, without limitation, any claim pursuant to Title VII of the Civil Rights Act of 1964, Americans with Disabilities Act of 1990, the Age Discrimination in Employment Act of 1967, as amended, the Family and Medical Act of 1993, the Equal Pay Act of 1963, the Fair Labor Standards Act, the State, City and local laws of New York, and the equal employment law or laws of the state and/or city in which you work), any claim pursuant to any other applicable employment standards or human rights legislation or for severance pay, salary, bonus, incentive or additional compensation, vacation pay, insurance, other benefits, interest, and/or attorney's fees. You acknowledge that this general release is not made in connection with an exit incentive or other employment termination program offered to a group or class of employees. If you have made or should hereafter make any complaint, charge, claim, allegation or demand, or commence or threaten to commence any action, complaint, charge, claim or proceeding, against any or all of the Releasees for or by reason of any cause, matter or thing whatsoever existing up to the present time, this Agreement may be raised as and shall constitute a complete bar to any such action, complaint, charge, claim, allegation or proceeding, and, subject to a favorable ruling by a tribunal of final jurisdiction, the Releasees shall recover from you, and you shall pay to the Releasees, all costs incurred by them, including their attorneys' fees, as a consequence of any such action, complaint charge, claim, allegation or proceeding; provided, however, that this is not intended to interfere with your right to file a charge with the Equal Employment Opportunity Commission ("EEOC") in connection with any claim you believe you may have against any Releasee. However, by signing this Agreement, you agree to waive any right to recover in any proceeding you may bring before the EEOC (or any state human rights commission) or in any proceeding brought by the EEOC (or any state human rights commission) on your behalf. You specifically release all claims under the Age Discrimination in Employment Act ("ADEA") relating to your employment and its termination. 3 This release shall not apply to any claims you may have relating to the Company's performance of its obligations under this Agreement or under the Ancillary Documents (as defined in Section 13). In the event any action is commenced to enforce your rights under this Agreement or under any Ancillary Document, each party shall bear its own legal fees and expenses. 6. You acknowledge that the payments and other considerations described in Sections 2, 3 and 4 above that you are receiving in connection with the foregoing release is in addition to anything of value to which you already are entitled from the Company. 7. You hereby agree and acknowledge that you shall be bound by and comply with the restrictive covenants provided in Sections 7, 8 (as modified by clause (e) of the Letter Agreement), 9 and 10 of the Employment Agreement (the "Restrictive Covenants"), and that such Restrictive Covenants are hereby made part of this Agreement as if specifically restated herein and that the payments and other considerations described in Sections 2, 3 and 4 above that you are receiving are subject to and contingent upon your compliance with Restrictive Covenants. You also acknowledge that your receipt of certain benefits hereunder are affected by you obtaining subsequent employment and therefore you agree to notify the Executive Vice President of Human Resources in writing prior to the effective date of any full-time employment with a new employer or, if earlier, the effective date you become eligible to be covered by a comparable plans of a subsequent employer, as described in Section 2. 8. You acknowledge and agree that, notwithstanding any other provision of this Agreement, if you breach any of your obligations under this Agreement or a Restrictive Covenant, (a) you will forfeit your right to receive the payment and other considerations described in Sections 2, 3 and 4 above (to the extent the payment was not theretofore paid) and the Company shall be entitled to recover any payments made to you or on your behalf, (b) the Vested Options shall expire as of the date of such breach to the extent not theretofore exercised and, if exercised as of the date of such breach, you shall immediately reimburse the Company for the profit upon exercise (such profit calculated as the difference between the (i) greater of either the Fair Market Value (as defined in the Option Plan) of a share of Common Stock on the date of exercise or the amount paid by the Company to you per share of Common Stock for the purchase of the shares acquired upon exercise, and (ii) exercise price, times the number of options exercised). 9. You hereby agree that the breach of a Restrictive Covenant may cause the Company to suffer irreparable harm for which money damages would not be an adequate remedy and therefore, if you breach a Restrictive Covenant, the Company would be entitled to temporary and permanent injunctive relief in any court of competent jurisdiction (without the need to post any bond) without prejudice to any other remedies under this Agreement or otherwise. 4 10. The Company affirms its obligation to indemnify, defend and hold you harmless, to the extent permitted by law, from and against all claims made by third parties against you arising out of actions taken by you in your capacity as an officer and director of the Company. You also agree to cooperate fully with the Company and the Releasees in connection with any existing or future litigation or proceedings involving the Company or any Releasee to the extent necessary and to notify the Company promptly upon receipt of any legal process or other request requiring you to testify, plead, respond, defend and/or produce documents relating to the Company or any Releasee. The Company represents that, as of the date of this Agreement, the Board of Directors is not aware of any claims that it has against you arising out of your employment with the Company; provided, however, that this shall not bar the Company from making any claims, charges or demands against you at any time in the future based on facts, circumstances or matters of which it may hereafter become aware regardless of when they occurred or to what time period they relate. 11. This Agreement does not constitute an admission of liability or wrongdoing of any kind by you or the Company or its affiliates. 12. The terms of this Agreement shall be binding on the parties hereto and their respective successors, assigns, heirs and representatives. 13. This Agreement, together with the documents relating to the Vested Options and the Company Loan (collectively referred to as the "Ancillary Documents"), constitute the entire understanding of the Company and you with respect to the subject matter hereof and supersedes all prior understandings, written or oral. The terms of this Agreement may be changed, modified or discharged only by an instrument in writing signed by the parties hereto. A failure of the Company or you to insist on strict compliance with any provision of this Agreement shall not be deemed a waiver of such provision or any other provision hereof. If any provision of this Agreement is determined to be so broad as to be unenforceable, such provision shall be interpreted to be only so broad as is enforceable. 14. This Agreement shall be construed, enforced and interpreted in accordance with and governed by the laws of the State of New York. 15. The parties hereto acknowledge and agree that each party has reviewed and negotiated the terms and provisions of this Agreement and has contributed to its revision. Accordingly, the rule of construction to the effect that ambiguities are resolved against the drafting party shall not be employed in the interpretation of this Agreement. Rather, the terms of this Agreement shall be construed fairly as to both parties hereto and not in favor or against either party. 16. This Agreement may be executed in any number of counterparts and by different parties on separate counterparts, each of which counterpart, when so executed and delivered, shall be deemed to be an original and all of which counterparts, taken together, shall constitute but one and the same Agreement. 5 17. You acknowledge that, by your free and voluntary act of signing below, you agree to all of the terms of this Agreement and intend to be legally bound thereby. 18. You acknowledge that you have received this Agreement on or before April 30, 2002. You understand that you may consider whether to agree to the terms contained herein for a period of twenty-one (21) days after the date hereof. However, the operation of the provisions of Sections 2 through 5 above may be delayed until you execute this Agreement and return it to the Company and it becomes effective as provided below. You acknowledge that you have consulted with an attorney prior to your execution of this Agreement or have determined by your own free will not to consult with an attorney. 19. This Agreement will become effective, enforceable and irrevocable seven days after the date on which it is executed by you (the "Effective Date"). During the seven-day period prior to the Effective Date, you may revoke your agreement to accept the terms hereof by indicating in writing to the Executive Vice President of Human Resources your intention to revoke. If you exercise your right to revoke hereunder, you shall forfeit your right to receive any of the payments and other considerations provided for herein, and to the extent such payments have already been made, you agree that you will immediately reimburse the Company for the amounts of such payments. 6 If the foregoing correctly reflects our understanding, please sign theenclosed copy of this letter agreement, whereupon it will become a bindingagreement between us. J. CREW OPERATING CORP. By: _____________________ Name: Title:Agreed to and accepted:By:_______________________ Mark SarvaryDated: _________, 2002AcknowledgmentSTATE OF _________________) ss:COUNTY OF _______________)On the __ day of _______, 2002, before me personally came Mark Savary who, beingby me duly sworn, did depose and say that he resides at 7 Fox Run, Purchase, NewYork, and did acknowledge and represent that he has had an opportunity toconsult with attorneys and other advisers of his choosing regarding theAgreement set forth above, that he has reviewed all of the terms of theAgreement and that he fully understands all of its provisions, including withoutlimitation, the general release and waiver set forth therein._________________________Notary PublicDate:____________________ 7 Exhibit 10.6(b) October 17, 2002Mr. Michael Scandiffio3 Smith Ridge LaneNew Canaan, CT 06840Dear Michael: This letter will confirm our understanding of the arrangements under whichyour Employment Agreement, dated May 17, 2001, with the Company ("EmploymentAgreement") is terminated. The terms and conditions of the termination of youremployment with the Company are set out below. 1. The parties hereby acknowledge and confirm that your employment with the Company is terminated effective as of October 17, 2002 (the "Termination Date"). 2. Subject to this Agreement becoming effective (as described in Paragraph 18 hereof), the Company will continue to pay you your base salary of $480,000 per annum for the twelve (12) month period beginning on the day immediately following the Termination Date ("Severance Period"), payable in accordance with the Company's regular payroll practices for its employees. You will also continue to have medical coverage during the Severance Period on the same terms and conditions as medical coverage is then made available to the employees of the Company. The foregoing payments shall be reduced by any required tax withholdings and shall not be taken into account as compensation and no service credit shall be given after the Termination Date for purposes of determining the benefits payable under any other plan, program, agreement or arrangement of the Company. You acknowledge that, except for the foregoing payments, you are not entitled to any payment by the Company in the nature of either severance or termination pay or other compensation of any kind. 3. As of the Termination Date, you have vested options to purchase 8,000 shares of Common Stock ("Common Stock") of J. Crew Group, Inc. ("Parent") at $19.18 per share (collectively, the "Vested Options"). You acknowledge that (i) your right to exercise the Vested Options shall expire 90 days immediately following the Termination Date (i.e. January 15, 2003) and (ii) all of your other options which have not yet vested (totaling 32,000 options to purchase Common Stock at $19.18 per share) terminate effective immediately, in accordance with the provisions of your stock option agreements with Parent and the J. Crew Group, Inc. 1997 Stock Option Plan, as amended (the "Option Plan"). 4. By signing this Agreement, you agree that in exchange for the consideration set forth herein, you hereby voluntarily, fully and unconditionally release and forever discharge the Company, Parent, their present and former parent corporation(s), subsidiaries, divisions, affiliates and otherwise related entities and their respective incumbent and former employees, directors, plan administrators, officers and agents, individually and in their official capacities (collectively, the "Releasees"), from any and all charges, actions, causes of action, demands, debts, dues, bonds, accounts, covenants, contracts, liabilities, or damages of any nature whatsoever, whether now known or claimed, to whomever made, which you have or may have against any or all of the Releasees for or by reason of any cause, nature or thing whatsoever, up to the present time, arising out of or related to your employment with the Company or the termination of such employment, including, by way of examples and without limiting the broadest application of the foregoing, any actions, causes of action, or claims under any contract or federal, state or local decisional law, statues, regulations or constitutions, any claims for notice, pay in lieu of notice, wrongful dismissal, breach of contract, defamation or other tortious conduct, discrimination on the basis of actual or perceived disability, age, sex, race or any other factor (including, without limitation, any claim pursuant to Title VII of the Civil Rights Act of 1964, Americans with Disabilities Act of 1990, the Age Discrimination in Employment Act of 1967, as amended, the Family and Medical Act of 1993, the Equal Pay Act of 1963, the Fair Labor Standards Act, the State, City and local laws of New York, and the equal employment law or laws of the state and/or city in which you work), any claim pursuant to any other applicable employment standards or human rights legislation or for severance pay, salary, bonus, incentive or additional compensation, vacation pay, insurance, other benefits, interest, and/or attorney's fees. You acknowledge that this general release is not made in connection with an exit incentive or other employment termination program offered to a group or class of employees. If you have made or should hereafter make any complaint, charge, claim, allegation or demand, or commence or threaten to commence any action, complaint, charge, claim or proceeding, against any or all of the Releasees for or by reason of any cause, matter or thing whatsoever existing up to the present time, this Agreement may be raised as and shall constitute a complete bar to any such action, complaint, charge, claim, allegation or proceeding, and, subject to a favorable ruling by a tribunal of final jurisdiction, the Releasees shall recover from you, and you shall pay to the Releasees, all costs incurred by them, including their attorneys' fees, as a consequence of any such action, complaint charge, claim, allegation or proceeding; provided, however, that this shall not limit you from enforcing your rights under this Agreement, your rights under your stock option agreement with Parent and the Option Plan or any rights to indemnification you may have under the Company's or Parent's certificates of incorporation and by-laws (including without limitation pursuant to their directors' and officers' liability insurance) with respect to claims relating to or arising out of your employment with the Company, and in the event any action is commenced to enforce your rights under this Agreement, each party shall bear its own legal fees and expenses; and provided further, however, that this is not intended to interfere with your right to file a charge with the Equal Employment Opportunity Commission ("EEOC") in connection with any claim you believe you may have 2 against any Releasee. However, by signing this Agreement, you agree to waive any right to recover in any proceeding you may bring before the EEOC (or any state human rights commission) or in any proceeding brought by the EEOC (or any state human rights commission) on your behalf. You specifically release all claims under the Age Discrimination in Employment Act ("ADEA") relating to your employment and its termination. 5. You acknowledge that the payments described in Section 2 above that you are receiving in connection with the foregoing release are in accordance with your Employment Agreement. 6. You hereby agree and acknowledge that you shall be bound by and comply with the restrictive covenants provided in Section 4 of the Employment Agreement (the "Restrictive Covenants"), and that such Restrictive Covenants are hereby made part of this Agreement as if specifically restated herein and that the payments described in Section 2 above that you are receiving are subject to and contingent upon your compliance with Restrictive Covenants. 7. You acknowledge and agree that, notwithstanding any other provision of this Agreement, if you breach any of your obligations under this Agreement or any Restrictive Covenant, (a) you will forfeit your right to receive the payments and benefits described in Section 2 above (to the extent the payments were not theretofore paid) and the Company shall be entitled to recover any payments already made to you or on your behalf, (b) the Vested Options shall expire as of the date of such breach to the extent not theretofore exercised and, if exercised as of the date of such breach, you shall immediately reimburse the Company for the profit upon exercise (such profit calculated as the difference between the (i) greater of either the Fair Market Value (as defined in the Option Plan) of a share of Common Stock on the date of exercise or the amount paid by the Company to you per share of Common Stock for the purchase of the shares acquired upon exercise, and (ii) exercise price, times the number of options exercised). 8. You hereby agree that the breach of any Restrictive Covenant may cause the Company to suffer irreparable harm for which money damages would not be an adequate remedy and therefore, if you breach a Restrictive Covenant, the Company would be entitled to temporary and permanent injunctive relief in any court of competent jurisdiction (without the need to post any bond) without prejudice to any other remedies under this Agreement or otherwise. 9. You agree that you will hold in strict confidence proprietary or Confidential Information (as defined in the Employment Agreement). It shall not be a violation of this Agreement if you are compelled to disclose such information pursuant to a subpoena, court order or similar process; provided that you agree that, in the event that you are served with legal process or other request purporting to require you to testify, plead, respond or defend and/or produce documents at a legal proceeding, threatened proceeding, investigation or inquiry involving the Releasees, you will: (1) refuse to provide testimony or documents absent a subpoena, court order or similar process from a regulatory agency: (2) within three (3) business days or as soon thereafter as practical, provide oral notification to the Company's Executive Vice-President of Human Resources of 3 your receipt of such process or request to testify or produce documents; and (3) provide to the Company's Executive Vice-President of Human Resources by overnight delivery service a copy of all legal papers and documents served upon you. You further agree that in the event you are served with such process, you will meet and confer with the Company's designee(s) in advance of giving such testimony or information. You also agree to cooperate, taking into account your own schedule, fully with the Releasees in connection with any existing or future litigation against the Releasees, whether administrative, civil or criminal in nature, in which and to the extent the Releasees deem your cooperation necessary. The Company agrees to reimburse you for your reasonable out-of-pocket expenses incurred in connection with the performance of your obligations under this Section 9. 10. This Agreement does not constitute an admission of liability or wrongdoing of any kind by you or the Company or its affiliates. 11. The terms of this Agreement shall be binding on the parties hereto and their respective successors, assigns, heirs and representatives. 12. This Agreement, together with your stock option agreements with Parent and the Option Plan, constitute the entire understanding of the Company and you with respect to the subject matter hereof and supersedes all prior understandings, written or oral. The terms of this Agreement may be changed, modified or discharged only by an instrument in writing signed by the parties hereto. A failure of the Company or you to insist on strict compliance with any provision of this Agreement shall not be deemed a waiver of such provision or any other provision hereof. If any provision of this Agreement is determined to be so broad as to be unenforceable, such provision shall be interpreted to be only so broad as is enforceable. 13. This Agreement shall be construed, enforced and interpreted in accordance with and governed by the laws of the State of New York. 14. The parties hereto acknowledge and agree that each party has reviewed and negotiated the terms and provisions of this Agreement and has contributed to its revision. Accordingly, the rule of construction to the effect that ambiguities are resolved against the drafting party shall not be employed in the interpretation of this Agreement. Rather, the terms of this Agreement shall be construed fairly as to both parties hereto and not in favor or against either party. 15. This Agreement may be executed in any number of counterparts and by different parties on separate counterparts, each of which counterpart, when so executed and delivered, shall be deemed to be an original and all of which counterparts, taken together, shall constitute but one and the same Agreement. 16. You acknowledge that, by your free and voluntary act of signing below, you agree to all of the terms of this Agreement and intend to be legally bound thereby. 17. You acknowledge that you have received this Agreement on or before October 17, 2002. You understand that you may consider whether to agree to the terms 4 contained herein for a period of twenty-one (21) days after the date hereof. However, the operation of the provisions of Sections 2 through 4 above may be delayed until you execute this Agreement and return it to the Company and it becomes effective as provided below. You acknowledge that you have consulted with an attorney prior to your execution of this Agreement or have determined by your own free will not to consult with an attorney. 5 18. This Agreement will become effective, enforceable and irrevocable seven days after the date on which it is executed by you (the "Effective Date"). During the seven-day period prior to the Effective Date, you may revoke your agreement to accept the terms hereof by indicating in writing to the Executive Vice-President of Human Resources your intention to revoke. If you exercise your right to revoke hereunder, you shall forfeit your right to receive any of the payments and other benefits provided for herein, and to the extent such payments or benefits have already been made, you agree that you will immediately reimburse the Company for the value of such payments and benefits. 6 If the foregoing correctly reflects our understanding, please sign theenclosed copy of this letter agreement, whereupon it will become a bindingagreement between us. J. CREW OPERATING CORP. By: _____________________ David F. Kozel Executive Vice-President, Human ResourcesAGREED TO AND ACCEPTED:By:_________________________ Michael ScandiffioDated: _________, 2002AcknowledgmentSTATE OF _________________) ss:COUNTY OF _______________)On the __ day of _______, 2002, before me personally came Michael Scandiffiowho, being by me duly sworn, did depose and say that he resides at 3 Smith RidgeLane, New Canaan, CT 06840, and did acknowledge and represent that he has had anopportunity to consult with attorneys and other advisers of his choosingregarding the Agreement set forth above, that he has reviewed all of the termsof the Agreement and that he fully understands all of its provisions, includingwithout limitation, the general release and waiver set forth therein.__________________________Notary PublicDate:_____________________ 7 Exhibit 10.7(b) January 30, 2003Mr. Blair Gordon359 West 20/th/ Street, #4New York, NY 10011Dear Blair: This letter will confirm our understanding of the arrangements underwhich your Employment Agreement, dated December 12, 2001, with the Company("Employment Agreement") is terminated. The terms and conditions of thetermination of your employment with the Company are set out below. 1. The parties hereby acknowledge and confirm that your employment with the Company is terminated effective as of January 30, 2003 (the "Termination Date"). 2. Subject to this Agreement becoming effective (as described in Paragraph 18 hereof), the Company will continue to pay you your base salary of $400,000 per annum for the twelve (12) month period beginning on the day immediately following the Termination Date ("Severance Period"), payable in accordance with the Company's regular payroll practices for its employees. You will also continue to have medical coverage during the Severance Period on the same terms and conditions as medical coverage is then made available to the employees of the Company. The foregoing payments shall be reduced by any required tax withholdings and shall not be taken into account as compensation and no service credit shall be given after the Termination Date for purposes of determining the benefits payable under any other plan, program, agreement or arrangement of the Company. You acknowledge that, except for the foregoing payments, you are not entitled to any payment by the Company in the nature of either severance or termination pay or other compensation of any kind. 3. As of the Termination Date, you have no vested options to purchase shares of Common Stock ("Common Stock") of J. Crew Group, Inc. ("Parent") and 30,000 unvested options to purchase Common Stock at $10.00 per share. You acknowledge that all of your unvested options terminate effective immediately, in accordance with the provisions of your stock option agreements with Parent and the J. Crew Group, Inc. 1997 Stock Option Plan, as amended (the "Option Plan"). 4. By signing this Agreement, you agree that in exchange for the consideration set forth herein, you hereby voluntarily, fully and unconditionally release and forever discharge the Company, Parent, their present and former parent corporation(s), subsidiaries, divisions, affiliates and otherwise related entities and their respective incumbent and former employees, directors, plan administrators, officers and agents, individually and in their official capacities (collectively, the "Releasees"), from any and all charges, actions, causes of action, demands, debts, dues, bonds, accounts, covenants, contracts, liabilities, or damages of any nature whatsoever, whether now known or claimed, to whomever made, which you have or may have against any or all of the Releasees for or by reason of any cause, nature or thing whatsoever, up to the present time, arising out of or related to your employment with the Company or the termination of such employment, including, by way of examples and without limiting the broadest application of the foregoing, any actions, causes of action, or claims under any contract or federal, state or local decisional law, statues, regulations or constitutions, any claims for notice, pay in lieu of notice, wrongful dismissal, breach of contract, defamation or other tortious conduct, discrimination on the basis of actual or perceived disability, age, sex, race or any other factor (including, without limitation, any claim pursuant to Title VII of the Civil Rights Act of 1964, Americans with Disabilities Act of 1990, the Age Discrimination in Employment Act of 1967, as amended, the Family and Medical Act of 1993, the Equal Pay Act of 1963, the Fair Labor Standards Act, the State, City and local laws of New York, and the equal employment law or laws of the state and/or city in which you work), any claim pursuant to any other applicable employment standards or human rights legislation or for severance pay, salary, bonus, incentive or additional compensation, vacation pay, insurance, other benefits, interest, and/or attorney's fees. You acknowledge that this general release is not made in connection with an exit incentive or other employment termination program offered to a group or class of employees. If you have made or should hereafter make any complaint, charge, claim, allegation or demand, or commence or threaten to commence any action, complaint, charge, claim or proceeding, against any or all of the Releasees for or by reason of any cause, matter or thing whatsoever existing up to the present time, this Agreement may be raised as and shall constitute a complete bar to any such action, complaint, charge, claim, allegation or proceeding, and, subject to a favorable ruling by a tribunal of final jurisdiction, the Releasees shall recover from you, and you shall pay to the Releasees, all costs incurred by them, including their attorneys' fees, as a consequence of any such action, complaint charge, claim, allegation or proceeding; provided, however, that this shall not limit you from enforcing your rights under this Agreement, and in the event any action is commenced to enforce your rights under this Agreement, each party shall bear its own legal fees and expenses; and provided further, however, that this is not intended to interfere with your right to file a charge with the Equal Employment Opportunity Commission ("EEOC") in connection with any claim you believe you may have against any Releasee. However, by signing this Agreement, you agree to waive any right to recover in any proceeding you may bring before the EEOC (or any state human rights commission) or in any proceeding brought by the EEOC (or any state human rights commission) on your behalf. You specifically release all claims under the Age Discrimination in Employment Act ("ADEA") relating to your employment and its termination. 5. You acknowledge that the payments described in Section 2 above that you are receiving in connection with the foregoing release are in accordance with your Employment Agreement. 2 6. You hereby agree and acknowledge that you shall be bound by and comply with the restrictive covenants provided in Section 4 of the Employment Agreement (the "Restrictive Covenants"), and that such Restrictive Covenants are hereby made part of this Agreement as if specifically restated herein and that the payments described in Section 2 above that you are receiving are subject to and contingent upon your compliance with Restrictive Covenants. 7. You acknowledge and agree that, notwithstanding any other provision of this Agreement, if you breach any of your obligations under this Agreement or any Restrictive Covenant, (a) you will forfeit your right to receive the payments and benefits described in Section 2 above (to the extent the payments were not theretofore paid) and the Company shall be entitled to recover any payments already made to you or on your behalf, (b) the Vested Options shall expire as of the date of such breach to the extent not theretofore exercised and, if exercised as of the date of such breach, you shall immediately reimburse the Company for the profit upon exercise (such profit calculated as the difference between the (i) greater of either the Fair Market Value (as defined in the Option Plan) of a share of Common Stock on the date of exercise or the amount paid by the Company to you per share of Common Stock for the purchase of the shares acquired upon exercise, and (ii) exercise price, times the number of options exercised). 8. You hereby agree that the breach of any Restrictive Covenant may cause the Company to suffer irreparable harm for which money damages would not be an adequate remedy and therefore, if you breach a Restrictive Covenant, the Company would be entitled to temporary and permanent injunctive relief in any court of competent jurisdiction (without the need to post any bond) without prejudice to any other remedies under this Agreement or otherwise. 9. You agree that, in the event that you are served with legal process or other request purporting to require you to testify, plead, respond or defend and/or produce documents at a legal proceeding, threatened proceeding, investigation or inquiry involving the Releasees, you will: (1) refuse to provide testimony or documents absent a subpoena, court order or similar process from a regulatory agency: (2) within three (3) business days or as soon thereafter as practical, provide oral notification to the Company's Executive Vice-President of Human Resources of your receipt of such process or request to testify or produce documents; and (3) provide to the Company's Executive Vice-President of Human Resources by overnight delivery service a copy of all legal papers and documents served upon you. You further agree that in the event you are served with such process, you will meet and confer with the Company's designee(s) in advance of giving such testimony or information. You also agree to cooperate fully with the Releasees in connection with any existing or future litigation against the Releasees, whether administrative, civil or criminal in nature, in which and to the extent the Releasees deem your cooperation necessary. The Company agrees to reimburse you for your reasonable out-of-pocket expenses incurred in connection with the performance of your obligations under this Section 9. 10. This Agreement does not constitute an admission of liability or wrongdoing of any kind by you or the Company or its affiliates. 3 11. The terms of this Agreement shall be binding on the parties hereto and their respective successors, assigns, heirs and representatives. 12. This Agreement constitutes the entire understanding of the Company and you with respect to the subject matter hereof and supersedes all prior understandings, written or oral. The terms of this Agreement may be changed, modified or discharged only by an instrument in writing signed by the parties hereto. A failure of the Company or you to insist on strict compliance with any provision of this Agreement shall not be deemed a waiver of such provision or any other provision hereof. If any provision of this Agreement is determined to be so broad as to be unenforceable, such provision shall be interpreted to be only so broad as is enforceable. 13. This Agreement shall be construed, enforced and interpreted in accordance with and governed by the laws of the State of New York. 14. The parties hereto acknowledge and agree that each party has reviewed and negotiated the terms and provisions of this Agreement and has contributed to its revision. Accordingly, the rule of construction to the effect that ambiguities are resolved against the drafting party shall not be employed in the interpretation of this Agreement. Rather, the terms of this Agreement shall be construed fairly as to both parties hereto and not in favor or against either party. 15. This Agreement may be executed in any number of counterparts and by different parties on separate counterparts, each of which counterpart, when so executed and delivered, shall be deemed to be an original and all of which counterparts, taken together, shall constitute but one and the same Agreement. 16. You acknowledge that, by your free and voluntary act of signing below, you agree to all of the terms of this Agreement and intend to be legally bound thereby. 17. You acknowledge that you have received this Agreement on or before January 30, 2003. You understand that you may consider whether to agree to the terms contained herein for a period of twenty-one (21) days after the date hereof. However, the operation of the provisions of Sections 2 through 4 above may be delayed until you execute this Agreement and return it to the Company and it becomes effective as provided below. You acknowledge that you have consulted with an attorney prior to your execution of this Agreement or have determined by your own free will not to consult with an attorney. 18. This Agreement will become effective, enforceable and irrevocable seven days after the date on which it is executed by you (the "Effective Date"). During the seven-day period prior to the Effective Date, you may revoke your agreement to accept the terms hereof by indicating in writing to the Executive Vice-President of Human Resources your intention to revoke. If you exercise your right to revoke hereunder, you shall forfeit your right to receive any of the payments and other benefits provided for herein, and to the extent such payments or benefits have already been made, you agree that you will immediately reimburse the Company for the value of such payments and benefits. 4 If the foregoing correctly reflects our understanding, please sign theenclosed copy of this letter agreement, whereupon it will become a bindingagreement between us. J. CREW OPERATING CORP. By: _________________________ David F. Kozel Executive Vice-President, Human ResourcesAgreed to and accepted:By:_______________________ Blair GordonDated: _____________, 2003AcknowledgmentSTATE OF _________________) ss:COUNTY OF _______________)On the __ day of _______, 2003, before me personally came Blair Gordon who,being by me duly sworn, did depose and say that he resides at_________________________________, and did acknowledge and represent that he hashad an opportunity to consult with attorneys and other advisers of his choosingregarding the Agreement set forth above, that he has reviewed all of the termsof the Agreement and that he fully understands all of its provisions, includingwithout limitation, the general release and waiver set forth therein._________________________Notary PublicDate:____________________ 5 Exhibit 10.8(b) Execution Copy SEPARATION AGREEMENT AND GENERAL RELEASE AND WAIVER This Separation Agreement and General Release and Waiver (this"Agreement") is made as of January 29, 2003, among J. Crew Group, Inc., a NewYork corporation (the "Parent") and its operating subsidiary J. Crew OperatingCorp. (the "Employer," and together with the Parent, "Crew"), with offices at770 Broadway, New York, NY, and Kenneth S. Pilot (the "Employee"). WHEREAS, Crew engaged the Employee to be the Chief Executive Officer ofthe Employer and the Parent; WHEREAS, the Employee, the Parent and the Employer are parties to anEmployment Agreement dated August 26, 2002 (the "Employment Agreement"); WHEREAS, Section 5(a) of the Employment Agreement provides that, as acondition to the receipt of certain benefits described therein, the Employeeshall be required to execute a general release of claims in the form appended tothe Employment Agreement; WHEREAS, the parties wish to confirm the termination of the Employee'semployment with Crew and set forth their agreement as to the manner in which theEmployee's employment with Crew will be closed out; NOW, THEREFORE, in consideration of the mutual covenants set forthherein and for other good and valuable consideration, receipt of which is herebyacknowledged, Crew and the Employee agree as follows: 1. Termination of Employment. The parties hereto hereby agree that theEmployee's employment with Crew terminated as of January 29, 2003 (the "Date ofTermination"). The Employee hereby resigns, effective as of the Date ofTermination, all positions, titles, duties, authorities and responsibilitieswith, arising out of or relating to his employment with Crew and its affiliatesand agrees to execute all additional documents and takes such further steps asmay be required to effectuate such resignation. 2. Certain Payments and Benefits. (a) Pursuant to Section 5(a) of the Employment Agreement, Crew shallpay the Employee the lump-sum amount of $2,494,500, which represents the sum of(i) $1,400,000 (two times the Employee's current base salary of $700,000), (ii)$546,000 (the Employee's guaranteed 2002 and 2003 Bonus), (iii) $530,000(transition services and relocation reimbursement), (iv) $13,500 (1 week ofaccrued vacation), and (v) $5,000 (tax adviser fees). In addition to theforegoing, (x) the Employee shall become fully vested in the Restricted Sharesgranted to him in accordance with Sections 2(f)(ii) of the Employment Agreement,(y) the Company agrees not to exercise the call rights provided under Section3(b) of the Stockholders' Agreement, dated September 9, 2002, between theParent, the Employee and TPG Partners II, L.P., with respect to the GrantedShares and Restricted Shares granted pursuant to Sections 2(f)(i) and (ii) ofthe Employment Agreement and waives the right of it and its designated assigneeto do so, and (z) the Company shall pay the premiums in connection withproviding COBRA coverage for the Employee until the earlier of (A) eighteenmonths from the Date ofTermination, or (B) such time as the Employee shall become entitled to coverageunder any welfare benefit plan of another employer. The payments and benefitsprovided in this Section 2(a) shall be referred to herein as the "TerminationPayment." (b) In addition to the Termination Payment, Crew shall (i) pay for theEmployee's reasonable legal fees incurred in connection with this Agreement inan amount not to exceed $7,500, (ii) provide a lump-sum payment to the Employeefor executive outplacement services for the Employee and miscellaneouspublications in an amount not to exceed $15,000 (iii) reimburse the Employee'sreasonable business expenses upon presentation to Crew by the Employee ofstatements of such expenses no later than thirty days after the Date ofTermination, (iv) permit the Employee to keep for his personal use the laptopcomputer and fax machine issued to the Employee by Crew, and (v) continue to paythe Employee's current Base Salary and provide benefits as if the Employeeremained employed through January 31, 2003. (c) The Termination Payment shall be reduced by any required taxwithholding. The Termination Payment shall not be taken into account ascompensation and no service credit shall be given after the Date of Terminationfor purposes of determining the benefits payable to the Employee or theEmployee's family under any plan, program, agreement or arrangement of Crew. TheEmployee acknowledges that, except for the Termination Payment, he is notentitled to any payment in the nature of severance or termination pay from Crew. (d) The Employee shall be entitled to any benefit to which the Employeemay be entitled under any tax qualified pension plan of Crew or its affiliates,continuation of health insurance benefits, as provided above, to the extentprovided in Section 4980B of the Internal Revenue Code of 1986 and Section 601of the Employee Retirement Income Security Act of 1974, as amended (whichprovisions are commonly known as "COBRA") and any other similar benefitsrequired to be provided by law. 3. General Release and Waiver (a) The Employee hereby releases, remises and acquits the Employer, theParent and all of their respective affiliates, and their respective officers,directors, shareholders, members, agents, employees, consultants, independentcontractors, attorneys, advisers, successors and assigns, jointly and severally,from any and all claims, known or unknown, which the Employee or the Employee'sheirs, successors or assigns have or may have against any of such partiesarising on or prior to the date this Agreement is executed by the Employee andany and all liability which any of such parties may have to the Employee,whether denominated claims, demands, causes of action, obligations, damages orliabilities arising from any and all bases, however, denominated, including butnot limited to, the Age Discrimination in Employment Act, the Americans withDisabilities Act of 1990, the Family and Medical Leave Act of 1993, Title VII ofthe United States Civil Rights Act of 1964, 42 U.S.C. ss. 1981, the New YorkHuman Rights Law, N.Y. Exec. Law Article 15 et seq., New York Executive Law ss.296, ss. 8-107 of the Administrative Code and Charter of New York City, or anyother federal, state or local law and any workers' compensation or disabilityclaims under any such laws or claims under any contract (including withoutlimitation the Employment Agreement). This release relates to any and allclaims, including without limitation claims arising from and during the 2Employee's employment relationship with the Employer, the Parent and theirrespective affiliates or as a result of the termination of such relationship.The Employee further agrees that the Employee will not file or permit to befiled on the Employee's behalf any such claim. Notwithstanding the precedingsentence or any other provision of this Agreement, this release is not intendedto interfere with the Employee's right to file a charge with the EqualEmployment Opportunity Commission (the "EEOC") in connection with any claim hebelieves he may have against the Employer, the Parent or their respectiveaffiliates. However, by executing this Agreement, the Employee hereby waives theright to recover in any proceeding the Employee may bring before the EEOC or anystate human rights commission or in any proceeding brought by the EEOC or anystate human rights commission on the Employee's behalf. This release is for anyrelief, no matter how denominated, including, but not limited to, injunctiverelief, wages, back pay, front pay, compensatory damages, or punitive damages.This release shall not apply to any obligation of the Employer, the Parent ortheir respective affiliates pursuant to this Agreement or any rights in thenature of indemnification (including without limitation pursuant to Crew'sdirectors' and officer's liability insurance policy) which the Employee may havewith respect to claims against the Employee relating to or arising out of hisemployment with the Employer, the Parent or their respective affiliates. (b) The Employee acknowledges that the Termination Payment constitutesgood and valuable consideration for the release contained in this Section 3. 4. Confidentiality of Agreement. The Employee and Crew shall keep theterms of this Agreement confidential and shall not directly or indirectlydisseminate any information (in any form) regarding this Agreement to any personor entity except as may be agreed to in writing by the other party.Notwithstanding the foregoing, either party may disclose the informationdescribed herein, to the extent compelled to do so by lawful service of process,subpoena, court order, or as otherwise compelled to do by law, including fulland complete disclosure in response thereto, in which event such party agrees toprovide the other party with a copy of the document(s) seeking disclosures ofsuch information promptly upon receipt of such document(s) and prior todisclosure of any such information, so that the other party may, upon notice tothe first party, take such action as it deems to be necessary or appropriate inrelation to such subpoena or request. The obligations under this Section 4 shallcease for both parties at such time that this document (once executed by bothparties) is filed publicly with the Securities and Exchange Commission. 5. Incorporation by Reference. The following sections of theEmployment Agreement are hereby incorporated by reference as if repeated herein:Section 2(n) (relating to indemnification); Section 6 ("Non-Solicitation"), asagreed by the parties; Section 8 ("Confidentiality; Non-Disclosure;Non-Disparagement"); Section 9 ("Injunctive Relief"); and Section 11(j)(relating to arbitration). Crew hereby expressly waives the Non-Competeprovisions contained in Section 7 of the Employment Agreement. 6. Certain Forfeitures in Event of Breach. The Employee acknowledgesand agrees that, notwithstanding any other provision of this Agreement, in theevent the Employee materially breaches any of his obligations under Section 3 ofthis Agreement, the Employee will forfeit his right to receive the TerminationPayment to the extent not theretofore paid to him as of 3the date of such breach and, if already made as of the time of breach, theEmployee agrees that he will reimburse Crew, immediately, for the amount of suchpayment. 7. No Admission. This Agreement does not constitute an admission ofliability or wrongdoing of any kind by Crew or its affiliates. 8. Heirs and Assigns. The terms of this Agreement shall be binding onthe parties hereto and their respective successors and assigns. 9. General Provisions (a) Integration. This Agreement constitutes the entire understanding ofCrew and the Employee with respect to the subject matter hereof and supersedesall prior understandings, written or oral, including without limitation theEmployment Agreement. The terms of this Agreement may be changed, modified ordischarged only by an instrument in writing signed by the parties hereto. Afailure of Crew or the Employee to insist on strict compliance with anyprovision of this Agreement shall not be deemed a waiver of such provision orany other provision hereof. In the event that any provision of this Agreement isdetermined to be so broad as to be unenforceable, such provision shall beinterpreted to be only so broad as is enforceable. (b) Choice of Law. This Agreement shall be construed, enforced andinterpreted in accordance with and governed by the laws of the State of NewYork, without regard to its choice of law provisions. (c) Construction of Agreement. The parties hereto acknowledge and agreethat each party has reviewed and negotiated the terms and provisions of thisAgreement and has had the opportunity to contribute to its revision.Accordingly, the rule of construction to the effect that ambiguities areresolved against the drafting party shall not be employed in the interpretationof this Agreement. Rather, the terms of this Agreement shall be construed fairlyas to both parties hereto and not in favor or against either party. (d) Counterparts. This Agreement may be executed in any number ofcounterparts and by different parties on separate counterparts, each of whichcounterpart, when so executed and delivered, shall be deemed to be an originaland all of which counterparts, taken together, shall constitute but one and thesame Agreement. (e) Notice. Any notice or other communication required or permittedunder this Agreement shall be effective only if it is in writing and shall bedeemed to be given when delivered personally or four days after it is mailed byregistered or certified mail, postage prepaid, return receipt requested or oneday after it is sent by a reputable overnight courier service and, in each case,addressed as follows (or if it is sent through any other method agreed upon bythe parties): If to Crew: J. Crew Group, Inc. 770 Broadway, Twelfth Floor 4 New York, New York 10003 Attention: Board of Directors and Secretary with a copy to: Paul Shim, Esq. Cleary, Gottlieb, Steen & Hamilton One Liberty Plaza New York, NY 10006If to the Employee, to the address on record with Crew; or, for either party, tosuch other address as any party hereto may designate by notice to the others,and shall be deemed to have been given upon receipt. 10. Knowing and Voluntary Waiver. The Employee acknowledges that, bythe Employee's free and voluntary act of signing below, the Employee agrees toall of the terms of this Agreement and intends to be legally bound thereby. The Employee understands that he may consider whether to agree to theterms contained herein for a period of twenty-one days after the date hereof.Accordingly, the Employee may execute this Agreement by February 19, 2003, toacknowledge his understanding of and agreement with the foregoing. However, theTermination Payment provided herein will be delayed until this Agreement isexecuted and returned to Crew. The Employee acknowledges that he has beenadvised to consult with an attorney prior to executing this Agreement. This Agreement will become effective, enforceable and irrevocable onthe eighth day after the date on which it is executed by the Employee (the"Effective Date"). During the seven-day period prior to the Effective Date, theEmployee may revoke his agreement to accept the terms hereof by indicating inwriting to Crew his intention to revoke. If the Employee exercises his right torevoke hereunder, he shall forfeit his right to receive any of the benefitsprovided for herein, and to the extent such payments have already been made, theEmployee agrees that he will immediately reimburse Crew for the amounts of suchpayment. The Employee acknowledges that, by his free and voluntary act ofsigning below, he agrees to all of the terms of this Release and intends to belegally bound thereby. 5 IN WITNESS WHEREOF, the Employer and the Parent have caused thisAgreement to be signed by their duly authorized representatives and the Employeehas signed this Agreement has of the day and year first above written. J. CREW GROUP, INC. ___________________________________________ Name: Scott M. Rosen Title: Executive Vice President and Chief Financial Officer J. CREW OPERATING CORP. ___________________________________________ Name: Scott M. Rosen Title: Executive Vice President and Chief Financial Officer ___________________________________________ Kenneth S. Pilot 6Acknowledgment STATE OF ___________________) ss: COUNTY OF___________________)On the ____ day of __________, ____, before me personally came ______________who, being by me duly sworn, did depose and say that he resides at___________________________; and did acknowledge and represent that he has hadan opportunity to consult with attorneys and other advisers of his choosingregarding the Separation Agreement and General Release and Waiver attachedhereto, that he has reviewed all of the terms of the Separation Agreement andGeneral Release and Waiver and that he fully understands all of its provisions,including, without limitation, the general release and waiver set forth therein._________________________Notary PublicDate: __________________ 7 Exhibit 10.9 SERVICES AGREEMENT AGREEMENT, dated this 24/th/ day of January, 2003 (this "Agreement"),among J. Crew Group, Inc., a New York Corporation (the "Parent") and itsoperating subsidiary J. Crew Operating Corp. (collectively with the Parent, the"Company"), with offices at 770 Broadway, New York, New York, 10003 Millard S.Drexler, Inc. (the "Service Company") and Millard S. Drexler (the "Principal"). l. Term; Position and Responsibilities; Company Headquarters andPrincipal Work Location. (a) Term. Unless the Service Period (as defined below) is terminatedearlier pursuant to Section 4 hereof, the Company shall engage the ServiceCompany and the Principal on the terms and subject to the conditions of thisAgreement for a five year term commencing on January 27, 2003 (the "CommencementDate") and ending on the day immediately preceding the fifth anniversary of theCommencement Date (the "Service Period"). (b) Position and Responsibilities. During the Service Period, theCompany hereby agrees to cause the Principal to be elected as Chairman of theBoard of Directors of the Company (the "Board") and to employ the Principal,both directly and through the Service Company, as the Company's Chief ExecutiveOfficer and such other position or positions with the Company as the Board andthe Principal may agree from time to time, provided that following the thirdanniversary of the Commencement Date, the Principal may step down as ChiefExecutive Officer, serve as the Company's Executive Chairman and delegate hisduties and responsibilities to the appropriate executive officers of theCompany, including to any newly-appointed or, if appropriate to hire suchofficer, newly-hired Chief Executive Officer. During the Service Period, thePrincipal, on behalf of the Service Company, shall perform the duties andresponsibilities that are customarily assigned to individuals serving in suchposition or positions and such other duties and responsibilities commensuratewith such positions as the Board may reasonably specify from time to time,including but not limited to recruitment and retention of key personnel of theCompany, hiring and terminating senior executives of the Company, establishmentand execution of brand vision, and direct responsibility for assembling andguiding product, merchandising and marketing functions, and oversight of andaccountability for the financial and strategic performance of the Company (the"Services"). The Principal shall report to the Board. (c) During the Service Period, excluding any periods of vacation andsick leave to which the Principal is entitled, (i) the Principal shall devotesubstantially all of his working time and attention to the performance of hisduties and responsibilities hereunder, provided that following the thirdanniversary of the Commencement Date if the Principal elects to step down asChief Executive Officer and serve as the Executive Chairman of the Company, heshall no longer be required to devote substantially all of his working time tothe performance of his duties hereunder. Following the Principal's resignationas Chief Executive Officer, he shall provide such oversight, direction andassistance as he deems appropriate and, in either case, he shall faithfully anddiligently endeavor to promote the business and best interests of theCompany, and (ii) the Principal may not, without the prior written consent ofthe Company, operate, participate in the management, operations or control of,or act as an employee, officer, consultant, agent or representative of, any typeof business or service (other than as an Chairman and Chief Executive Officer ofthe Company), provided that it shall not be a violation of the foregoing for thePrincipal to (A) act or serve as a director, trustee, committee member orprincipal of any type of business or civic or charitable organization, (B)manage his personal, financial and legal affairs, and (C) pursue a very limitednumber of small retail and other consumer brand building ventures without TPGand TPG Ventures (provided that the activities described in clauses (A), (B) and(C) do not interfere with the performance of his duties and responsibilities tothe Company as provided hereunder). Notwithstanding anything to the contrary inthis Section 1(c), the Principal may pursue emerging retail and other consumerbrand building opportunities with TPG and TPG Ventures and their affiliates. (d) Company Headquarters; Principal Work Location. Unless otherwisemutually agreed upon, the Company's headquarters shall be the New Yorkmetropolitan area. The Company intends to establish a West Coast merchandisingoffice at the Principal's reasonable direction, which will be the Principal'sprincipal work location,. The Principal shall travel as reasonably required tocarry out his duties and obligations hereunder, including to New York. 2. Compensation; Expenses; Benefits and Perquisites. During theService Period, as compensation for the performance of the Services, the ServiceCompany and the Principal, as applicable shall be entitled to the followingcompensation from the Company, which subsections (a), (b) and (c) below shallnot exceed an aggregate of $700,000 per annum: (a) Base Salary. The Company shall pay the Principal, not less thanonce a month pursuant to the Company's normal and customary payroll procedures,a base salary at the rate of $200,000 per annum (the "Base Salary"). The Boardshall annually reevaluate the Principal's salary and bonus opportunities forincrease based on the Company's performance and the Principal's contributions tothe Company for the preceding fiscal year. (b) Annual Bonus. In addition to the Base Salary, the Service Companyshall have an opportunity to earn an annual bonus (the "Bonus") in respect ofeach fiscal year in accordance with the terms of the J. Crew Operating Corp.Performance Incentive Plan then existing for such fiscal year based on theachievement of performance objectives as may be established from time to time bythe Board or a committee thereof; provided, however, that the Bonus for anyfiscal year shall be payable to the Service Company only if the Principal,through the Service Company, is employed by the Company on the date on whichsuch Bonus is paid. The actual Bonus that may become payable shall be determinedby the Board, in its sole discretion. (c) Business Expenses. The Company shall promptly reimburse theService Company for all reasonable business expenses incurred by the ServiceCompany in connection with the performance of the Services, including withoutlimitation airfare, upon the presentation of statements of such expenses inaccordance with the Company's policies and procedures now 2in force or as such policies and procedures may be modified with respect to allsenior executive officers of the Company. (d) Employee Benefits. During the Service Period, the Principal shallbe eligible to participate in the employee benefit plans and programs maintainedby the Company from time to time and generally available to senior executives ofthe Company, including, to the extent maintained by the Company, medical,dental, accidental and disability insurance plans and profit sharing, pension,retirement, deferred compensation and savings plans, to the extent permitted byand in accordance with the terms and conditions of the applicable plan andapplicable law in effect from time to time. (e) Vacation. During the Service Period, the Principal shall beentitled to twenty-five days of paid time off per annum pursuant to theCompany's Paid Time Off Policy, without carryover accumulation, which may betaken at the Principal's sole discretion. 3. Grant of Stock Options and Restricted Stock. (a) Initial Stock Options. As soon as reasonably practicable after theCommencement Date, the Company shall cause the Board or a committee thereof togrant to the Principal a non-qualified option to purchase 557,926 shares ofcommon stock of the Parent (the "Common Stock") at an exercise price per shareequal to $6.82 per share (the "Initial Option") in exchange for considerationpaid by the Principal to the Company, within three business days aftershareholder approval of such grant, in the amount of $200,000. The terms andconditions of the Initial Option shall be evidenced by a separate stock optionagreement executed by the Company and the Principal (the "Initial OptionAgreement") which shall contain terms consistent with the Company's 2003 EquityIncentive Plan as it may be amended from time to time (the "Equity Plan"), thisSection 3(a) and other customary terms. The Initial Option Agreement shallprovide, among other things, for the following: (i) The Initial Option shall vest in equal installments on the second, third, fourth and fifth anniversaries of the Commencement Date; provided that the Service Period is not terminated prior to any such applicable anniversary date; (ii) Notwithstanding the foregoing, (A) in the event that the Company terminates the Service Period without Cause (as defined below) or the Principal terminates the Service Period for Good Reason (as defined below) prior to the consummation of a Change in Control (as defined in the Equity Plan), that portion of the Initial Option that would have become vested and exercisable on the anniversary of the Commencement Date immediately following the Date of Termination (as defined below) shall vest and become immediately exercisable and any remaining portion of the Initial Option that has not become vested and exercisable shall immediately expire and be forfeited, (B) in the event that, within the two-year period following the consummation of a Change in Control, the Company terminates the Service Period without Cause or the Principal terminates the Service Period for Good Reason, all or any portion of the Initial Option that has not yet become 3 exercisable shall vest and become immediately exercisable, or (C) if the Service Period terminates for any other reason, any portion of the Initial Option which has not become exercisable on such Date of Termination shall immediately expire and be forfeited; and (iii) Any portion of the Initial Option which has become vested and exercisable shall expire on the earlier of (A) the tenth anniversary of the date of grant, (B) the commencement of business on the date the Service Period is terminated for Cause, (C) ninety days after the Service Period is terminated by the Principal without Good Reason, or (D) the second anniversary of the date the Service Period is terminated (x) on account of the Principal's death or Disability, (as defined below), (y) by the Company without Cause, or (z) by the Principal for Good Reason. (b) Premium Stock Options. As soon as reasonably practicable afterthe Commencement Date, the Company shall cause the Board or a committee thereofto grant to the Principal a non-qualified option to purchase 836,889 shares ofCommon Stock at an exercise price per share equal to $25.00 per share (the"Premium Option Tranche 1") and an additional non-qualified option to purchase836,889 shares of Common Stock at an exercise price per share equal to $35.00per share (the "Premium Option Tranche 2" and, collectively with Premium OptionTranche 1, the "Premium Options") . The terms and conditions of the PremiumOptions shall be evidenced by a separate stock option agreement executed by theCompany and the Principal (the "Premium Option Agreement") which shall containterms consistent with the Equity Plan, this Section 3(b) and other customaryterms. The Premium Option Agreement shall provide, among other things, for thefollowing: (i) The Premium Options shall vest in equal installments on the second, third, fourth and fifth anniversaries of the Commencement Date; provided that the Service Period is not terminated prior to any such applicable anniversary date; (ii) Notwithstanding the foregoing, (A) in the event that the Company terminates the Service Period without Cause or the Principal terminates the Service Period for Good Reason prior to the consummation of a Change in Control, that portion of the Premium Option that would have become vested and exercisable on the anniversary of the Commencement Date immediately following the Date of Termination shall vest and become immediately exercisable and any remaining portion of the Premium Option that has not become vested and exercisable shall immediately expire and be forfeited, (B) in the event that, within the two-year period following the consummation of a Change in Control, the Company terminates the Service Period without Cause or the Principal terminates the Service Period for Good Reason, all or any portion of the Premium Option that has not yet become exercisable shall vest and become immediately exercisable, or (C) if the Service Period terminates for any other reason, any portion of the Premium Option which has not become exercisable on such Date of Termination shall immediately expire and be forfeited; and 4 (iii) Any portion of the Premium Option which has become vested and exercisable shall expire on the earlier of (A) the tenth anniversary of the date of grant, (B) the commencement of business on the date the Service Period is terminated for Cause, (C) ninety days after the Service Period is terminated by the Principal without Good Reason, or (D) the second anniversary of the date the Service Period is terminated (x) on account of the Principal's death or Disability, (y) by the Company without Cause, or (z) by the Principal for Good Reason.(c) Restricted Stock. As soon as reasonably practicable following theCommencement Date, the Principal shall purchase from the Company 725,303restricted shares (the "Restricted Shares") of Common Stock under the EquityPlan in exchange for consideration paid by the Principal to the Company, withinthree business days after shareholder approval of such grant, in the amount of$800,000. The terms and conditions of the Restricted Shares shall be evidencedby a separate restricted stock agreement executed by the Company, the ServiceCompany and the Principal (the "Restricted Stock Agreement") which shall containterms consistent with this Section 3(c) and other customary terms. TheRestricted Stock Agreement shall provide, among other things, that theRestricted Shares shall vest in equal installments on the first, second, thirdand fourth anniversaries of the Commencement Date; provided that (i) in theevent that the Company terminates the Service Period without Cause or thePrincipal terminates the Service Period for Good Reason, all or any portion ofthe Restricted Shares not previously forfeited shall vest, or (ii) in the eventthat the Service Period terminates for any other reason, the Restricted Shareswhich have not vested on such Date of Termination shall be immediately forfeitedby the Principal (or Service Company in the event of their assignment) andreturned to the Company. The Company shall use its reasonable efforts tocooperate with the Principal, provide the necessary information and make orassist in making the necessary filings for the Principal or the Service Company,as applicable, to make an election to include an amount equal to the difference,if any, between the value of the Restricted Shares and the purchase price incurrent income under Section 83(b) of the Internal Revenue Code of 1986, asamended (the "Code"). In addition to the Restricted Shares described above, as soon asreasonably practicable after the date hereof, the Company shall grant theService Company 55,793 restricted shares (the "Additional Restricted Shares") ofCommon Stock under the Equity Plan. The terms and conditions of the RestrictedShares shall be evidenced by a separate restricted stock agreement executed bythe Company, the Service Company and the Principal which shall contain termsconsistent with this Section 3(c) and other customary terms and shall beimmediately vested upon grant. (d) Special Shareholders' Meeting. As soon as reasonably practicableafter the date hereof (but no later than thirty days after approval of thisAgreement by the Board) and prior to the grant of the foregoing equity awards,the Company shall hold a special shareholders' meeting for the purpose ofapproving the Equity Plan and shall use its reasonable efforts to providedisclosure to the shareholders that would satisfy the provisions of Section 280Gof the Code and obtain shareholder approval of the equity awards provided inSections 3(a), (b) and (c) herein. 5 (e) Stockholders' Agreement. Unless otherwise specified, all shares ofCommon Stock and all other securities issued in connection with this Agreementor acquired by the Service Company and/or the Principal under this Agreement orotherwise on or after the date hereof shall be subject to the Stockholders'Agreement attached hereto as Exhibit A. 4. Termination of Services. The Service Period may be terminated prior to the fifth anniversary ofthe Commencement Date (the "Scheduled Termination Date") upon the earliest tooccur of the following events (at which time the Services provided hereundershall be terminated): (a) Death. The Services hereunder shall terminate upon the Principal'sdeath. (b) Disability. The Company shall be entitled to terminate theServices hereunder by reason of the Principal's "Disability" if, as a result ofthe Principal's incapacity due to physical or mental illness, the Principalshall have been unable to perform his duties hereunder for a period of six (6)consecutive months or for 180 days within any 365-day period, and within 30 daysafter written Notice of Termination (as defined below) for Disability is givenfollowing such 6-month or 180-day period, as the case may be, the Principalshall not have returned to the performance of his duties in accordance with thisAgreement. (c) Cause. The Company may terminate the Services hereunder for Cause.For purposes of this Agreement, the term "Cause" shall mean: (1) the willful andcontinued failure of the Principal substantially to perform the Principal'sduties under this Agreement (other than as a result of physical or mentalillness or injury), after the Board delivers to the Principal a written demandfor substantial performance that specifically identifies the manner in which theBoard believes that the Principal has not substantially performed thePrincipal's duties; (2) the willful engaging by the Principal in illegal conductor gross misconduct which is materially and demonstrably injurious to theCompany; and (3) a breach of any of the obligations under Sections 9, 10 and 11or any of the representations and covenants contained in Section 13 hereof. Anyact or failure to act that is based upon authority given pursuant to aresolution duly adopted by the Board, or the advice of counsel for the Company,shall not constitute Cause. Cause shall not exist unless and until the Companyhas delivered to the Principal a copy of a resolution duly adopted by a majorityof the Board at a meeting of the Board called and held for such purpose (afterreasonable but in no event less than thirty (30) days' notice to the Principaland an opportunity for the Principal, together with his counsel, to be heardbefore the Board), finding that, in the good faith opinion of the Board, thePrincipal was guilty of the conduct set forth above and specifying theparticulars thereof in detail. This Section 4(c) shall not prevent the Principalfrom challenging in any court of competent jurisdiction the Board'sdetermination that Cause exists or that the Principal has failed to cure any act(or failure to act) that purportedly formed the basis for the Board'sdetermination. (d) Good Reason. The Principal may cause the Service Company toterminate the Services hereunder for "Good Reason," for any of the followingreasons enumerated in this Section 4(d): (i) the diminution of, or appointmentof anyone other than the Principal to serve in 6or handle, the Principal's positions, authority, duties or responsibilities fromthe positions, authority, duties or responsibilities set forth in Section 1 ofthis Agreement without the Principal's consent, provided that any diminution ordelegation of the Principal's duties in connection with the Principal ceasing toact as the Chief Executive Officer of the Company in accordance with Section1(b) shall not constitute Good Reason; (ii) any purported termination of theService Period by the Company for a reason or in a manner not expresslypermitted by this Agreement; (iii) relocation of the Principal's principal worklocation to more than fifty (50) miles from the Principal's principal worklocation, (iv) any failure by the Company to comply with Sections 2 or 3 of thisAgreement, including any failure to obtain the shareholder approval described inSection 3(d) above, or any other material breach of this Agreement, includingwithout limitation Section 14(e)(ii), or (v) the removal of the Principal or anyof the Principal's nominees as directors under Section 4(d) of the Stockholders'Agreement. Termination of the Services by the Principal, on behalf of himselfand the Service Company, pursuant to this Section 4(d) shall not be effectiveuntil the Principal delivers to the Board a written notice specificallyidentifying the conduct of the Company which he believes constitutes a reasonenumerated in this Section 4(d) and the Principal provides the Board at leastthirty (30) days to remedy such conduct and then provides an additional Noticeof Termination in the event the Company does not cure such conduct. (e) Without Cause. The Company may terminate the Services hereunderwithout Cause. (f) Without Good Reason. The Principal may cause the Service Companyto terminate the Services hereunder without Good Reason, provided that thePrincipal provides the Company with notice of intent to terminate without GoodReason at least three months in advance of the Date of Termination. ThePrincipal and the Company shall mutually agree on the time, method and contentof any public announcement regarding the termination of the Services hereunderand neither the Principal nor the Company shall make any public statements whichare inconsistent with the information mutually agreed upon by the Company andthe Principal and the parties hereto shall cooperate with each other in refutingany public statements made by other persons, which are inconsistent with theinformation mutually agreed upon between the Principal and Company as describedabove. 5. Termination Procedure. (a) Notice of Termination. Any termination of the Services hereunderby the Company or by the Principal, on behalf of himself and the ServiceCompany, during the Service Period (other than termination pursuant to Section4(a)) shall be communicated by written notice of termination ("Notice ofTermination") to the other party hereto in accordance with Section 14(a). (b) Date of Termination. "Date of Termination" shall mean (i) if theServices are terminated by reason of the Principal's death, the date of hisdeath, (ii) if the Services are terminated pursuant to Section 4(b), thirty (30)days after Notice of Termination (provided that the Principal shall not havereturned to the substantial performance of his duties in accordance with thisAgreement during such thirty (30) day period), (iii) if the Services areterminated 7pursuant to Section 4(f), a date specified in the Notice of Termination which isat least three months from the date of such notice as specified in such Section4(f); and (iv) if the Services are terminated for any other reason, the date onwhich a Notice of Termination is given or any later date (within thirty (30)days (or any alternative time period agreed upon by the parties) after thegiving of such notice) set forth in such Notice of Termination. 6. Termination Payments. (a) Without Cause or for Good Reason. In the event of the terminationof the Services during the Service Period by the Company without Cause or by thePrincipal, on behalf of himself and the Service Company, for Good Reason, theService Company and the Principal, as applicable, shall be entitled to (i) apayment, within ten (10) days following the Date of Termination, of Base Salarythrough the Date of Termination (to the extent not theretofore paid), anyaccrued vacation pay, and any unreimbursed expenses under Sections 2(c) and (d)(the "Accrued Obligations") and (ii) subject to the effectiveness of the ServiceCompany's and the Principal's execution of a general release and waiver of allclaims against the Company, its affiliates and their respective officers anddirectors related to the Services and the related arrangements including withoutlimitation, certain related investments in the Company, but excluding his rightsto receive the benefits provided under this Agreement or under any agreemententered into in connection herewith and to be indemnified in accordance with theprovisions of the Company's charter and bylaws and Section 8 hereof, in a formreasonably satisfactory to the Company and subject to the Service Company's andthe Principal's compliance with the terms and conditions contained in thisAgreement, (A) the continued payment of Base Salary for the one year periodfollowing the Date of Termination; (B) the immediate vesting of any portion ofthe Restricted Shares that have not yet become vested as of the Date ofTermination and (C) that portion of the Initial Option and the Premium Optionsthat would have become vested and exercisable on the anniversary of the date ofgrant immediately following the Date of Termination shall vest and becomeimmediately exercisable and any remaining portion of the Initial Option andPremium Options that has not become vested and exercisable shall immediatelyexpire and be forfeited, provided that if such termination occurs after theconsummation of a Change in Control, any portion of the Initial Option andPremium Option that has not become exercisable shall become immediatelyexercisable on such Date of Termination. The Company shall have no additionalobligations under this Agreement. In no event shall the Principal be obligated to seek other employmentor take any other action by way of mitigation of the amounts payable to thePrincipal under any of the provisions of this Agreement, and such amounts shallnot be reduced, regardless of whether the Principal obtains other employment. (b) Cause, Death, Disability or Without Good Reason. If the Servicesare terminated during the Service Period by the Company for Cause, by thePrincipal, on behalf of himself and the Service Company, without Good Reason, oras a result of the Principal's death or Disability, the Company shall pay theAccrued Obligations to the Service Company within thirty (30) days following theDate of Termination. The Company shall have no additional obligations under thisAgreement. 8 (c) Other Rights and Benefits. In the event of the termination ofthe Service Period for any reason, the Principal shall retain his rights underall employee benefit plans, including the Equity Plan, in accordance with theterms and conditions of such plans, provided that in no event will the Principalbe entitled to any payments in the nature of severance or termination paymentsexcept as specifically provided herein. 8. Indemnification. The Company agrees that if the Principal is made a party orthreatened to be made a party to any action, suit or proceeding, whether civil,criminal, administrative or investigative (a "Proceeding"), other than anyProceeding related to any contest or dispute between the Principal and theCompany or any of its affiliates with respect to this Agreement or the Servicesof the Principal hereunder, by reason of the fact that the Principal is or was adirector or officer of the Company, or any subsidiary of the Company or is orwas serving at the request of the Company, as a director, officer, member,employee or agent of another corporation or a partnership, joint venture, trustor other enterprise, the Principal shall be indemnified and held harmless by theCompany to the fullest extent authorized by applicable law. In addition, thePrincipal has represented that he has no applicable non-solicit, non-compete, orother restriction that could adversely affect his ability to perform theServices contemplated by this Agreement. Based on this representation, theCompany agrees to pay, promptly and contemporaneously, all losses, includingwithout limitation, reasonable legal fees and legal expenses, incurred by thePrincipal in connection with any action brought by his former employer relatedto his commencement of employment with or the performance of services for theCompany. 9. Non-Solicitation. During the Service Period and for a period of two years followingthe Date of Termination, the Principal hereby agrees not to, directly orindirectly, for his own account or for the account of any other person orentity, (i) solicit or hire or assist any other person or entity in solicitingor hiring any employee of the Company or any of its subsidiaries or affiliatesto perform any services for any entity (other than the Company or theirrespective subsidiaries or affiliates), attempt to induce any such employee toleave the employ of the Company or any affiliates of the Company, or otherwiseinterfere with or adversely modify such employee's relationship with the Companyor any of its subsidiaries or affiliates, or (ii) induce any employee of theCompany who is a member of management to engage in any activity which thePrincipal is prohibited from engaging in under any of Sections 9, 10 or 11 ofthis Agreement. For purposes of this Agreement, "employee" shall mean anynatural person anywhere in the world who is employed by or otherwise engaged toperform services for the Company or any of its affiliates on the Date ofTermination or during the one-year period preceding the Date of Termination. 10. Non-Compete. In connection with the Services of the Principal performed underthis Agreement and in recognition that the Principal shall be a significantstockholder in the Company, and except as specifically provided in Section 1(c)above, the Principal hereby agrees that, during the 9Service Period and for the one year period following any termination of theServices of the Principal (other than a termination without Cause or for GoodReason as described in Sections 4(d) and 4(e) above), the Principal shall notbecome associated with any entity, whether as a principal, partner, employee,consultant or shareholder (other than as a holder of a passive investment of notin excess of 5% of the outstanding voting shares of any publicly tradedcompany), that is actively engaged in retail apparel business in any geographicarea in which the Company or any of its subsidiaries or affiliates are engagedin such business. 11. Confidentiality; Non-Disclosure. (a) The Principal hereby agrees that, during the Service Period andthereafter, he will hold in strict confidence any proprietary or ConfidentialInformation related to the Company and its affiliates. For purposes of thisAgreement, the term "Confidential Information" shall mean all information of theCompany or any of its affiliates (in whatever form) which is not generally knownto the public, including without limitation any inventions, processes, methodsof distribution or customers' or trade secrets. (b) The Principal hereby agrees that, upon the termination of theService Period, he shall not take, without the prior written consent of theCompany, any drawing, blueprint, specification or other document (in whateverform) of the Company or its affiliates, which is of a confidential naturerelating to the Company or its affiliates, or, without limitation, relating toits or their methods of distribution, or any description of any formulas orsecret processes and will return any such information (in whatever form) then inhis possession. 12. Injunctive Relief. It is impossible to measure in money the damages that will accrueto the Company in the event that the Principal breaches any of the restrictivecovenants provided in Sections 9, 10 or 11 hereof. In the event that thePrincipal breaches any such restrictive covenant, the Company shall be entitledto an injunction restraining the Principal from violating such restrictivecovenant. If the Company shall institute any action or proceeding to enforce anysuch restrictive covenant, the Principal hereby waives the claim or defense thatthe Company has an adequate remedy at law and agrees not to assert in any suchaction or proceeding the claim or defense that the Company has an adequateremedy at law. The foregoing shall not prejudice the Company's right to requirethe Principal to account for and pay over to the Company, and the Principalhereby agrees to account for and pay over, the compensation, profits, monies,accruals or other benefits derived or received by the Principal, directly orindirectly, as a result of any transaction constituting a breach of any of therestrictive covenants provided in Sections 9, 10 or 11 of this Agreement. 13. Representations and Covenants; Certain Reimbursements. (a) The Principal and the Company hereby represent to each otherthat they have full power and authority to enter into this Agreement on behalfof themselves and with respect to the Principal, the Service Company, and thatthe execution of, and performance of duties or obligations under, this Agreementshall not constitute a breach of or otherwise violate 10any other agreement to which the Principal or the Company, as applicable, is aparty. Notwithstanding the foregoing, the parties hereto understand that theCompany intends and is required to have the Equity Plan approved by theshareholders of the Company and that such grants are subject to such shareholderapproval. (b) The Principal hereby represents to the Company that he will notutilize or disclose any confidential information obtained by the Principal inconnection with his former employment with respect to his duties andresponsibilities hereunder, and the Company covenants that it will not ask thePrincipal to do so. (c) The Principal represents and warrants that all of the capitalstock of the Service Company are and will be throughout the Service Period ownedby him, his immediate family members and no more than ten percent (10%) byemployees of or service providers to the Service Company. (d) The Principal agrees that he will not cause any person otherthan the Principal to perform the Services or any other obligations of theService Company under this Agreement. (e) The Principal agrees that he shall not sell, transfer,hypothecate, assign, transfer or otherwise dispose of his interest in theService Company (other than to his immediate family members, upon his death tohis heirs, and up to 10% of the Service Company to employees of or serviceproviders to the Service Company) during the Service Period. (f) The Company represents to the Principal that the Company is inmaterial compliance with all financial reporting requirements under thesecurities laws and is not aware of any material misstatement, or of any otherissue that may potentially result in an accounting restatement, in any financialdocument that has been publicly issued or filed with the U.S. Securities andExchange Commission prior to the Commencement Date. 14. Miscellaneous. (a) Any notice or other communication required or permitted underthis Agreement shall be effective only if it is in writing and deliveredpersonally or sent by registered or certified mail, postage prepaid, addressedas follows (or if it is sent through any other method agreed upon by theparties): If to the Company: J. Crew Group, Inc. 770 Broadway New York, NY 10003 Attention: Board of Directors and Secretary 11 with a copy to: Paul Shim, Esq. Cleary, Gottlieb, Steen & Hamilton One Liberty Plaza New York, NY 10006 If to the Service Company: To the Principal, with a copy to: Stephen T. Lindo, Esq. Willkie Farr & Gallagher 787 Seventh Avenue New York, NY 10019-6099 If to the Principal: To the address on file with the Company, with a copy to: Stephen T. Lindo, Esq. Willkie Farr & Gallagher 787 Seventh Avenue New York, NY 10019-6099or to such other address as any party hereto may designate by notice to theothers, and shall be deemed to have been given upon receipt. (b) The Company shall reimburse the Service Company and thePrincipal for reasonable legal fees incurred by the Service Company and/or thePrincipal in connection with the negotiation of this Agreement and the relatedagreements. (c) This Agreement constitutes the entire agreement among theparties hereto with respect to the employment of the Principal, directly andthrough the Service Company, and supersedes and is in full substitution for anyand all prior understandings or agreements with respect to such employment. (d) This Agreement may be amended only by an instrument in writingsigned by the parties hereto, and any provision hereof may be waived only by aninstrument in writing signed by the party or parties against whom or whichenforcement of such waiver is sought. The failure of any party hereto at anytime to require the performance by any other party hereto of any provisionhereof shall in no way affect the full right to require such performance at anytime 12thereafter, nor shall the waiver by any party hereto of a breach of anyprovision hereof be taken or held to be a waiver of any succeeding breach ofsuch provision or a waiver of the provision itself or a waiver of any otherprovision of this Agreement. (e) (i) This Agreement is binding on and is for the benefit of theparties hereto and their respective successors, heirs, executors, administratorsand other legal representatives. Neither this Agreement nor any right orobligation hereunder may be assigned by the Company, the Service Company or thePrincipal. (ii) The Company shall require any successor (whether direct orindirect, by purchase, merger, consolidation or otherwise) to all orsubstantially all of the business and/or assets of the Company expressly toassume and agree to perform this Agreement in the same manner and to the sameextent that the Company would have been required to perform it if no suchsuccession had taken place. As used in the Agreement, the "Company" shall meanboth the Company as defined above and any such successor that assumes and agreesto perform this Agreement, by operation of law or otherwise. (f) If any provision of this Agreement or portion thereof is sobroad, in scope or duration, so as to be unenforceable, such provision orportion thereof shall be interpreted to be only so broad as is enforceable. (g) The Company may withhold from any amounts payable to theService Company and/or the Principal hereunder all federal, state, city or othertaxes that the Company may reasonably determine are required to be withheldpursuant to any applicable law or regulation. (h) This Agreement shall be governed by and construed inaccordance with the laws of the State of NEW YORK, without reference to itsprinciples of conflicts of law. (i) Any disagreement, dispute, controversy or claim arising out ofor relating to this Agreement or the interpretation hereof or any agreementsrelating hereto or contemplated herein or the interpretation, breach,termination, validity or invalidity hereof shall be settled exclusively andfinally by arbitration; provided that the Company shall not be required tosubmit claims for injunctive relief to enforce the covenants contained inSections 9, 10 or 11 of this Agreement to arbitration. The arbitration shall beconducted in accordance with the Commercial Arbitration Rules (the "Rules") ofthe American Arbitration Association (the "AAA"), except as amplified orotherwise varied hereby. The Company and the Principal jointly shall appoint oneindividual to act as arbitrator within thirty (30) days of initiation of thearbitration. If the parties shall fail to appoint such arbitrator as providedabove, such arbitrator shall be appointed by the President of the Association ofthe Bar of the City of New York and shall be a person who maintains his or herprincipal place of business in the New York metropolitan area and shall be anattorney, accountant or other professional licensed to practice by the State ofNew York who has substantial experience in employment and executive compensationmatters. All fees and expenses of such arbitrator shall be shared equally by theCompany and the Principal. The situs of the arbitration shall be New York City.Any decision or 13award of the arbitral tribunal shall be final and binding upon the parties tothe arbitration proceeding. The parties hereto hereby waive to the extentpermitted by law any rights to appeal or to seek review of such award by anycourt or tribunal. The arbitration award shall be paid within thirty (30) daysafter the award has been made. Judgment upon the award may be entered in anyfederal or state court having jurisdiction over the parties and shall be finaland binding. Each party shall be required to keep all proceedings related to anysuch arbitration and the final award and judgment strictly confidential;provided that either party may disclose such award as necessary to enter theaward in a court of competent jurisdiction or to enforce the award, and to theextent required by law, court order, regulation or similar order. (j) This Agreement may be executed in several counterparts, each ofwhich shall be deemed an original, but all of which shall constitute one and thesame instrument. (k) 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. 14 IN WITNESS WHEREOF, the parties have executed this Agreement asof the date first written above. J. CREW GROUP, INC. _______________________________ Name: Title: J. CREW OPERATING CORP. _______________________________ Name: Title: MILLARD S. DREXLER, INC. ________________________________ Name: Millard S. Drexler Title: Principal ________________________________ Millard S. Drexler 15 Exhibit 10.10 EMPLOYMENT AGREEMENT AGREEMENT, dated this 24th day of January, 2003 (this "Agreement"),among J. Crew Group, Inc., a New York Corporation (the "Parent") and itsoperating subsidiary J. Crew Operating Corp. (collectively with the Parent, the"Company"), with offices at 770 Broadway, New York, New York, 10003 and JeffreyA. Pfeifle (the "Executive"). l. Term; Position and Responsibilities; Principal Work Location. (a) Term. Unless the Employment Period (as defined below) isterminated earlier pursuant to Section 4 hereof, the Company shall engage theExecutive on the terms and subject to the conditions of this Agreement for afive year term commencing on the earliest date mutually agreeable between theparties hereto (the "Commencement Date") and ending on the day immediatelypreceding the fifth anniversary of the Commencement Date (the "Initial Term").Effective upon the expiration of the Initial Term and of each Additional Term(as defined below), the Employment Period hereunder shall be deemed to beautomatically extended, upon the same terms and conditions for an additionalperiod of one year (each, an "Additional Term"), in each such case, commencingupon the expiration of the Initial Term or the then current Additional Term, asthe case may be, unless the Company or the Executive, at least three monthsprior to the expiration of the Initial Term or such Additional Term, shall givewritten notice to the other party of its intention not to extend the EmploymentPeriod (as defined below) hereunder. The period during which the Executive isemployed by the Company pursuant to this Agreement, including any extensionthereof in accordance with the preceding sentence, shall be referred to as the"Employment Period." (b) Position and Responsibilities. During the Employment Period, theCompany hereby agrees to employ the Executive as the President and in such otherposition or positions with the Company as the Chairman and Chief ExecutiveOfficer of the Company (the "Chairman & CEO") may specify from time to time thatare consistent with the Executive's title and position. During the EmploymentPeriod, the Executive shall perform the duties and responsibilities that arecustomarily assigned to individuals serving in such position or positions andsuch other duties and responsibilities as the Board may reasonably specify fromtime to time that are consistent with the Executive's title and position. TheExecutive shall report to the Chairman & CEO while the Chairman and CEO are thesame person and thereafter to the CEO. (c) During the Employment Period, excluding any periods of vacationand sick leave to which the Executive is entitled, (i) the Executive shalldevote all of his working time and attention to the performance of his dutiesand responsibilities hereunder and shall faithfully and diligently endeavor topromote the business and best interests of the Company, and (ii) the Executivemay not, without the prior written consent of the Company, operate, participatein the management, operations or control of, or act as an employee, officer,consultant, agent or representative of, any type of business or service (otherthan as the President of the Company), provided that it shall not be a violationof the foregoing for the Executive to (A) act or serve as a director, trustee,committee member or principal of any type of business or civic or charitableorganization, or (B) manage his personal, financial and legal affairs (providedthat the activities described in clauses (A) and (B) do not interfere with theperformance of his duties and responsibilities to the Company as providedhereunder). (d) Principal Place of Employment. Unless otherwise mutually agreedupon, the Executive's principal place of employment shall be the New Yorkmetropolitan area and the Executive shall also travel as reasonably required tocarry out his duties and obligations hereunder. 2. Compensation; Expenses; Benefits and Perquisites. During theEmployment Period, as compensation for the performance of the services by theExecutive, the Executive shall be entitled to the following compensation fromthe Company: (a) Transition Bonus. Within a reasonable time after the date thisAgreement is executed, in order to assist the Executive in transitioning intohis new position and in partial consideration for lost compensation from hisformer employer, the Company shall pay to the Executive a one-time transitionbonus of $1,000,000. (b) Base Salary. The Company shall pay the Executive, not less thanonce a month pursuant to the Company's normal and customary payroll procedures,a base salary at the rate of $760,000 per annum (the "Base Salary"). The Companyshall review the Executive's Base Salary annually. (c) Annual Bonus. In addition to the Base Salary, in respect of eachfiscal year during the Employment Period, the Executive shall have anopportunity to earn an annual bonus (the "Bonus"), which shall be paid no laterthan April 30 of the next succeeding fiscal year and which shall equal 25% ofBase Salary if "threshold performance objectives" are achieved, 50% of BaseSalary if the "target performance objectives" are achieved, and 100% of BaseSalary if "stretch performance objectives" are achieved, in accordance with theterms of the J. Crew Operating Corp. Performance Incentive Plan then existingfor such fiscal year based on the achievement of performance objectives as maybe established from time to time by the Board of Directors of the Company (the"Board") or a committee thereof; provided that, the Bonus for any fiscal yearshall be payable to the Executive only if the Executive is employed by theCompany on the date on which such Bonus is paid. Notwithstanding the foregoing,in respect of fiscal year beginning in 2003, the Executive's Bonus shall equalat least $400,000 (the "2003 Bonus"), which shall be payable as soon asreasonably practicable following the Commencement Date; provided that, in theevent that the Executive's employment with the Company is terminated by theCompany for Cause or by the Executive without Good Reason prior to February 1,2004, the Executive shall immediately pay the Company an amount equal to the2003 Bonus; and further provided that, to the extent that the Executive fails topay back any portion of the 2003 Bonus as provided herein, the Company shallhave the right to offset any other payment(s) provided under this Agreement orotherwise owed to the Executive. The actual Bonus that may become payable shallbe determined by the Board in accordance with the performance objectivesestablished by the Board. (d) Long-Term Cash Incentive. The Executive shall be eligible toreceive a long-term cash incentive (the "Long-Term Incentive"), in an amountbetween $800,000 and $1,200,000, with a target amount of $1,000,000, based onthe achievement of performance objectives established for the Company by theBoard, in its sole discretion. The Long-Term Incentive, if any, will be payableas follows: (i) $400,000 on the last day of fiscal year beginning in 2003 (the 2"2003 Long-Term Incentive"), and (ii) an amount between $400,000 and $800,000,$400,000 of which shall be paid on the last day of the fiscal year beginning in2004 provided that the Executive remains continuously employed by the Companythrough the applicable payment date (the "2004 Long-Term Incentive") and theremaining amount, if any, shall be paid at the same time annual bonuses arepaid, but in no event later than April 30, 2005, provided the Executive remainscontinuously employed through the applicable payment date. (e) Special Bonus. Within a reasonable time after the date thisAgreement is executed, as a special inducement to execute this Agreement and inpartial consideration for lost compensation from the Executive's formeremployer, the Company shall pay to the Executive a one-time special bonus of$1,000,000. (e) Business Expenses. The Company shall promptly reimburse theExecutive for all reasonable business expenses incurred by the Executive inconnection with the performance of the services for the Company (including,without limitation, first class airfare) upon the presentation of statements ofsuch expenses in accordance with the Company's policies and procedures now inforce or as such policies and procedures may be modified with respect to allsenior executive officers of the Company provided that such policies andpractices shall not affect the Executive's ability to fly first class onbusiness trips and the Company shall also provide the Executive with reasonablecar service as appropriate. (f) Employee Benefits. During the Employment Period, the Executiveshall be eligible to participate in the employee benefit plans and programsmaintained by the Company from time to time and generally available to seniorexecutives of the Company, including, to the extent maintained by the Company,medical, dental, accidental and disability insurance plans and profit sharing,pension, retirement, deferred compensation and savings plans, in accordance withthe terms and conditions thereof in effect from time to time. 3. Grant of Stock Options and Restricted Stock. (a) Initial Stock Options. Subject to shareholder approval, as soonas reasonably practicable after the date of the Commencement Date, the Companyshall cause the Board or a committee thereof to grant to the Executive anon-qualified option to purchase 167,378 shares of Common Stock, whichrepresents 0.75% of the total outstanding shares of Common Stock of the Companyas of the date hereof, at an exercise price per share equal to $6.82 per share(the "Initial Option"). The terms and conditions of the Initial Option shall beevidenced by a stock option agreement executed by the Company and the Executive(the "Initial Option Agreement") which shall contain terms consistent with theEquity Plan, this Section 3(a) and other customary terms. The Initial OptionAgreement shall provide, among other things, for the following: (i) The Initial Option shall vest in equal installments on the second, third, fourth and fifth anniversaries of the Commencement Date; provided that the Executive is continuously employed by the Company through each such applicable anniversary date; (ii) Notwithstanding the foregoing, (A) in the event that (x) the Company terminates the Executive's employment without Cause (as defined below) or the Executive terminates his employment for Good Reason (as defined below) prior to the consummation of a Change in Control (as defined in the Equity Plan) or (y) the Executive's 3 employment is terminated on account of the Executive's death or Disability (as defined below) at any time during the Employment Period, that portion of the Initial Option that would have become vested and exercisable on the anniversary of the Commencement Date immediately following the Date of Termination (as defined below) shall vest and become immediately exercisable and any remaining portion of the Initial Option that has not become vested and exercisable shall immediately expire and be forfeited, (B) in the event that, within the two year period following the consummation of a Change in Control or within six months prior to a Change in Control if such termination is in contemplation of the Change in Control, the Company terminates the Executive's employment without Cause or the Executive terminates his employment for Good Reason, all shares of Common Stock underlying the Initial Option shall become immediately vested and exercisable; or (C) if the Executive's employment terminates for any other reason, any portion of the Initial Option which has not become exercisable on such Date of Termination shall immediately expire and be forfeited; and (iii) Any portion of the Initial Option which has become vested and exercisable shall expire on the earlier of (A) the tenth anniversary of the date of grant, (B) the commencement of business on the date the Executive's employment is terminated by the Company for Cause, (C) ninety days after the date the Executive's employment is terminated by the Executive without Good Reason, or (D) the second anniversary of the date the Executive's employment is terminated (x) on account of the Executive's death or Disability, (y) by the Company without Cause, or (z) by the Executive for Good Reason. (b) Premium Stock Options. Subject to shareholder approval, as soonas reasonably practicable after the Commencement Date, the Company shall causethe Board or a committee thereof to grant to the Executive a non-qualifiedoption to purchase 111,585 shares of Common Stock, which represents 0.5% of thetotal outstanding shares of Common Stock of the Company as of the date hereof,at an exercise price per share equal to $25.00 per share (the "Premium OptionTranche 1") and an additional non-qualified option to purchase 111,585 shares ofCommon Stock, which represents 0.5% of the total outstanding shares of CommonStock of the Company as of the date hereof, at an exercise price per share equalto $35.00 per share (the "Premium Option Tranche 2" and, collectively withPremium Option Tranche 1, the "Premium Options") . The terms and conditions ofthe Premium Options shall be evidenced by a stock option agreement executed bythe Company and the Executive (the "Premium Option Agreement" and, collectivelywith the Initial Option Agreement, the "Option Agreements") which shall containterms consistent with the Equity Plan, this Section 3(b) and other customaryterms. The Premium Option Agreement shall provide, among other things, for thefollowing: (i) The Premium Options shall vest in equal installments on the second, third, fourth and fifth anniversaries of the Commencement Date; provided that the Executive is continuously employed by the Company through each such applicable anniversary date; (ii) Notwithstanding the foregoing, (A) in the event that (x) the Company terminates the Executive's employment without Cause or the Executive 4 terminates his employment for Good Reason prior to the consummation of a Change in Control or (y) the Executive's employment is terminated on account of the Executive's death or Disability at any time during the Employment Period, that portion of the Premium Options that would have become vested and exercisable on the anniversary of the Commencement Date immediately following the Date of Termination shall vest and become immediately exercisable and any remaining portion of the Premium Options that have not become vested and exercisable shall immediately expire and be forfeited, (B) in the event that, within the two year period following the consummation of a Change in Control or within six months prior to a Change in Control if such termination is in contemplation of the Change in Control, the Company terminates the Executive's employment without Cause or the Executive terminates his employment for Good Reason, all shares of Common Stock underlying the Premium Options shall become immediately vested and exercisable; or (C) if the Executive's employment terminates for any other reason, any portion of the Premium Options which have not become exercisable on such Date of Termination shall immediately expire and be forfeited; and (iii) Any portion of the Premium Options which has become vested and exercisable shall expire on the earlier of (A) the tenth anniversary of the date of grant, (B) the commencement of business on the date the Executive's employment is terminated by the Company for Cause, (C) ninety days after the date the Executive's employment is terminated by the Executive without Good Reason, or (D) the second anniversary of the date the Executive's employment is terminated (x) on account of the Executive's death or Disability, (y) by the Company without Cause, or (z) by the Executive for Good Reason. (c) Restricted Stock. Subject to shareholder approval, as soon asreasonably practicable following the Commencement Date, the Company shall grantthe Executive 111,585 restricted shares (the "Restricted Shares") of CommonStock, which represents 0.5% of the total outstanding shares of Common Stock ofthe Company as of the date hereof. The terms and conditions of the RestrictedShares shall be evidenced by a separate restricted stock agreement executed bythe Company and the Executive (the "Restricted Stock Agreement") which shallcontain terms consistent with the Equity Plan and this Section 3(c) and othercustomary terms. The Restricted Stock Agreement shall provide, among otherthings, that the Restricted Shares shall vest in equal installments on thefirst, second, third and fourth anniversaries of the Commencement Date; providedthat the Executive is continuously employed by the Company through each suchapplicable anniversary date; and further provided that, (i) in the event that(x) the Company terminates the Executive's employment without Cause or theExecutive terminates his employment for Good Reason prior to the consummation ofa Change in Control or (y) the Executive's employment is terminated on accountof the Executive's death or Disability at any time during the Employment Period,that portion of the Restricted Shares that would have become vested on theanniversary of the Commencement Date immediately following the Date ofTermination shall vest, (ii) in the event that, within the two year periodfollowing the consummation of a Change in Control or within six months prior toa Change in Control if such termination is in contemplation of the Change inControl, the Company terminates the Executive's employment without Cause or ifthe Executive terminates his 5employment for Good Reason, all or any portion of the Restricted Shares notpreviously forfeited shall vest, or (iii) if the Employment Period terminatesfor any other reason, the Restricted Shares which have not vested on such Dateof Termination shall be forfeited immediately by the Executive and returned tothe Company. (d) Future Grants. During the Employment Period, the Executive willbe eligible to receive future grants of restricted shares of Common Stock oroptions to purchase shares of Common Stock pursuant to the Equity Plan from timeto time in accordance with the terms and conditions of the Equity Plan. (e) Stockholders' Agreement. All shares of Common Stock and all othersecurities issued in connection with this Agreement or acquired by the Executiveunder this Agreement or otherwise shall be subject to the Stockholders'Agreement attached hereto as Exhibit A. 4. Termination of the Employment Period. The Executive's employment with the Company hereunder may beterminated during the Employment Period prior to the fifth anniversary of theCommencement Date upon the earliest to occur of the following events (at whichtime the Employment Period shall be terminated): (a) Death. The Executive's employment hereunder shall terminate uponthe Executive's death. (b) Disability. The Company shall be entitled to terminate theExecutive's employment hereunder by reason of the Executive's "Disability" if,as a result of the Executive's incapacity due to physical or mental illness, theExecutive shall have been unable to perform his duties hereunder for a period ofsix (6) consecutive months or for 180 days within any 365-day period, and within30 days after written Notice of Termination (as defined below) for Disability isgiven following such 6-month or 180-day period, as the case may be, theExecutive shall not have returned to the performance of his duties in accordancewith this Agreement. (c) Cause. The Company may terminate the Executive's employmenthereunder for Cause. For purposes of this Agreement, the term "Cause" shallmean: (i) the failure of the Executive to substantially perform his dutieshereunder (other than any such failure due to the Executive's Disability); (ii)the Executive's dishonesty, gross negligence in the performance of his dutieshereunder or engaging in willful misconduct, which in the case of any such grossnegligence, has caused or is reasonably expected to result in direct or indirectmaterial injury (monetarily or otherwise) to the Company or any of itsaffiliates; (iii) a material breach by the Executive of any provision of thisAgreement or of any other written agreement with the Company or any of itsaffiliates or material violation of any Company policy applicable to theExecutive; or (iv) the Executive's indictment for a crime that constitutes afelony or other crime of moral turpitude or fraud, provided that in the case ofclauses (i) and (iii) above, the Company shall provide written notice to theExecutive specifically identifying the conduct of the Executive which theCompany believes constitutes a reason enumerated in clause (i) or (iii) of thisSection 4(c) and, to the extent reasonably susceptible, provide the Executive areasonable opportunity 6(not to exceed thirty days) to remedy such violation. If, subsequent to theExecutive's termination of employment hereunder for other than Cause, it isdetermined in good faith by the Company that the Executive's employment couldhave been terminated for Cause hereunder, the Executive's employment shall, atthe election of the Company, be deemed to have been terminated for Causeretroactively to the date the events giving rise to Cause occurred. (d) Good Reason. The Executive may terminate his employment hereunderfor "Good Reason," for any of the following reasons enumerated in this Section4(d): (i) the assignment to the Executive of any duties materially inconsistentwith Section 1 hereof, or any other action by the Company that results in amaterial diminution in the Executive's position, authority, duties orresponsibilities; (ii) any purported termination of the Executive's employmentby the Company for a reason or in a manner not expressly permitted by thisAgreement; (iii) relocation of the Executive's principal place of employment tomore than thirty-five (35) miles from the Executive's principal place ofemployment, (iv) a material reduction in the Executive's total compensationopportunity unless such reduction is part of a reduction applicable to a broadclass of management employees, or any other material breach of this Agreement;or (v) while Millard Drexler is serving as the Company's Chairman and ChiefExecutive Officer, requiring the executive to report to someone other than Mr.Drexler and in the event Mr. Drexler is no longer serving as the Company'sChairman and CEO, requiring the Executive to report to someone other than theCompany's Chief Executive Officer. Termination of the Executive's employment bythe Executive pursuant to this Section 4(d) shall not be effective until theExecutive delivers to the Board a written notice specifically identifying theconduct of the Company which he believes constitutes a reason enumerated in thisSection 4(d) and, to the extent reasonably susceptible to cure the Executive,provides the Board at least thirty (30) days to remedy such conduct. (e) Without Cause. The Company may terminate the Executive'semployment hereunder without Cause. (f) Without Good Reason. The Executive may terminate his employmenthereunder without Good Reason, provided that the Executive provides the Companywith notice of intent to terminate without Good Reason at least thirty (30) daysin advance of the Date of Termination. The Executive and the Company shallmutually agree on the time, method and content of any public announcementregarding the termination of the Executive's employment hereunder and neitherthe Executive nor the Company shall make any public statements which areinconsistent with the information mutually agreed upon by the Company and theExecutive and the parties hereto shall cooperate with each other in refuting anypublic statements made by other persons, which are inconsistent with theinformation mutually agreed upon between the Executive and Company as describedabove. 5. Termination Procedure. (a) Notice of Termination. Any termination of the Executive'semployment hereunder by the Company or by the Executive during the EmploymentPeriod (other than termination pursuant to Section 4(a)) shall be communicatedby written notice of termination ("Notice of Termination") to the other partyhereto in accordance with Section 12(a). 7 (b) Date of Termination. "Date of Termination" shall mean (i) if theExecutive's employment is terminated by reason of the Executive's death, thedate of his death, (ii) if the Executive's employment is terminated pursuant toSection 4(b), thirty (30) days after Notice of Termination (provided that theExecutive shall not have returned to the substantial performance of his dutiesin accordance with this Agreement during such thirty (30) day period), (iii) ifthe Executive's employment is terminated pursuant to Section 4(f), a datespecified in the Notice of Termination which is at thirty (30) days from thedate of such notice as specified in such Section 4(f); and (iv) if theExecutive's employment is terminated for any other reason, the date on which aNotice of Termination is given or any later date (within thirty (30) days (orany alternative time period agreed upon by the parties) after the giving of suchnotice) set forth in such Notice of Termination. 6. Termination Payments. (a) Without Cause; for Good Reason or Company's Failure to Renew. Inthe event of the termination of the Executive's employment during the EmploymentPeriod by the Company without Cause, as a result of the Company's providingnotice to the Executive of its intent not to renew the Employment Period (asdescribed in Section 1(a) herein) or by the Executive for Good Reason, theExecutive shall be entitled to (i) a payment, within ten (10) days following theDate of Termination, of Base Salary through the Date of Termination (to theextent not theretofore paid), any accrued vacation pay, any unreimbursedbusiness expenses, any Annual Bonus and/or Long-Term Incentive payment earned inthe fiscal year ending on or prior to the Date of Termination but not yet paid(provided that such Annual Bonus and/or Long-Term Incentive payment shall bepaid on the date specified in Section 2(c) or Section 2(d), as applicable, ifsuch date is later than the tenth day following the Date of Termination)(together, the "Accrued Obligations") and (ii) subject to the effectiveness ofthe Executive's execution of a general release and waiver of all claims againstthe Company, its affiliates and their respective officers and directors in aform reasonably satisfactory to the Company and subject to the Executive'scompliance with the terms and conditions contained in this Agreement, (A) thecontinued payment of Base Salary for the two year period following the Date ofTermination, (B) a lump sum amount equal to the product of (x) the Bonus, ifany, that he would have earned based on the performance objectives described in,and in accordance with, Section 2(c) herein in the fiscal year which includesthe Date of Termination had his employment not been terminated and (y) afraction, the numerator of which is the number of days in the calendar year thatincludes the Date of Termination through the Date of Termination and thedenominator of which is 365, and (C) the immediate vesting of that portion ofthe Restricted Shares, Initial Options and Premium Options that would havebecome vested on the anniversary of the Commencement Date immediately followingthe Date of Termination, provided that if such termination occurs after theconsummation of a Change in Control or within six months prior to a Change inControl if such termination is in contemplation of the Change in Control, allRestricted Shares, Initial Options and Premium Options not previously vestedshall become immediately vested; provided that, for any such termination of theExecutive's employment prior to third anniversary of the Commencement Date, inno event will the Executive receive less than $2,000,000 in cash severance. TheCompany shall have no additional obligations under this Agreement. (b) Cause, Death, Disability or Without Good Reason. If theExecutive's employment with the Company is terminated during the EmploymentPeriod by the Company for Cause, by the Executive without Good Reason, or as aresult of the Executive's death or Disability, the Company shall pay the AccruedObligations to the Executive (or his estate in the event of his death) withinthirty (30) days following the Date of Termination and in the case of 8(i) a termination on account of death or Disability, the Executive or theExecutive's estate, as applicable, shall be entitled to the additional vestingof Options and Restricted Shares as provided in Sections 3(a), (b) and (c)herein or (ii) a termination by the Executive without Good Reason after thefifth anniversary of the Commencement Date, the Executive shall be entitled toany Bonus earned in the fiscal year ended immediately prior to the Date ofTermination. The Company shall have no additional obligations under thisAgreement. 7. Indemnification. The Company agrees that if the Executive is made a party orthreatened to be made a party to any action, suit or proceeding, whether civil,criminal, administrative or investigative (a "Proceeding"), other than anyProceeding related to any contest or dispute between the Executive and theCompany or any of its affiliates with respect to this Agreement or theemployment of the Executive hereunder, by reason of the fact that the Executiveis or was a director or officer of the Company, or any subsidiary of the Companyor is or was serving at the request of the Company, as a director, officer,member, employee or agent of another corporation or a partnership, jointventure, trust or other enterprise, the Executive shall be indemnified and heldharmless by the Company to the fullest extent authorized by applicable law. 8. Non-Solicitation. During the Employment Period and for a period of one year followingthe Date of Termination, the Executive hereby agrees not to, directly orindirectly, for his own account or for the account of any other person orentity, (i) solicit or hire or assist any other person or entity in solicitingor hiring any employee of the Company or any of its subsidiaries or affiliatesto perform any services for any entity (other than the Company or itssubsidiaries or affiliates), attempt to induce any such employee to leave theemploy of the Company or any affiliates of the Company, or otherwise interferewith or adversely modify such employee's relationship with the Company or any ofits subsidiaries or affiliates, (ii) induce any employee of the Company who is amember of management to engage in any activity which the Executive is prohibitedfrom engaging in under any of Sections 8, 9 or 10 of this Agreement, or (iii)solicit or assist any other person or entity in soliciting or attempting tosolicit any suppliers of the Company or any of its subsidiaries or affiliates toterminate or otherwise adversely modify their relationship with the Company orany of its subsidiaries or affiliates, provided that nothing herein shallprohibit the Executive from recruiting his personal administrative assistant.For purposes of this Agreement, "employee" shall mean any natural person anywhere in the world who is employed by or otherwise engaged to perform servicesfor the Company or any of its subsidiaries or affiliates on the Date ofTermination or during the one-year period preceding the Date of Termination. 9. Non-Compete. In connection with the services of the Executive performed under thisAgreement, the Executive hereby agrees that, during the Employment Period andfor the six-month period following any termination of the employment of theExecutive (other than a termination by the Company without Cause, by theExecutive for Good Reason or by the Executive for any reason following a Changein Control), the Executive shall not become associated with any entity, whetheras a principal, partner, employee, consultant or shareholder (other than as aholder of a 9passive investment of not in excess of 5% of the outstanding voting shares ofany publicly traded company), that is actively engaged in the retail apparelbusiness in any geographic area in which the Company or its affiliates areengaged in such business. 10. Confidentiality; Non-Disclosure. (a) The Executive hereby agrees that, during the Employment Periodand thereafter, he will hold in strict confidence any proprietary orConfidential Information related to the Company and its affiliates. For purposesof this Agreement, the term "Confidential Information" shall mean allinformation of the Company or any of its affiliates (in whatever form) which isnot generally known to the public, including without limitation any inventions,processes, methods of distribution or customers' or trade secrets. (b) The Executive hereby agrees that, upon the termination of theEmployment Period, he shall not take, without the prior written consent of theCompany, any drawing, blueprint, specification or other document (in whateverform) of the Company or its affiliates, which is of a confidential naturerelating to the Company or its affiliates, or, without limitation, relating toits or their methods of distribution, or any description of any formulas orsecret processes and will return any such information (in whatever form) then inhim possession. 11. Injunctive Relief. It is impossible to measure in money the damages that will accrue tothe Company in the event that the Executive breaches any of the restrictivecovenants provided in Sections 8, 9 or 10 hereof. In the event that theExecutive breaches any such restrictive covenant, the Company shall be entitledto an injunction restraining the Executive from violating such restrictivecovenant. If the Company shall institute any action or proceeding to enforce anysuch restrictive covenant, the Executive hereby waives the claim or defense thatthe Company has an adequate remedy at law and agrees not to assert in any suchaction or proceeding the claim or defense that the Company has an adequateremedy at law. The foregoing shall not prejudice the Company's right to requirethe Executive to account for and pay over to the Company, and the Executivehereby agrees to account for and pay over, the compensation, profits, monies,accruals or other benefits derived or received by the Executive, directly orindirectly, as a result of any transaction constituting a breach of any of therestrictive covenants provided in Sections 8, 9 or 10 hereof. 12. Miscellaneous. (a) Any notice or other communication required or permitted underthis Agreement shall be effective only if it is in writing and deliveredpersonally or sent by registered or certified mail, postage prepaid, addressedas follows (or if it is sent through any other method agreed upon by theparties): If to the Company: J. Crew Group, Inc. 770 Broadway 10 New York, NY 10003 Attention: Board of Directors and Secretary with a copy to: Paul Shim, Esq. Cleary, Gottlieb, Steen & Hamilton One Liberty Plaza New York, NY 10006 If to the Executive: To the address on file at the Company with a copy to: Lanny A. Oppenheim, Esq. Salans 620 Fifth Avenue New York, NY 10020or to such other address as any party hereto may designate by notice to theothers, and shall be deemed to have been given upon receipt. (b) This Agreement constitutes the entire agreement among theparties hereto with respect to the employment of the Executive and supersedesand is in full substitution for any and all prior understandings or agreementswith respect to such employment. (c) This Agreement may be amended only by an instrument in writingsigned by the parties hereto, and any provision hereof may be waived only by aninstrument in writing signed by the party or parties against whom or whichenforcement of such waiver is sought. The failure of any party hereto at anytime to require the performance by any other party hereto of any provisionhereof shall in no way affect the full right to require such performance at anytime thereafter, nor shall the waiver by any party hereto of a breach of anyprovision hereof be taken or held to be a waiver of any succeeding breach ofsuch provision or a waiver of the provision itself or a waiver of any otherprovision of this Agreement. (d) (i) This Agreement is binding on and is for the benefit of theparties hereto and their respective successors, heirs, executors, administratorsand other legal representatives. Neither this Agreement nor any right orobligation hereunder may be assigned by the Company or the Executive. (ii) The Company shall require any successor (whether direct orindirect, by purchase, merger, consolidation or otherwise) to all orsubstantially all of the business and/or assets of the Company expressly toassume and agree to perform this Agreement in the same manner and to the sameextent that the Company would have been required to perform it if no 11such succession had taken place. As used in the Agreement, the "Company" shallmean both the Company as defined above and any such successor that assumes andagrees to perform this Agreement, by operation of law or otherwise. (e) If any provision of this Agreement or portion thereof is sobroad, in scope or duration, so as to be unenforceable, such provision orportion thereof shall be interpreted to be only so broad as is enforceable. (f) The Company may withhold from any amounts payable to theExecutive hereunder all federal, state, city or other taxes that the Company mayreasonably determine are required to be withheld pursuant to any applicable lawor regulation. (g) This Agreement shall be governed by and construed in accordancewith the laws of the State of NEW YORK, without reference to its principles ofconflicts of law. (h) The Executive hereby represents to the Company that he has fullpower and authority to enter into this Agreement that the execution of, andperformance of duties under, this Agreement shall not constitute a breach of orotherwise violate any other agreement to which the Executive is a party. (i) The Executive hereby represents to the Company that he will notutilize or disclose any confidential information obtained by the Executive inconnection with his former employment with respect to his duties andresponsibilities hereunder, and the Company will not ask the Executive to do so. (j) This Agreement may be executed in several counterparts, each ofwhich shall be deemed an original, but all of which shall constitute one and thesame instrument. (k) 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. 12 IN WITNESS WHEREOF, the parties have executed this Agreement as ofthe date first written above. J. CREW GROUP, INC. _______________________________ Name: Title: J. CREW OPERATING CORP. _______________________________ Name: Title: _______________________________ JEFFREY A. PFEIFLE 13 Exhibit 10.11 Execution Copy EMPLOYMENT AGREEMENT AGREEMENT, dated this 27th day of January, 2003 (this "Agreement"),among J. Crew Group, Inc., a New York Corporation (the "Parent") and itsoperating subsidiary J. Crew Operating Corp. (collectively with the Parent, the"Company"), with offices at 770 Broadway, New York, New York, and ScottGilbertson (the "Executive"). l. Term; Position and Responsibilities; Principal Work Location. (a) Term. Unless the Employment Period (as defined below) is terminatedearlier pursuant to Section 4 hereof, the Company shall engage the Executive onthe terms and subject to the conditions of this Agreement for a five-year termcommencing on January 27, 2003 (the "Commencement Date") and ending on the dayimmediately preceding the fifth anniversary of the Commencement Date (the"Initial Term"). Effective upon the expiration of the Initial Term and of eachAdditional Term (as defined below), the Employment Period hereunder shall bedeemed to be automatically extended, upon the same terms and conditions for anadditional period of one year (each, an "Additional Term"), in each such case,commencing upon the expiration of the Initial Term or the then-currentAdditional Term, as the case may be, unless the Company or the Executive, atleast three months prior to the expiration of the Initial Term or suchAdditional Term, shall give written notice to the other party of its intentionnot to extend the Employment Period (as defined below) hereunder. The periodduring which the Executive is employed by the Company pursuant to thisAgreement, including any extension thereof in accordance with the precedingsentence, shall be referred to as the "Employment Period." (b) Position and Responsibilities. During the Employment Period, theCompany hereby agrees to employ the Executive as the Chief Operating Officer andin such other position or positions with the Company as the Chairman and ChiefExecutive Officer of the Company (the "Chairman & CEO") may specify from time totime. During the Employment Period, the Executive shall perform the duties andresponsibilities that are customarily assigned to individuals serving in suchposition or positions and such other duties and responsibilities as the Chairman& CEO may reasonably specify from time to time. (c) During the Employment Period, excluding any periods of vacation andsick leave to which the Executive is entitled, (i) the Executive shall devoteall of his working time and attention to the performance of his duties andresponsibilities hereunder and shall faithfully and diligently endeavor topromote the business and best interests of the Company, and (ii) the Executivemay not, without the prior written consent of the Company, operate, participatein the management, operations or control of, or act as an employee, officer,consultant, agent or representative of, any type of business or service (otherthan as the Chief Operating Officer of the Company), provided that it shall notbe a violation of the foregoing for the Executive to (A) act or serve as adirector, trustee, committee member or principal of any type of business orcivic or charitable organization, or (B) manage his personal, financial andlegal affairs (provided that the activities described in clauses (A) and (B) donot interfere with the performance of his duties and responsibilities to theCompany as provided hereunder). (d) Principal Place of Employment. Unless otherwise mutually agreedupon, the Executive's principal place of employment shall be the New Yorkmetropolitan area and the Executive shall also travel as reasonably required tocarry out his duties and obligations hereunder. 2. Compensation; Expenses; Benefits and Perquisites. During theEmployment Period, as compensation for the performance of the services by theExecutive, the Executive shall be entitled to the following compensation fromthe Company: (a) Base Salary. The Company shall pay the Executive, not less thanonce a month pursuant to the Company's normal and customary payroll procedures,a base salary at the rate of $450,000 per annum (the "Base Salary"). (b) Annual Bonus. In addition to the Base Salary, in respect of eachfiscal year during the Employment Period, the Executive shall have anopportunity to earn an annual bonus (the "Bonus"), which shall equal 35% of BaseSalary if "threshold performance objectives" are achieved, 70% of Base Salary if"target performance objectives" are achieved, and 140% of Base Salary if"stretch performance objectives" are achieved, in accordance with the terms ofthe J. Crew Operating Corp. Performance Incentive Plan then existing for suchfiscal year based on the achievement of performance objectives as may beestablished from time to time by the Board or a committee thereof; provided thatthe Bonus paid with respect to services provided by the Executive duringcalendar year 2003 shall not be less than $250,000, of which $75,000 shall bepaid to the Executive as soon as practicable after the Commencement Date; andprovided further that the Bonus for any fiscal year shall be payable to theExecutive only if the Executive is employed by the Company on the date on whichsuch Bonus is paid. The actual Bonus that may become payable shall be determinedby the Board, in its sole discretion. (c) Business Expenses. The Company shall promptly reimburse theExecutive for all reasonable business expenses incurred by the Executive inconnection with the performance of the services for the Company upon thepresentation of statements of such expenses in accordance with the Company'spolicies and procedures now in force or as such policies and procedures may bemodified with respect to all senior executive officers of the Company. (d) Employee Benefits. During the Employment Period, the Executiveshall be eligible to participate in the employee benefit plans and programsmaintained by the Company from time to time and generally available to seniorexecutives of the Company, including, to the extent maintained by the Company,medical, dental, accidental and disability insurance plans and profit sharing,pension, retirement, deferred compensation and savings plans, in accordance withthe terms and conditions thereof in effect from time to time. (e) Relocation Expenses. The Executive shall be entitled to theCompany's standard relocation package pursuant to the Company's RelocationPolicy. 3. Grant of Stock Options and Restricted Stock. (a) Initial Stock Options. As soon as reasonably practicable after thedate of the Commencement Date, the Company shall cause the Board or a committeethereof to grant to 2the Executive a non-qualified option to purchase 111,585 shares of Common Stockat an exercise price per share equal to $6.82 per share (the "Initial Option").The terms and conditions of the Initial Option shall be evidenced by a separatestock option agreement executed by the Company and the Executive (the "InitialOption Agreement") which shall contain terms consistent with the 2003 EquityIncentive Plan, as may be amended from time to time (the "Equity Plan"), thisSection 3(a) and other customary terms. The Initial Option Agreement shallprovide, among other things, for the following: (i) The Initial Option shall vest in equal installments on the second, third, fourth and fifth anniversaries of the Commencement Date; provided that the Executive is continuously employed by the Company through each such applicable anniversary date; (ii) Notwithstanding the foregoing, (A) in the event that the Company terminates the Executive's employment without Cause or the Executive terminates his employment for Good Reason prior to the consummation of a Change in Control (as defined in the Equity Plan), that portion of the Initial Option that would have become vested and exercisable on the next applicable anniversary of the Commencement Date following the Date of Termination (as defined below) shall vest and become immediately exercisable and any remaining portion of the Initial Option that has not become vested and exercisable shall immediately expire and be forfeited, (B) in the event that, within the two year period following the consummation of a Change in Control, the Company terminates the Executive's employment without Cause or the Executive terminates his employment for Good Reason, all shares of Common Stock underlying the Initial Option shall become immediately vested and exercisable; or (C) if the Executive's employment terminates for any other reason, any portion of the Initial Option which has not become exercisable on such Date of Termination shall immediately expire and be forfeited; and (iii) Any portion of the Initial Option which has become vested and exercisable shall expire on the earlier of (A) the tenth anniversary of the date of grant, (B) the commencement of business on the date the Executive's employment is terminated by the Company for Cause, (C) ninety days after the date the Executive's employment is terminated by the Executive without Good Reason, or (D) the second anniversary of the date the Executive's employment is terminated (x) on account of the Executive's death or Disability, (y) by the Company without Cause, or (z) by the Executive for Good Reason. (b) Premium Stock Options. As soon as reasonably practicable after theCommencement Date, the Company shall cause the Board or a committee thereof togrant to the Executive a non-qualified option to purchase 66,951 shares ofCommon Stock at an exercise price per share equal to $25.00 per share (the"Premium Option Tranche 1") and an additional non-qualified option to purchase66,951 shares of Common Stock at an exercise price per share equal to $35.00 pershare (the "Premium Option Tranche 2" and, collectively with Premium OptionTranche 1, the "Premium Options") . The terms and conditions of the PremiumOptions shall be evidenced by a separate stock option agreement executed by theCompany and the 3Executive (the "Premium Option Agreement" and, collectively with the InitialOption Agreement, the "Option Agreements") which shall contain terms consistentwith the Equity Plan, this Section 3(b) and other customary terms. The PremiumOption Agreement shall provide, among other things, for the following: (i) The Premium Options shall vest in equal installments on the second, third, fourth and fifth anniversaries of the Commencement Date; provided that the Executive is continuously employed by the Company through each such applicable anniversary date; (ii) Notwithstanding the foregoing, (A) in the event that the Company terminates the Executive's employment without Cause or the Executive terminates his employment for Good Reason prior to the consummation of a Change in Control (as defined in the Equity Plan), that portion of the Premium Options that would have become vested and exercisable on the next applicable anniversary of the Commencement Date following the Date of Termination (as defined below) shall vest and become immediately exercisable and any remaining portion of the Premium Options that have not become vested and exercisable shall immediately expire and be forfeited, (B) in the event that, within the two year period following the consummation of a Change in Control, the Company terminates the Executive's employment without Cause or the Executive terminates his employment for Good Reason, all shares of Common Stock underlying the Premium Options shall become immediately vested and exercisable; or (C) if the Executive's employment terminates for any other reason, any portion of the Premium Options which have not become exercisable on such Date of Termination shall immediately expire and be forfeited; and (iii) Any portion of the Premium Options which has become vested and exercisable shall expire on the earlier of (A) the tenth anniversary of the date of grant, (B) the commencement of business on the date the Executive's employment is terminated by the Company for Cause, (C) ninety days after the date the Executive's employment is terminated by the Executive without Good Reason, or (D) the second anniversary of the date the Executive's employment is terminated (x) on account of the Executive's death or Disability, (y) by the Company without Cause, or (z) by the Executive for Good Reason. (c) Restricted Stock. As soon as reasonably practicable following theCommencement Date, the Company shall grant the Executive 111,585 restrictedshares (the "Restricted Shares") of Common Stock. The terms and conditions ofthe Restricted Shares shall be evidenced by a separate restricted stockagreement executed by the Company and the Executive (the "Restricted StockAgreement") which shall contain terms consistent with the Equity Plan and thisSection 3(c) and other customary terms. The Restricted Stock Agreement shallprovide, among other things, that the Restricted Shares shall vest in equalinstallments on the first, second, third and fourth anniversaries of the date ofgrant; provided that the Executive is continuously employed by the Companythrough each such applicable anniversary date; and further provided that, (i) inthe event that the Company terminates the Executive's employment without Causeor the Executive terminates his employment for Good Reason prior to the 4consummation of a Change in Control, that portion of the Restricted Shares thatwould have become vested on the next applicable anniversary date following theDate of Termination shall vest, (ii) in the event that, within the two yearperiod following the consummation of a Change in Control, the Company terminatesthe Executive's employment without Cause or the Executive terminates hisemployment for Good Reason, all or any portion of the Restricted Shares notpreviously forfeited shall vest, or (iii) if the Employment Period terminatesfor any other reason, the Restricted Shares which have not vested on such Dateof Termination shall be forfeited immediately by the Executive and returned tothe Company. (d) Stockholders' Agreement. All shares of Common Stock and all othersecurities issued in connection with this Agreement or acquired by the Executiveunder this Agreement or otherwise shall be subject to the Stockholders'Agreement attached hereto as Exhibit A. 4. Termination of the Employment Period. The Executive's employment with the Company hereunder may be terminatedduring the Employment Period prior to the fifth anniversary of the CommencementDate upon the earliest to occur of the following events (at which time theEmployment Period shall be terminated): (a) Death. The Executive's employment hereunder shall terminate uponthe Executive's death. (b) Disability. The Company shall be entitled to terminate theExecutive's employment hereunder by reason of the Executive's "Disability" if,as a result of the Executive's incapacity due to physical or mental illness, theExecutive shall have been unable to perform his duties hereunder for a period of6 consecutive months or for 180 days within any 365-day period, and within 30days after written Notice of Termination (as defined below) for Disability isgiven following such 6-month or 180-day period, as the case may be, theExecutive shall not have returned to the performance of his duties in accordancewith this Agreement. (c) Cause. The Company may terminate the Executive's employmenthereunder for Cause. For purposes of this Agreement, the term "Cause" shallmean: (i) the failure of the Executive to substantially perform his dutieshereunder (other than any such failure due to the Executive's Disability); (ii)the Executive's dishonesty, gross negligence in the performance of his dutieshereunder or engaging in willful misconduct, which in the case of any such grossnegligence, has caused or is reasonably expected to result in direct or indirectmaterial injury (monetarily or otherwise) to the Company or any of itsaffiliates; (iii) a material breach by the Executive of any provision of thisAgreement or of any other written agreement with the Company or any of itsaffiliates or a material violation of any Company policy applicable to theExecutive; or (iv) the Executive's commission of a crime that constitutes afelony or other crime of moral turpitude or fraud. If, subsequent to theExecutive's termination of employment hereunder for other than Cause, it isdetermined in good faith by the Company that the Executive's employment couldhave been terminated for Cause hereunder, the Executive's employment shall, atthe election of the Company, be deemed to have been terminated for Causeretroactively to the date the events giving rise to Cause occurred. 5 (d) Good Reason. The Executive may terminate his employment hereunderfor "Good Reason," for any of the following reasons enumerated in this Section4(d): (1) the assignment to the Executive of any duties materially inconsistentwith Section 1 hereof, or any other action by the Company that results in amaterial diminution in the Executive's position, authority, duties orresponsibilities; (2) any purported termination of the Executive's employment bythe Company for a reason or in a manner not expressly permitted by thisAgreement; (3) relocation of the Executive's principal place of employment tomore than fifty (50) miles from the Executive's principal place of employment,(4) a material reduction in the Executive's total compensation opportunityunless such reduction is part of a reduction applicable to a broad class ofmanagement employees, or any other material breach of this Agreement.Termination of the Executive's employment by the Executive pursuant to thisSection 4(d) shall not be effective until the Executive delivers to the Board awritten notice specifically identifying the conduct of the Company which hebelieves constitutes a reason enumerated in this Section 4(d) and the Executiveprovides the Board at least thirty (30) days to remedy such conduct. (e) Without Cause. The Company may terminate the Executive's employmenthereunder without Cause. (f) Without Good Reason. The Executive may terminate his employmenthereunder without Good Reason, provided that the Executive provides the Companywith notice of intent to terminate without Good Reason at least three months inadvance of the Date of Termination. The Executive and the Company shall mutuallyagree on the time, method and content of any public announcement regarding thetermination of the Executive's employment hereunder and neither the Executivenor the Company shall make any public statements which are inconsistent with theinformation mutually agreed upon by the Company and the Executive, and theparties hereto shall cooperate with each other in refuting any public statementsmade by other persons which are inconsistent with the information mutuallyagreed upon between the Executive and Company as described above. 5. Termination Procedure. (a) Notice of Termination. Any termination of the Executive'semployment hereunder by the Company or by the Executive during the EmploymentPeriod (other than termination pursuant to Section 4(a)) shall be communicatedby written notice of termination ("Notice of Termination") to the other partyhereto in accordance with Section 12(a). (b) Date of Termination. "Date of Termination" shall mean (i) if theExecutive's employment is terminated by reason of the Executive's death, thedate of his death, (ii) if the Executive's employment is terminated pursuant toSection 4(b), thirty (30) days after Notice of Termination (provided that theExecutive shall not have returned to the substantial performance of his dutiesin accordance with this Agreement during such thirty (30) day period), (iii) ifthe Executive's employment is terminated pursuant to Section 4(f), a datespecified in the Notice of Termination which is at least three (3) months fromthe date of such notice as specified in such Section 4(f); and (iv) if theExecutive's employment is terminated for any other reason, the date on which aNotice of Termination is given or any later date (within thirty (30) days (or 6any alternative time period agreed upon by the parties) after the giving of suchnotice) set forth in such Notice of Termination. 6. Termination Payments. (a) Without Cause or for Good Reason. In the event of the terminationof the Executive's employment during the Employment Period by the Companywithout Cause or by the Executive for Good Reason prior to the consummation of aChange in Control, the Executive shall be entitled to (i) a payment, within ten(10) days following the Date of Termination, of Base Salary through the Date ofTermination (to the extent not theretofore paid), any accrued vacation pay, andany unreimbursed expenses under Sections 2(c) and (d) (the "AccruedObligations") and (ii) subject to the effectiveness of the Executive's executionof a general release and waiver of all claims against the Company, itsaffiliates and their respective officers and directors in a form reasonablysatisfactory to the Company and subject to the Executive's compliance with theterms and conditions contained in this Agreement, (A) the continued payment ofBase Salary for the eighteen-month period following the Date of Termination, (B)a lump sum amount equal to the product of (x) the Bonus, if any, that he wouldhave earned in the calendar year which includes the Date of Termination had hisemployment not been terminated and (y) a fraction, the numerator of which is thenumber of days in the calendar year that includes the Date of Terminationthrough the Date of Termination and the denominator of which is 365, and (C) theimmediate vesting of that portion of the Restricted Shares, Initial Options andPremium Options that would have become vested on the next applicable anniversaryof the Commencement Date following the Date of Termination on which the nexttranche of Initial Options, Premium Options and Restricted Shares would havevested, provided that if such termination occurs after the consummation of aChange in Control, all Restricted Shares, Initial Options and Premium Optionsnot previously vested shall become immediately vested. The Company shall have noadditional obligations under this Agreement. (b) Cause, Death, Disability or Without Good Reason. If the Executive'semployment with the Company is terminated during the Employment Period by theCompany for Cause, by the Executive without Good Reason, or as a result of theExecutive's death or Disability, the Company shall pay the Accrued Obligationsto the Executive (or his estate in the event of his death) within thirty (30)days following the Date of Termination. The Company shall have no additionalobligations under this Agreement. 7. Indemnification. The Company agrees that if the Executive is made a party or threatenedto be made a party to any action, suit or proceeding, whether civil, criminal,administrative or investigative (a "Proceeding"), other than any Proceedingrelated to any contest or dispute between the Executive and the Company or anyof its affiliates with respect to this Agreement or the employment of theExecutive hereunder, by reason of the fact that the Executive is or was adirector or officer of the Company, or any subsidiary of the Company or is orwas serving at the request of the Company, as a director, officer, member,employee or agent of another corporation or a partnership, joint venture, trustor other enterprise, the Executive shall be indemnified and held harmless by theCompany to the fullest extent authorized by applicable law. 7 8. Non-Solicitation. During the Employment Period and for a period of two years followingthe Date of Termination, the Executive hereby agrees not to, directly orindirectly, for his own account or for the account of any other person orentity, (i) solicit or hire or assist any other person or entity in solicitingor hiring any employee of the Company or any of its subsidiaries or affiliatesto perform any services for any entity (other than the Company or itssubsidiaries or affiliates), attempt to induce any such employee to leave theemploy of the Company or any affiliates of the Company, or otherwise interferewith or adversely modify such employee's relationship with the Company or any ofits subsidiaries or affiliates, (ii) induce any employee of the Company who is amember of management to engage in any activity in which the Executive isprohibited from engaging under any of Sections 8, 9 or 10, or (iii) solicit orassist any other person or entity in soliciting or attempting to solicit anycustomers or suppliers of the Company or any of its subsidiaries or affiliatesto terminate or otherwise adversely modify their relationship with the Companyor any of its subsidiaries or affiliates. For purposes of this Agreement,"employee" shall mean any natural person anywhere in the world who is employedby or otherwise engaged to perform services for the Company or any of itssubsidiaries or affiliates on the Date of Termination or during the one-yearperiod preceding the Date of Termination. 9. Non-Compete. In connection with the services of the Executive performed under thisAgreement, the Executive hereby agrees that, during the Employment Period andfor the one year period following any termination of the employment of theExecutive (other than a termination by the Company without Cause or by theExecutive for Good Reason), the Executive shall not become associated with anyentity, whether as a principal, partner, employee, consultant or shareholder(other than as a holder of a passive investment not in excess of 5% of theoutstanding voting shares of any publicly traded company), that is activelyengaged in the retail apparel business in any geographic area in which theCompany or its affiliates are engaged in such business. 10. Confidentiality; Non-Disclosure. (a) The Executive hereby agrees that, during the Employment Period andthereafter, he will hold in strict confidence any proprietary or ConfidentialInformation related to the Company and its affiliates. For purposes of thisAgreement, the term "Confidential Information" shall mean all information of theCompany or any of its affiliates (in whatever form) which is not generally knownto the public, including without limitation any inventions, processes, methodsof distribution or customers' secrets or trade secrets. (b) The Executive hereby agrees that, upon the termination of theEmployment Period, he shall not take, without the prior written consent of theCompany, any drawing, blueprint, specification or other document (in whateverform) of the Company or its affiliates, which is of a confidential naturerelating to the Company or its affiliates, or, without limitation, relating toits or their methods of distribution, or any description of any formulas orsecret processes and will return any such information (in whatever form) then inhis possession. 8 11. Injunctive Relief. It is impossible to measure in money the damages that will accrue tothe Company in the event that the Executive breaches any of the restrictivecovenants provided in Sections 8, 9 or 10 hereof. In the event that theExecutive breaches any such restrictive covenant, the Company shall be entitledto an injunction restraining the Executive from violating such restrictivecovenant. If the Company shall institute any action or proceeding to enforce anysuch restrictive covenant, the Executive hereby waives the claim or defense thatthe Company has an adequate remedy at law and agrees not to assert in any suchaction or proceeding the claim or defense that the Company has an adequateremedy at law. The foregoing shall not prejudice the Company's right to requirethe Executive to account for and pay over to the Company, and the Executivehereby agrees to account for and pay over, the compensation, profits, monies,accruals or other benefits derived or received by the Executive, directly orindirectly, as a result of any transaction constituting a breach of any of therestrictive covenants provided in Sections 8, 9 or 10. 12. Miscellaneous. (a) Any notice or other communication required or permitted under thisAgreement shall be effective only if it is in writing and delivered personallyor sent by registered or certified mail, postage prepaid, addressed as follows(or if it is sent through any other method agreed upon by the parties): If to the Company: J. Crew Group, Inc. 770 Broadway New York, NY 10003 Attention: Board of Directors and Secretary with a copy to: Paul Shim, Esq. Cleary, Gottlieb, Steen & Hamilton One Liberty Plaza New York, NY 10006 If to the Executive: At the address on file in the Company's files.or to such other address as any party hereto may designate by notice to theothers, and shall be deemed to have been given upon receipt. (b) This Agreement constitutes the entire agreement among the partieshereto with respect to the employment of the Executive and supersedes and is infull substitution for any and all prior understandings or agreements withrespect to such employment. 9 (c) This Agreement may be amended only by an instrument in writingsigned by the parties hereto, and any provision hereof may be waived only by aninstrument in writing signed by the party or parties against whom or whichenforcement of such waiver is sought. The failure of any party hereto at anytime to require the performance by any other party hereto of any provisionhereof shall in no way affect the full right to require such performance at anytime thereafter, nor shall the waiver by any party hereto of a breach of anyprovision hereof be taken or held to be a waiver of any succeeding breach ofsuch provision or a waiver of the provision itself or a waiver of any otherprovision of this Agreement. (d) (i) This Agreement is binding on and is for the benefit of theparties hereto and their respective successors, heirs, executors, administratorsand other legal representatives. Neither this Agreement nor any right orobligation hereunder may be assigned by the Company or the Executive. (ii) The Company shall require any successor (whether direct orindirect, by purchase, merger, consolidation or otherwise) to all orsubstantially all of the business and/or assets of the Company expressly toassume and agree to perform this Agreement in the same manner and to the sameextent that the Company would have been required to perform it if no suchsuccession had taken place. As used in the Agreement, the "Company" shall meanboth the Company as defined above and any such successor that assumes and agreesto perform this Agreement, by operation of law or otherwise. (e) If any provision of this Agreement or portion thereof is so broad,in scope or duration, so as to be unenforceable, such provision or portionthereof shall be interpreted to be only so broad as is enforceable. (f) The Company may withhold from any amounts payable to the Executivehereunder all federal, state, city or other taxes that the Company mayreasonably determine are required to be withheld pursuant to any applicable lawor regulation. (g) This Agreement shall be governed by and construed in accordancewith the laws of the State of NEW YORK, without reference to its principles ofconflicts of law. (h) This Agreement may be executed in several counterparts, each ofwhich shall be deemed an original, but all of which shall constitute one and thesame instrument. (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. 10 IN WITNESS WHEREOF, the parties have executed this Agreement as of thedate first written above. J. CREW GROUP, INC. _______________________________ Name: Title: J. CREW OPERATING CORP. _______________________________ Name: Title: _______________________________ SCOTT GILBERTSON 11 Exhibit 10.12 March 7, 2003Walter Killough6 Garden CourtMahwah, NJ 07430Dear Walter: This letter will confirm our understanding of the arrangements under whichyour employment with J.Crew is terminated as set forth below: 1. The parties hereby acknowledge and confirm that your employment with the Company is terminated effective as of March 14, 2003 (the "Termination Date"). 2. Subject to this Agreement becoming effective (as described in Paragraph 17 hereof), the Company will continue to pay you your base salary of $390,000 per annum for the twelve (12) month period beginning on the day immediately following the Termination Date ("Severance Period"), payable in accordance with the Company's regular payroll practices for its employees. At your election, the Company will also reimburse you for Cobra premiums paid by you during the Severance Period. The foregoing payments shall be reduced by any required tax withholdings and shall not be taken into account as compensation and no service credit shall be given after the Termination Date for purposes of determining the benefits payable under any other plan, program, agreement or arrangement of the Company. Notwithstanding anything herein to the contrary, your right to receive the foregoing payments shall terminate effective immediately upon the date that you become employed as a full-time employee with a new employer; provided that if the base salary you receive pursuant to such new employment ("New Salary") is less than $390,000 per annum, the Company will continue to pay you an incremental amount during the remaining Severance Period such that the New Salary payments you receive together with such incremental amount will equal $390,000 on an annualized basis. In addition, upon request, outplacement services will be provided in accordance with the Company's policy. You acknowledge that, except for the foregoing payments, you are not entitled to any payment by the Company in the nature of either severance or termination pay or other compensation of any kind. 3. As of the Termination Date, you have vested options to purchase (i) 31,400 shares of Common Stock ("Common Stock") of J. Crew Group, Inc. ("Parent") at $6.82 exercise price per share, (ii) 11,160 shares of Common Stock at a $10.00 exercise price per share, and (iii) 5,000 shares of Common Stock at a $10.65 exercise price per share (collectively, the "Vested Options"). You acknowledge that (i) your right to exercise the Vested Options shall expire 90 days immediately following the Termination Date (i.e. June 12, 2003) and (ii) all of your other options which have not yet vested (totaling options to purchase 27,400 shares of Common Stock) terminate effective immediately, in accordance with the provisions of your stock option agreements with Parent and the J. Crew Group, Inc. 1997 Stock Option Plan, as amended (the "Option Plan"). 4. By signing this Agreement, you agree that in exchange for the consideration set forth herein, you hereby voluntarily, fully and unconditionally release and forever discharge the Company, Parent, their present and former parent corporation(s), subsidiaries, divisions, affiliates and otherwise related entities and their respective incumbent and former employees, directors, plan administrators, officers and agents, individually and in their official capacities (collectively, the "Releasees"), from any and all charges, actions, causes of action, demands, debts, dues, bonds, accounts, covenants, contracts, liabilities, or damages of any nature whatsoever, whether now known or claimed, to whomever made, which you have or may have against any or all of the Releasees for or by reason of any cause, nature or thing whatsoever, up to the present time, arising out of or related to your employment with the Company or the termination of such employment, including, by way of examples and without limiting the broadest application of the foregoing, any actions, causes of action, or claims under any contract or federal, state or local decisional law, statues, regulations or constitutions, any claims for notice, pay in lieu of notice, wrongful dismissal, breach of contract, defamation or other tortious conduct, discrimination on the basis of actual or perceived disability, age, sex, race or any other factor (including, without limitation, any claim pursuant to Title VII of the Civil Rights Act of 1964, Americans with Disabilities Act of 1990, the Age Discrimination in Employment Act of 1967, as amended, the Family and Medical Act of 1993, the Equal Pay Act of 1963, the Fair Labor Standards Act, the State, City and local laws of New York, and the equal employment law or laws of the state and/or city in which you work), any claim pursuant to any other applicable employment standards or human rights legislation or for severance pay, salary, bonus, incentive or additional compensation, vacation pay, insurance, other benefits, interest, and/or attorney's fees. If you have made or should hereafter make any complaint, charge, claim, allegation or demand, or commence or threaten to commence any action, complaint, charge, claim or proceeding, against any or all of the Releasees for or by reason of any cause, matter or thing whatsoever existing up to the present time, this Agreement may be raised as and shall constitute a complete bar to any such action, complaint, charge, claim, allegation or proceeding, and, subject to a favorable ruling by a tribunal of final jurisdiction, the Releasees shall recover from you, and you shall pay to the Releasees, all costs incurred by them, including their attorneys' fees, as a consequence of any such action, complaint charge, claim, allegation or proceeding; provided, however, that this shall not limit you from enforcing your rights under this Agreement and in the event any action is commenced to enforce your rights under this Agreement, each party shall bear its own legal fees and expenses; and provided further, however, that this is not intended to interfere with your right to file a charge with the Equal Employment Opportunity Commission ("EEOC") in connection with any claim you believe you may have against any Releasee. However, by signing this Agreement, you agree to waive any right to recover in any proceeding you may bring before the EEOC (or any state human rights commission) or in any proceeding brought by the EEOC (or any state human rights commission) on your behalf. 2 You specifically release all claims under the Age Discrimination in Employment Act ("ADEA") relating to your employment and its termination. 5. You acknowledge that the payments and benefits described in Section 2 above that you are receiving in connection with the foregoing release is in accordance with the provisions of your letter agreement, dated March 14, 2000 ("Letter Agreement"). 6. You hereby agree and acknowledge that you shall be bound by and comply with the restrictive covenants provided in the Letter Agreement (the "Restrictive Covenants"), and that such Restrictive Covenants are hereby made part of this Agreement as if specifically restated herein and that the payments described in Section 2 above that you are receiving are subject to and contingent upon your compliance with Restrictive Covenants. 7. You acknowledge and agree that, notwithstanding any other provision of this Agreement, if you breach any of your obligations under this Agreement or any Restrictive Covenant, (a) you will forfeit your right to receive the payments and benefits described in Section 2 above (to the extent the payments were not theretofore paid) and the Company shall be entitled to recover any payments already made to you or on your behalf, (b) the Vested Options shall expire as of the date of such breach to the extent not theretofore exercised and, if exercised as of the date of such breach, you shall immediately reimburse the Company for the profit upon exercise (such profit calculated as the difference between the (i) greater of either the Fair Market Value (as defined in the Option Plan) of a share of Common Stock on the date of exercise or the amount paid by the Company to you per share of Common Stock for the purchase of the shares acquired upon exercise, and (ii) exercise price, times the number of options exercised). 8. You agree that, in the event that you are served with legal process or other request purporting to require you to testify, plead, respond or defend and/or produce documents at a legal proceeding, threatened proceeding, investigation or inquiry involving the Releasees, you will: (1) refuse to provide testimony or documents absent a subpoena, court order or similar process from a regulatory agency: (2) within three (3) business days or as soon thereafter as practical, provide oral notification to the Company's Executive Vice-President of Human Resources of your receipt of such process or request to testify or produce documents; and (3) provide to the Company's Executive Vice-President of Human Resources by overnight delivery service a copy of all legal papers and documents served upon you. You further agree that in the event you are served with such process, you will meet and confer with the Company's designee(s) in advance of giving such testimony or information. You also agree to cooperate fully with the Releasees in connection with any existing or future litigation against the Releasees, whether administrative, civil or criminal in nature, in which and to the extent the Releasees deem your cooperation necessary. The Company agrees to reimburse you for your reasonable out-of-pocket expenses incurred in connection with the performance of your obligations under this Section 8. 9. This Agreement does not constitute an admission of liability or wrongdoing of any kind by you or the Company or its affiliates. 3 10. The terms of this Agreement shall be binding on the parties hereto and their respective successors, assigns, heirs and representatives. 11. This Agreement, together with your stock option agreements with Parent and the Option Plan, constitute the entire understanding of the Company and you with respect to the subject matter hereof and supersedes all prior understandings, written or oral. The terms of this Agreement may be changed, modified or discharged only by an instrument in writing signed by the parties hereto. A failure of the Company or you to insist on strict compliance with any provision of this Agreement shall not be deemed a waiver of such provision or any other provision hereof. If any provision of this Agreement is determined to be so broad as to be unenforceable, such provision shall be interpreted to be only so broad as is enforceable. 12. This Agreement shall be construed, enforced and interpreted in accordance with and governed by the laws of the State of New York. 13. The parties hereto acknowledge and agree that each party has reviewed and negotiated the terms and provisions of this Agreement and has contributed to its revision. Accordingly, the rule of construction to the effect that ambiguities are resolved against the drafting party shall not be employed in the interpretation of this Agreement. Rather, the terms of this Agreement shall be construed fairly as to both parties hereto and not in favor or against either party. 14. This Agreement may be executed in any number of counterparts and by different parties on separate counterparts, each of which counterpart, when so executed and delivered, shall be deemed to be an original and all of which counterparts, taken together, shall constitute but one and the same Agreement. 15. You acknowledge that, by your free and voluntary act of signing below, you agree to all of the terms of this Agreement and intend to be legally bound thereby. 16. You acknowledge that you have received this Agreement on or before March 7, 2003. You understand that you may consider whether to agree to the terms contained herein for a period of forty-five (45) days after the date hereof. However, the operation of the provisions of Sections 2 through 4 above may be delayed until you execute this Agreement and return it to the Company and it becomes effective as provided below. You acknowledge that you have consulted with an attorney prior to your execution of this Agreement or have determined by your own free will not to consult with an attorney. 17. This Agreement will become effective, enforceable and irrevocable seven days after the date on which it is executed by you (the "Effective Date"). During the seven-day period prior to the Effective Date, you may revoke your agreement to accept the terms hereof by indicating in writing to the Executive Vice-President of Human Resources your intention to revoke. If you exercise your right to revoke hereunder, you shall forfeit your right to receive any of the payments and other benefits provided for herein, and to the extent such payments or benefits have already been made, you agree that you will immediately reimburse the Company for the value of such payments and benefits. 4 If the foregoing correctly reflects our understanding, please sign theenclosed copy of this letter agreement, whereupon it will become a bindingagreement between us. J. CREW OPERATING CORP. By: _______________________ Name: David F. Kozel Title: Executive Vice-President, Human ResourcesAgreed to and accepted:By:__________________________ Walter KilloughDated: _________, 2003AcknowledgmentSTATE OF _________________) ss:COUNTY OF _______________)On the __ day of _______, 2003, before me personally came Walter Killough who,being by me duly sworn, did depose and say that he resides at 6 Garden Court,Mahwah, New Jersey 07430, and did acknowledge and represent that he has had anopportunity to consult with attorneys and other advisers of his choosingregarding the Agreement set forth above, that he has reviewed all of the termsof the Agreement and that he fully understands all of its provisions, includingwithout limitation, the general release and waiver set forth therein.__________________________Notary PublicDate:_____________________ 5 Exhibit 21.1 Subsidiaries of J. Crew Group, Inc. Name Under WhichName of Subsidiary State of Incorporation Subsidiary Does Business------------------ ---------------------- ------------------------ J. Crew Operating Corp. Delaware J. Crew Operating Corp.J. Crew Inc. New Jersey J. Crew Inc.Grace Holmes, Inc. Delaware J. Crew Retail StoresH.F.D. No. 55, Inc. Delaware J. Crew Factory StoresJ. Crew Virginia, Inc. Virginia J. Crew Virginia, Inc.J. Crew International, Inc. Delaware J. Crew International, Inc.J. Crew Intermediate LLC Delaware J. Crew Intermediate LLCC & W Outlet, Inc.* New York C & W Outlet, Inc.J. Crew Services, Inc.* Delaware J. Crew Services, Inc.ERL, Inc.* New Jersey ERL, Inc.____________* Inactive subsidiary Exhibit 23.1The Board of DirectorsJ. Crew Group, Inc.:We consent to incorporation by reference in the previously filed registrationstatement on Form S-8 of J. Crew, Group Inc. 1997 Stock Option Plan of ourreport dated March 25, 2003, except as to the note 18, which is dated April 4,2003, relating to the consolidated balance sheets of J. Crew Group, Inc andsubsidiaries as of February 1, 2003 and February 2, 2002, and the relatedconsolidated statements of operations, cash flows, and changes in stockholders'deficit for each of the years in the three-year period ended February 1, 2003,and the related schedule, which report appears in the February 1, 2003 annualreport on Form 10-K of J. Crew Group, Inc./s/ KPMG LLPNew York, New YorkApril 15, 2003 Exhibit 99.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002In connection with the Annual Report of J. Crew Group, Inc. and J. CrewOperating Corp. (collectively, the "Company") on Form 10-K for the period endingFebruary 1, 2003 as filed with the Securities and Exchange Commission on thedate hereof (the "Report"), I, Millard S. Drexler, Chief Executive Officer ofthe Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant toSection 906 of the Sarbanes-Oxley Act of 2002, that, to my knowledge:1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. By: /s/ Millard S. Drexler ---------------------------- Millard S. Drexler Chief Executive Officer April 21, 2003 Exhibit 99.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002In connection with the Annual Report of J. Crew Group, Inc. and J. CrewOperating Corp. (collectively, the "Company") on Form 10-K for the period endingFebruary 1, 2003 as filed with the Securities and Exchange Commission on thedate hereof (the "Report"), I, Scott M. Rosen, Executive Vice-President andChief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,that, to my knowledge:1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. By: /s/ Scott M. Rosen ---------------------------- Scott M. Rosen Executive Vice-President and Chief Financial Officer April 21, 2003

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