J. Crew Group, Inc.
Annual Report 2004

Plain-text annual report

QuickLinks -- Click here to rapidly navigate through this documentUNITED STATESSECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549FORM 10-K(Mark One) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGEACT OF 1934For the fiscal year ended January 29, 2005OroTRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934CommissionFile Number Registrant, State of IncorporationAddress and Telephone Number I.R.S. EmployerIdentification No.333-42427 J. CREW GROUP, INC.(Incorporated in New York)770 BroadwayNew York, New York 10003Telephone: (212) 209-2500 22-2894486333-42423 J. CREW OPERATING CORP.(Incorporated in Delaware)770 BroadwayNew York, New York 10003Telephone: (212) 209-2500 22-3540930Securities Registered Pursuant to Section 12(b) of the Act: NoneSecurities Registered Pursuant to Section 12(g) of the Act: None Indicate by check mark whether each registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and(2) has been subject to such filing requirements for the past 90 days. Yes  No o Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not becontained, to the best of each registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of thisForm 10-K or any amendment to this Form 10-K.  Indicate by a check mark whether either of the registrants is an accelerated filer (as defined in Rule 12b-2 of the ExchangeAct). Yes o No  The common stock of each registrant is not publicly traded. Therefore, the aggregate market value is not readily determinable. Outstanding at April 1, 2005:J. Crew Group, Inc. 12,473,306 shares of common stock, par value $.01 per shareJ. Crew Operating Corp. 100 shares of common stock, par value $.01 per share (all of which are ownedindirectly by J.Crew Group, Inc.) This Annual Report on Form 10-K is a combined report being filed by two different registrants: J.Crew Group, Inc. and J.Crew OperatingCorp. (a wholly-owned indirect subsidiary of J.Crew Group, Inc.). The information contained herein relating to each individual registrant isfiled by such registrant on its own behalf. No registrant makes any representation as to information relating to any other registrant. 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 with the reduced disclosure format.FILING FORMAT This Annual Report on Form 10-K is a combined report being filed by two different registrants: J.Crew Group, Inc. ("Group") and J.CrewOperating Corp., a wholly-owned indirect subsidiary of Group ("Operating"). Except where the content clearly indicates otherwise, anyreferences in this report to the "Company", "J.Crew" or "Group" include all subsidiaries of Group, including Operating. Operating does notmake any representations as to the information contained in this report in relation to Group and its subsidiaries other than Operating. References herein to fiscal years are to the fiscal years of Group and Operating, which end on the Saturday closest to January 31 in thefollowing calendar year for fiscal years 2000, 2001, 2002, 2003 and 2004. Accordingly, fiscal years 2000, 2001, 2002, 2003 and 2004 endedon February 3, 2001, February 2, 2002, February 1, 2003, January 31, 2004 and January 29, 2005. All fiscal years for which financialinformation is included are 52 weeks, except fiscal year 2000 which had 53 weeks.PART IBUSINESS In this section, "we," "us" and "our" refer to Group and our wholly owned subsidiaries, including Operating.General We are a nationally recognized retailer of women's and men's apparel, shoes, and accessories sold under the "J.Crew" brand name.Started in 1983, we have built and reinforced our brand name and image through both the circulation of catalogs that use magazine-qualityphotography to portray a classic American perspective and aspirational lifestyle and the operation of our stores and internet website. Webelieve that the "J. Crew" brand name is widely recognized as an iconic American brand known for its classic styles. We offer a full line ofmen's and women's clothing, including basic durables, wear to work, wedding attire, swimwear, loungewear, accessories and shoes tomeet our customers' lifestyle needs. J. Crew products are distributed through our retail and factory outlet stores, our catalog and our internet website located atwww.jcrew.com. As of January 29, 2005, we operated 156 retail stores and 41 factory outlet stores in the United States. We believe that ourcustomer base consists primarily of college-educated, professional and upscale men and women who in our experience have demonstratedstrong brand loyalty and a tendency to make repeated purchases. In addition, J.Crew products are distributed through 43 freestanding andshop-in-shop stores in Japan under a licensing agreement with Itochu Corporation. We have two major operating divisions: J.Crew Retail (consisting of our retail and factory outlet stores) and J.Crew Direct (consisting ofour catalog and Internet website), each of which operate under the J.Crew brand name. In fiscal 2004, products sold under the J.Crew brandcontributed $778.3 million in revenues, comprised of:•$579.8 million from J.Crew Retail; and •$198.5 million from J.Crew Direct. In addition, in fiscal 2004, we generated other revenues of $25.9 million, consisting principally of shipping and handling fees derivedfrom J.Crew Direct. Group was incorporated in the State of New York in 1988 and Operating was incorporated in the State of Delaware in 1997. Group is thesole member of J.Crew Intermediate LLC, a Delaware limited liability company ("Intermediate"), and Intermediate owns 100% of theoutstanding shares of Operating. Our principal executive offices are located at 770 Broadway, New York, NY 10003, and our telephonenumber is (212) 209-2500. See "Forward Looking Statements and Risk Factors".Merchandising and Design Over time, our merchandising strategy has evolved from providing unisex products to creating full lines of men's and women'sclothing, shoes and accessories. This strategy had the effect of increasing overall J.Crew brand sales volume and significantly increasingrevenues from sales of women's apparel to 75% of J.Crew brand sales in fiscal 2004. All of our products are designed by an in-house design staff to reflect a classic, clean aesthetic that is consistent with our Americanlifestyle brand image. Design teams are formed around J.Crew product lines and categories to develop concepts, themes and products foreach of our J.Crew businesses. Our technical design teams develop construction and fit specifications for every product to ensure quality1workmanship and consistency across product lines. These teams work in close collaboration with the merchandising, production and qualityassurance staffs in order to gain market and other input and ensure quality of the J.Crew products.Sourcing and Production Our merchandise is produced for us by a variety of manufacturers in 35 countries. We do not own or operate any manufacturing facilitiesand instead contract with third-party vendors for production of our merchandise. In fiscal 2004, approximately 77% of our merchandise wassourced in Asia, 8% was sourced in the United States and 15% was sourced in Europe and other regions. Any event causing a suddendisruption of manufacturing or imports from Asia, including the imposition of additional import restrictions, could have a material adverseimpact on our operations. In addition, one vendor supplies approximately 15% of our merchandise, but we believe that the loss of this vendorwould not have a material adverse impact on our ability to source our products. Substantially all of our foreign purchases are negotiated andpaid for in U.S. dollars. We cannot predict whether any of the countries in which our merchandise is currently produced or may be produced in the future will besubject to additional trade restrictions imposed by the United States and other foreign governments, nor can we predict the likelihood, type oreffect of any such restrictions. Trade restrictions, including increased tariffs or quotas, against apparel and other items sold by us couldincrease the cost or reduce the supply of merchandise available to us and adversely affect our business, financial condition and results ofoperations. Our sourcing operations may also be adversely affected by political and financial instability in any country in which our goods areproduced or by acts of war or terrorism in the United States or worldwide to the extent these acts impact the production, shipment or receipt ofmerchandise. Sourcing operations may also be adversely affected by significant fluctuation in the value of the U.S. dollar against foreigncurrencies or restrictions on the transfer of funds. See "Forward-Looking Statements and Risk Factors".Distribution We operate one primary customer call center and two distribution facilities for our operations. We own a 406,500 square foot facility inLynchburg, Virginia that contains our customer call center, order fulfillment operations for J.Crew Direct and distribution operations for ourfactory outlet stores. This facility employs approximately 500 full and part-time employees during our non-peak season and additionalemployees during our peak season. We also own a 192,500 square foot facility in Asheville, North Carolina that contains our distributionoperations for our retail stores. This facility employs approximately 100 full and part-time employees during our non-peak season andadditional employees during our peak season. To enhance efficiency, each facility is fully equipped with an automated warehouse locatorsystem and inventory bar coding system. In addition, our facility in Lynchburg has automated packing and shipping sorters. Merchandise isshipped to our customers via the United States Postal Service and Federal Express. We believe that our customer call center, orderfulfillment operations and distribution operations are designed to handle customer orders and distribute merchandise to stores in a customer-friendly, efficient and cost-effective manner.Information Systems Our management information systems are designed to provide, among other things, comprehensive order processing, production,accounting and management information for the marketing, manufacturing, importing and distribution functions of our business. We haveinstalled an SAP enterprise resource planning system for our information technology requirements. We have point-of-sale registers in ourretail and factory outlet stores that enable us to track inventory from store receipt to final sale on a real-time basis. We believe ourmerchandising and financial systems, coupled with our point-of-sale registers and software programs, allow for rapid stock replenishment,concise2merchandise planning and real-time inventory accounting practices. Our telephone and telemarketing systems, warehouse package sortingsystems, automated warehouse locator and inventory bar coding systems utilize advanced technology. These systems have provided us witha number of benefits in the form of enhanced customer service, improved operational efficiency and increased management control andreporting. In addition, our real-time inventory systems provide inventory management on a stock keeping unit basis and allow for an efficientfulfillment process.Trademarks and Licensing The "J.Crew" trademark and variations thereon, and certain other trademarks, are registered or are subject to pending trademarkapplications with the United States Patent and Trademark Office and with the registries of many foreign countries. We believe that ourtrademarks have significant value and we intend to continue to vigorously protect them against infringement. In addition, we license our "J.Crew" trademark to Itochu Corporation in Japan for which we receive percentage royalty fees. Under thelicense agreement, we retain a high degree of control over the manufacture, design, marketing and sale of merchandise by ItochuCorporation under the J.Crew trademark. This agreement expires in January 2007. In fiscal 2004, licensing revenues totaled $2.8 million.Employees As of January 29, 2005, we had approximately 6,100 employees, of whom approximately 2,200 were full-time employees and 3,900were part-time employees. In addition, approximately 1,900 employees are hired on a seasonal basis to meet demand during the peakseason. None of our employees are represented by a union. We believe that our relationship with our employees is good.Competition All aspects of our business are highly competitive. We compete primarily with specialty brand retailers, other catalog and internetoperations, department stores and mass merchandisers that offer similar merchandise. We believe that the principal bases upon which wecompete are quality, design, efficient service, selection and price. Many of our competitors are substantially larger, have a more establishedretail store presence and experience and have greater financial, marketing and other resources than us. There is no assurance that we will beable to successfully compete with our competitors in the future. In addition, our business is sensitive to a number of factors that could affectthe level of consumer spending, including adverse economic conditions, the levels of disposable consumer income, consumer confidenceand interest rates. See "Forward-Looking Statements and Risk Factors".Our BusinessJ. Crew Retail J.Crew Retail consists of our retail and factory outlet store operations. During fiscal 2004, J.Crew Retail generated revenues of$579.8 million, representing 72.1% of our total revenues. As of January 29, 2005, we operated 156 retail stores and 41 factory outlet stores throughout the United States. Our retail stores arelocated in upscale regional malls, lifestyle centers, shopping centers and street locations. Our factory outlet stores are generally located inmajor regional outlet centers. Store locations are determined based on several factors, including geographic location, demographicinformation, presence of anchor tenants in mall locations and proximity to other specialty retail stores. All of our stores are designed in-houseand fixtured to create a distinctive J.Crew environment and our store associates are trained to maintain high standards of visual presentationand customer service.3 All stores that were open during all of fiscal 2004 averaged $2.9 million per store in sales and produced sales per gross square foot of$397. Our retail and factory outlet stores have an average size of 7,400 total square feet. The table below highlights certain informationregarding our retail and factory outlet stores open during the five years ended January 29, 2005:Fiscal Year Stores OpenAt Beginningof Fiscal Year StoresOpenedDuringFiscal Year StoresClosedDuringFiscal Year StoresOpen atEnd ofFiscal Year Total SquareFootage (inthousands) AverageStoreSquareFootage2000 123 24 1 146 1,094 7,4962001 146 34 3 177 1,314 7,4252002 177 18 1 194 1,436 7,4022003 194 4 2 196 1,447 7,3812004 196 5 4 197 1,457 7,394J.Crew Direct J.Crew Direct consists of our catalog and internet website operations. During fiscal 2004, J.Crew Direct generated $198.5 million inrevenues, including $76.5 million from the catalog and $122.0 million from the internet website, representing 24.7% of our total revenues. We believe we have distinguished ourselves from other catalog retailers by our catalog which utilizes magazine-quality photography todepict an aspirational lifestyle image. In fiscal 2004, we distributed 32 catalog editions with a circulation of approximately 50 million andpages circulated of approximately 5.4 billion. This represented an increase from fiscal 2003 in which we distributed 28 catalog editions, butreflects a decrease in circulation as our fiscal 2003 circulation was approximately 53 million and pages circulated were approximately5.8 billion. We focus on continually improving the segmentation of customer files and the acquisition of additional customer names. In fiscal 2004,approximately 58% of J.Crew Direct revenues were generated by customers who had made a purchase from any J.Crew catalog or on ourinternet website in the prior 12 months. We segment our customer files and tailor our catalog offerings to address the different product needsof our customer segments. To increase core catalog productivity and improve the effectiveness of marginal and prospecting circulation, eachcustomer segment is offered appropriate catalog editions. We also acquire new names from various sources, including our retail stores, ourinternet website, list rentals and exchanges with other catalog companies. Telephones are also installed in most of our stores with directaccess to our customer call center to allow customers in our stores to order catalog-specific or out-of-stock items. All creative work on the catalogs is coordinated by J.Crew personnel to maintain and reinforce our brand image. Photography is executedboth on location and in studios, and creative design and copy writing are executed on a desktop publishing system. Digital images aretransmitted directly to outside printers, thereby reducing lead times and improving reproduction quality. We do 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. We believe that our long-standing relationships with a number of the largest coated papermills in the United States allow us to purchase paper at favorable prices commensurate with the volume of our purchases. In 1996, we launched our internet website located at www.jcrew.com, making J.Crew merchandise available to our customers over theinternet. In fiscal 2004, our website logged over 48 million unique visitors, an increase of 26% over our fiscal 2003 visitors of 38 million,and represented 62% of the J.Crew Direct business. We design and operate our website using an in-house technical staff and our4website emphasizes simplicity and ease of customer use while integrating the J.Crew brand's aspirational lifestyle imagery used in thecatalog.Available Information We are subject to the informational requirements of the Securities Exchange Act of 1934 (Exchange Act). We therefore file periodicreports and other information with the Securities and Exchange Commission (SEC). Such reports may be obtained by visiting the PublicReference Room of the SEC at 450 Fifth Street NW, Washington, D.C. 20549, or by calling the SEC at (800) SEC-0330. In addition, theSEC maintains an internet website (www.sec.gov) that contains reports, proxy information statements and other information regardingissuers that file electronically. Our filings under the Exchange Act (including annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to these reports) are also available free of charge on our internet website at www.jcrew.com. These reports areavailable as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. The reference to theCompany's website address does not constitute incorporation by reference of the information contained on the website, and the informationcontained on the website is not part of this document.ITEM 2. PROPERTIES We are headquartered in New York City. Our headquarter offices are leased under a lease agreement expiring in 2012, with an option torenew thereafter. We own two facilities: a 406,500-square-foot customer contact call center, order fulfillment and distribution center inLynchburg, Virginia and a 192,500-square-foot distribution center in Asheville, North Carolina. As of January 29, 2005, we operated 156 J.Crew retail stores and 41 factory outlet stores in 39 states and the District of Columbia. All ofthe retail and factory outlet stores are leased from third parties, and the leases in most cases have terms of 10 to 12 years, with options torenew for periods typically ranging from five to ten years. As a general matter, the leases contain standard provisions concerning the paymentof rent, events of default and the rights and obligations of each party. Rent due under the leases is generally comprised of annual base rentplus a contingent rent payment based on the store's sales in excess of a specified threshold. Some of the leases also contain earlytermination options, which can be exercised by us or in some cases the landlord under certain conditions. The leases also generally requireus to pay real estate taxes, insurance and certain common area costs. Substantially all of the leases are guaranteed by us. The table below sets forth the number of stores by state operated by us in the United States as of January 29, 2005. Retail Stores FactoryStores Total Numberof StoresAlabama 2 1 3Arizona 4 — 4California 20 3 23Colorado 4 2 6Connecticut 6 1 7Delaware — 1 1Florida 4 3 7Georgia 4 2 6Illinois 9 — 9Iowa 1 — 1Indiana 1 1 2Kansas 1 — 1 5Kentucky 2 — 2Louisiana 1 — 1Maine — 2 2Maryland 3 1 4Massachusetts 6 2 8Michigan 6 1 7Minnesota 4 — 4Missouri 2 1 3Nevada 1 — 1New Hampshire 1 2 3New Jersey 9 1 10New Mexico 1 — 1New York 16 4 20North Carolina 4 — 4Ohio 6 — 6Oklahoma 2 — 2Oregon 2 — 2Pennsylvania 8 3 11Rhode Island 1 — 1South Carolina 2 2 4Tennessee 3 1 4Texas 6 2 8Utah 2 — 2Vermont 1 1 2Virginia 5 2 7Washington 3 1 4Wisconsin 1 1 2District of Columbia 2 — 2 Total 156 41 197 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 Texasagainst us and seventeen other defendants, primarily large retailers, alleging infringement of three patents registered to Hill relating toelectronic catalog systems and methods for processing data at a remote location and updating and displaying that data. The suit seeks aninjunction against continuing infringement, unspecified damages, including treble damages for willful infringement, and interest, costs,expenses and fees. We believe that we have meritorious defenses and intend to defend ourselves vigorously. In addition, we are subject to various legal proceedings and claims that arise in the ordinary conduct of our business. Although theoutcome of these other claims cannot be predicted with certainty, management does not believe that the ultimate resolution of these matterswill have a material adverse effect on our financial condition or results of operations.ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the quarter ended January 29, 2005.6PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS There is no established public trading market for Group or Operating common stock. As of April 1, 2005, there were 54 shareholders ofrecord of the Group common stock. See "Item 12. Security Ownership of Certain Beneficial Owners and Management" for a discussion ofthe ownership of Group. Operating is a wholly-owned indirect subsidiary of Group. Group has not paid cash dividends on its common stock and does not anticipate paying any such dividends in the foreseeable future.Operating may from time to time pay cash dividends on its common stock to permit Group to make required payments relating to itsoutstanding 131/8% Senior Discount Debentures due 2008. Our amended and restated credit facility with Wachovia Capital Markets LLC, as arranger, Wachovia Bank National Association, asadministrative agent, Bank of America N.A,. as syndication agent, and Congress Financial Corporation, as collateral agent, and a syndicateof lenders (Amended Wachovia Credit Facility) and the Indenture relating to Group's 131/8% Senior Discount Debentures due 2008 (GroupIndenture) prohibit the payment of dividends by Group on shares of common stock (other than dividends payable solely in shares of capitalstock of Group). Additionally, because Group is a holding company, its ability to pay dividends is dependent upon the receipt of dividendsfrom its direct and indirect subsidiaries. Each of the Amended Wachovia Credit Facility, the Group Indenture and the Indenture relating toOperating's 93/4% Senior Subordinated Notes due 2014 contains covenants that impose substantial restrictions on Operating's ability to paydividends or make distributions to Group.Equity Compensation Plan Information The following table summarizes information about the Amended and Restated J. Crew Group, Inc. 1997 Stock Option Plan and theJ.Crew Group, Inc. 2003 Equity Incentive Plan (2003 Plan), as of January 29, 2005. Our shareholders have approved both of these plans. (c) Number ofSecuritiesRemainingAvailable forFuture IssuanceUnder EquityCompensationPlans (ExcludingSecurities Reflectedin Column(a) (a) (b)Plan Category Number of Securitiesto be Issued UponExercise ofOutstanding OptionsWarrants and Rights Weighted AverageExercise Price ofOutstanding Options,Warrants and RightsEquity Compensation PlansApproved by Shareholders 4,582,265 $13.15 675,171Equity Compensation Plans NotApproved by Shareholders — N/A — TOTAL 4,582,265 13.15 675,171 In addition to options, the 2003 Plan authorizes the issuance of restricted Group common stock. The 2003 Plan contains a sub-limit of1,450,724 shares on the aggregate number of shares of restricted Group common stock that may be issued, of which 1,340,979 shares areoutstanding and 109,745 shares are available for grant as of January 29, 2005.7ITEM 6. SELECTED FINANCIAL DATA The following table sets forth selected consolidated historical income statement, balance sheet and operating data of the Company. Theselected income statement and balance sheet data for each of the five fiscal years ended January 29, 2005 are derived from the ConsolidatedFinancial Statements of the Company, which have been audited by KPMG LLP, independent auditors. The data presented below should beread in conjunction with the Consolidated Financial Statements, including the related Notes thereto, included herein, the other financialinformation included herein, and "Management's Discussion and Analysis of Financial Condition and Results of Operations." Fiscal Year Ended February 3,2001(a) February 2,2002 February 1,2003 January 31,2004 January 29,2005 ($ in thousands, except per square foot data) Income statement data: Revenues $825,975 $777,940 $768,344 $689,965 $804,216 Cost of goods sold(b) 458,205 454,491 472,262 440,276 478,829 Selling, general and administrativeexpenses 307,569 303,448 301,718 280,464 287,745 Charges incurred in connection withdiscontinuance of Clifford & Wills 4,130 — — — — Income/(loss) from operations 56,071 20,001 (5,636) (30,775) 37,642 Interest expense—net 36,642 36,512 40,954 63,844 87,571 (Gain) loss on debt refinancing — — — (41,085) 49,780 Insurance proceeds — — (1,800) (3,850) — Provision (benefit) for income taxes 7,500 (5,500) (4,200) 500 600 Net income (loss) $11,929 $(11,011)$(40,590)$(50,184)$(100,309) Balance sheet data (at period end): Cash and cash equivalents $32,930 $16,201 $18,895 $49,650 $23,647 Working capital 49,482 39,164 38,015 46,217 12,168 Total assets 389,861 401,320 348,878 297,611 278,194 Total long-term debt and preferred stock 464,310 510,147 556,038 609,440 669,733 Stockholders' deficit $(278,347)$(319,043)$(391,663)$(468,066)$(581,712) Operating data: Revenues: J.Crew Retail $502,898 $483,083 $484,292 $487,092 $579,793 J.Crew Direct Catalog 177,535 135,353 108,531 61,883 76,548 Internet 107,225 122,844 139,456 111,653 121,954 284,760 258,197 247,987 173,536 198,502 Other 38,317 36,660 36,065 29,337 25,921 Total revenues $825,975 $777,940 $768,344 $689,965 $804,216 J.Crew Retail: Sales per gross square foot(c) $494 $406 $351 $337 $397 Number of stores open at end of period 146 177 194 196 197 Comparable store sales change(d) 0.7% (14.5)% (11.2)% (2.5)% 16.4%J.Crew Direct: Number of catalogs circulated (inthousands) 73,000 71,000 66,000 53,000 50,000 Number of pages circulated (inmillions) 8,700 8,300 7,800 5,800 5,400 Depreciation and amortization $28,670 $39,963 $43,197 $43,075 $37,061 Capital expenditures: New store openings $30,219 $36,859 $17,202 $5,663 $5,910 Other 25,475 25,003 9,718 4,245 7,521 Total capital expenditures: $55,694 $61,862 $26,920 $9,908 $13,431 Total capital expenditures: $55,694 $61,862 $26,920 $9,908 $13,431 (a)The fiscal year 2000 consisted of 53 weeks compared to 52 weeks in all other fiscal years. Net sales for the fifty-third week increasedfiscal 2000 sales by $10.8 million. (b)Includes buying and occupancy costs. (c)Includes stores that have been opened for a full twelve month period. (d)Comparable store sales excludes the sales of stores that were not open during the same period in the prior year.8Forward Looking Statements and Risk Factors Certain statements in this Annual Report on Form 10-K under the captions "Business," "Selected Financial Data," "Management'sDiscussion and Analysis of Financial Condition and Results of Operations," "Financial Statements and Supplementary Data" andelsewhere constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. We may alsomake written or oral forward-looking statements in our periodic reports to the Securities and Exchange Commission on Forms 10-Q, 8-K,etc., in press releases and other written materials and in oral statements made by our officers, directors or employees to third parties.Statements that are not historical facts, including statements about our beliefs and expectations, are forward-looking statements. Suchforward-looking statements involve known and unknown risks, uncertainties and other important factors that could cause the actual results,performance or achievements of we, or industry results, to differ materially from historical results, any future results, performance orachievements expressed or implied by such forward-looking statements. Such risks and uncertainties include, but are not limited to:•competitive pressures in the apparel industry; •changes in levels of consumer spending or preferences in apparel and acceptance by customers of our products; •overall economic conditions, governmental regulations and trade restrictions, domestic and foreign; •acts of war or terrorism in the United States or worldwide; •political or financial instability in the countries where our goods are manufactured; •postal rate increases, paper and printing costs; •availability of suitable store locations at appropriate terms; •the level of our indebtedness and exposure to interest rate fluctuations;and other risks and uncertainties described in this report and our other reports and documents filed or which may be filed, from time to time,with the Securities and Exchange Commission. These statements are based on current plans, estimates and projections, and therefore youshould not place undue reliance on them. Forward looking statements speak only as of the date they are made and we undertake noobligation to update publicly any of them in light of new information or future events. We caution that there are important factors, in addition to those listed above, that may cause actual results to differ materially from thosecontained in forward-looking statements. These factors include the following:We must successfully gauge fashion trends and changing consumer preferences to succeed. We believe that our success depends in substantial part on our ability to originate and define product and fashion trends as well as toanticipate, gauge and react to changing consumer demands in a timely manner. There can be no assurance that we will be successful in thisregard. We attempt to reduce the risks of changing fashion trends and product acceptance by devoting a substantial portion of our product lineto basic durables which are not significantly modified from year to year. Nevertheless, if we misjudge the market for our products, we may befaced with significant excess inventories for some products and missed opportunities with others.The fashion and apparel industry is highly competitive. The fashion and apparel industry is highly competitive. We compete primarily with other catalog operations, specialty brand retailers,department stores, mass merchandisers and Internet businesses that engage in the retail sale of men's and women's apparel, accessories,footwear and general merchandise. We believe that the principal bases upon which we compete are quality, design, efficient service,selection and price. However, many of our competitors are larger and have greater financial,9marketing and other resources, and there can be no assurance that we will be able to compete successfully with them in the future.We may be substantially more leveraged than certain of our competitors, which may place us at a competitive disadvantage. Our substantial degree of leverage may limit our flexibility to adjust to changing market conditions, reduce our ability to withstandcompetitive pressures and make us more vulnerable to a downturn in general economic conditions or our business. Our ability to makescheduled payments or to refinance our debt obligations will depend upon future financial and operating performance of Operating, which willbe affected by prevailing economic conditions and financial, business and other factors, certain of which are beyond our control. There can beno assurance that Operating's operating results, cash flow and capital resources will be sufficient for payment of our indebtedness in thefuture. In the absence of such operating results, cash flow and capital resources, we could face substantial liquidity problems and might berequired to dispose of material assets or operations to meet our debt service and other obligations, and there can be no assurance as to thetiming of such sales or the proceeds that we could realize from such sale. If we are unable to service our indebtedness, we may take actionssuch as reducing or delaying planned expansion and capital expenditures, selling assets, restructuring or refinancing our indebtedness orseeking additional equity capital. There can be no assurance that any of these actions could be effected on satisfactory terms, if at all.Competition for qualified personnel is intense in the fashion and apparel industry. Our ability to anticipate and effectively respond to changing fashion trends depends in part on our ability to attract and retain keypersonnel in our design, merchandising and marketing staff. Competition for these personnel is intense, and there can be no assurance thatwe will be able to attract and retain a sufficient number of qualified personnel in the future. We rely, in particular, on the strategic guidance ofMillard Drexler, our Chief Executive Officer, and Jeffrey Pfeifle, our President. The loss, for any reason, of the services of either of theseindividuals could have a material adverse effect on us.The fashion and apparel industry is cyclical, and decline in consumer spending on apparel and accessories could have anadverse effect on our results of operations. The industry in which we operate is cyclical. Purchases of apparel and related merchandise is sensitive to a number of factors thatinfluence the levels of general consumer spending, including economic conditions and the level of disposable consumer income, consumerdebt, interest rates and consumer confidence. A decline in consumer spending on apparel and accessories could have an adverse effect onour financial condition and results of operations.Increase in costs of mailing, paper and printing will have an adverse effect on our results of operations. Postal rate increases and paper and printing costs affect the cost of our catalog and promotional mailings. We rely on discounts from thebasic postal rate structure, such as discounts for bulk mailings and sorting by zip code and carrier routes. We are not a party to any long-termcontracts for the supply of paper. Our cost of paper has fluctuated significantly, and our future paper costs are subject to supply and demandforces external to our business. Consequently, there can be no assurance that we will not be subject to an increase in paper costs. Futureincreases in postal rates or paper or printing costs would have a negative impact on our earnings to the extent that we are unable to passsuch increases directly to customers or offset such increases by raising selling prices or by implementing more efficient mailings. See "—Our Business—J. Crew Direct."We rely on foreign sourcing and are subject to a variety of risks associated with doing business abroad. In fiscal 2004, approximately 92% of our merchandise was sourced from independent foreign factories located primarily in Asia, andmany of our domestic vendors import a substantial portion of10their merchandise from abroad. Any event causing a sudden disruption of manufacturing or imports from China, including the imposition ofadditional import restrictions, could have a material adverse impact on our operations. We have no long-term merchandise supply contracts,and many of our imports are subject to existing or potential duties, tariffs or quotas that may limit the quantity of certain types of goods thatmay be imported into the United States from countries in those regions. We compete with other companies for production facilities and importquota capacity. Our business is also subject to a variety of other risks generally associated with doing business abroad, such as politicalinstability, currency and exchange risks and potential local issues. Our sourcing operations may also be adversely affected by political andfinancial instability or health concerns regarding infectious diseases in countries in which our merchandise is produced or acts of war orterrorism in the United States or worldwide, to the extent these acts impact the production, shipment or receipt of merchandise. Our futureperformance will be subject to such factors, which are beyond our control, and there can be no assurance that such factors would not have amaterial adverse effect on our financial condition and results of operations. Trade restrictions, including increased tariffs or quotas, against apparel and other items sold by us could increase the cost or reduce thesupply of merchandise available to us and adversely affect our business, financial condition and results of operations. The United States hasagreed, as of January 1, 2005, to a phase out of import quotas for WTO member countries. This should improve flexibility in importing textileand apparel products from WTO member countries. However, any flexibility resulting from this agreement may be eliminated if newrestrictions are imposed on the import of apparel from China. In addition, a number of pending applications have been made to U.S.government agencies to delay the elimination of certain quota categories at January 1, 2005. The outcome of these applications, plus otherpossible efforts to impede the elimination of quotas, could have a significant impact on worldwide sourcing patterns in 2005. The extent ofthis impact, if any, and the possible effect on our purchasing patterns and costs, cannot be determined at this time. We cannot predictwhether any of the countries in which our merchandise currently is manufactured or may be manufactured in the future will be subject toadditional trade restrictions imposed by the United States and other foreign governments, including the likelihood, type or effect of any suchrestrictions. Trade restrictions, including increased tariffs or quotas, embargoes, safeguards and customs restrictions, against apparel items,as well as U.S. or foreign labor strikes, work stoppages or boycotts, could increase the cost or reduce the supply of apparel available to we andadversely affect its business, financial condition and results of operations. See "—Sourcing and Production."We require our licensing partner and independent manufacturers to operate in compliance with applicable laws andregulations. While our internal and vendor operating guidelines promote ethical business practices, we do not control such manufacturers or theirlabor practices. Violation of labor or other laws by our independent manufacturers or our licensing partner, or the divergence of anindependent manufacturer's or our licensing partner's labor practices from those generally accepted as ethical in the United States, couldhave a material adverse effect on our financial condition and results of operations if, as a result of such violation, we were to incur substantialliability or attract negative 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 growth strategy. There can be no assurance that this strategy will besuccessful. Our success depends, in part, on our ability to improve sales and margins at our stores. Actual number and type of such stores tobe opened and their success will be dependent upon a number of factors, including, among other things, the ability to manage suchexpansion and hire and train qualified associates, the availability of suitable store locations and the negotiation of acceptable lease terms fornew locations and upon lease renewals for existing locations. There can be no assurance that we will be able to open and operate new storeson a timely or profitable basis. See "Management's Discussion and Analysis of Financial Condition and11Results of Operations of Holdings" and "Our Business—J. Crew Retail." We believe that the opening of J. Crew Retail stores has divertedsome revenues from the J. Crew Direct operations. There can be no assurance that future store openings will not continue to have such aneffect.Our quarterly results of operations fluctuate significantly due to seasonality and a variety of other factors. We experience seasonal fluctuations in revenues and operating income, with a disproportionate amount of our revenues and a majorityof our income from operations typically realized during the fourth quarter of each fiscal year. Revenues and income from operations aregenerally weakest during the first and second quarters of each fiscal year. As a result of this seasonality, sales during the third and fourthfiscal quarters cannot be used as accurate indicators for our annual results. In addition, any factors negatively affecting we during the thirdand fourth fiscal quarters of any year, including adverse weather or unfavorable economic conditions, could have a material adverse effect onits financial condition and results of operations for the entire year. Also, in order to prepare for our peak shopping seasons, we must order andkeep in stock significantly more merchandise than we would carry at other times of the year. Any unanticipated decrease in demand for ourproducts during our peak shopping seasons could require us to sell excess inventory at a substantial markdown, which could reduce our netsales and gross margins and negatively impact our profitability. See "Management's Discussion and Analysis of Financial Condition andResults of Operations—Seasonality." Our quarterly results of operations may also fluctuate significantly as a result of a variety of otherfactors, including the timing of new store openings and of catalog mailings, and the revenues contributed by new stores, merchandise mixand the timing and level of markdowns.ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This discussion summarizes the significant factors affecting our consolidated operating results, financial condition and liquidity duringthe three-year period ended January 29, 2005. You should read the following discussion and analysis in conjunction with our auditedconsolidated financial statements for the three-year period ended January 29, 2005 and the related notes thereto included herein. Management's discussion and analysis of the results of operations are provided solely with respect to Operating and its subsidiariessince substantially all of the Company's operations are conducted by Operating. However, Group has additional debt securities that areoutstanding. Accordingly, information with respect to interest expense of Group is also provided herein. The discussion of liquidity and capitalresources pertains to Group and its consolidated subsidiaries, including Operating.Management Overview The fashion and apparel industry is highly competitive. We compete primarily with specialty brand retailers, department stores, othercatalog operations, and internet businesses that engage in the retail sale of men's and women's apparel, accessories, footwear and similarmerchandise. We believe that the principal bases upon which we compete are quality, design, efficient service, selection and price. Webelieve that our success depends in substantial part on our ability to originate and define product and fashion trends as well as to anticipate,gauge and react to changing consumer demands in a timely manner. The industry in which we operate is cyclical. Purchases of apparel and related merchandise are sensitive to a number of factors thatinfluence the levels of consumer spending including economic conditions and the level of disposable consumer income, consumer debt,interest rates and consumer confidence. The economic environment in 2002 had a negative impact on our sales and required a higher levelof promotional sales activities, which adversely affected our profitability. We believe our comparable store sales results in fiscal 2002 and thefirst half of 2003 also reflected in large part customer dissatisfaction with our product offerings. When our new management took over inJanuary 2003, they initiated a program to upgrade the quality and style of our merchandise12assortments. These changes were not implemented until our Fall and Holiday 2003 product offerings. We believe that our comparable storesales increase in fiscal 2004 reflects a positive customer response to our merchandise development efforts and an emphasis on customerservice in our retail stores. An important aspect of our business strategy has been an expansion program designed to reach new and existing customers throughthe opening of new stores. However, as a result of an overall slowdown in the economic environment in 2002 and our declining comparablestore sales trends in 2002 and 2003, we curtailed in the number of new store openings to concentrate on improving the store productivity (asmeasured by sales per square foot) of our existing stores. We believe that we have begun to accomplish this, which is reflected in theincrease in our store productivity as sales per square foot increased to $397 in 2004 from $337 per square foot in 2003. We opened five newstores (and closed 4 stores) in fiscal 2004 and expect to accelerate the pace of our store openings in fiscal 2005 with the addition of ten newstores.Results of Operations Our consolidated statements of operations presented as a percentage of revenues are as follows: Fiscal Year Ended January 29,2005 January 31,2004 February 1,2003 Revenues(1) 100.0% 100.0% 100.0% Cost of goods sold, including buying and occupancy costs(2) 59.5 63.8 61.5 Gross profit(2) 40.5 36.2 38.5 Selling, general and administrative expenses(2) 35.8 40.7 39.3 Income/(loss) from operations 4.7 (4.5) (0.7)Interest expense, net 10.9 9.3 5.3 (Gain) loss on refinancing of debt 6.2 (6.0) — Insurance proceeds — (.6) (0.2)Loss before income taxes (12.4) (7.2) (5.8)Provision (benefit) for income taxes 0.1 0.1 (0.5) Net loss (12.5)% (7.3)% (5.3)% Selected retail store data: Number of stores open 197 196 194 Sales per gross square foot $397 $337 $351 Comparable store sales change 16.4 % (2.5)% (11.2)%(1)Includes licensing, shipping and handling fees and other. (2)Our gross margins may not be comparable to others, as some companies include all of the costs related to their distribution networkin cost of goods sold while others, like us, exclude all or a portion of them from gross margin and include them in selling, general andadministrative expenses.Fiscal 2004 Compared to Fiscal 2003Net Sales Net sales in fiscal 2004 increased by $114.2 million, or 16.6%, to $804.2 million from $690.0 million in fiscal 2003. The increaseresulted primarily from an increase in J.Crew Retail sales of $92.6 million, due to an increase of 16.4% in comparable store sales, and anincrease in J.Crew Direct sales of $25.1 million, or 14%, which we believe resulted in part from a 40% increase in the second half of 2004 inthe number of styles presented in our catalog and on our website, as well as the mailing of four new catalog editions. These increases wereoffset in part by a decrease in other revenues of $3.5 million resulting primarily from a decrease in shipping and handling fees as a result of adecline in orders in the J.Crew Direct business in the first half of fiscal 2004. We believe that the increase in comparable store sales and inthe J. Crew Direct business resulted from the positive customer response to the continuing improvements in our product offerings and anemphasis on customer service.13Gross Profit Gross profit increased by $75.7 million, or 30.3%, to $325.4 million in fiscal 2004 from $249.7 million in fiscal 2003. Gross marginincreased from 36.2% in 2003 to 40.5% in 2004, attributable primarily to a 440 basis point increase in merchandise margins, which resultedfrom lower markdowns and improved inventory management in 2004, coupled with the negative effect on 2003 margins from the liquidationof prior season inventories in the first half of the year.Selling, General and Administrative Expenses Selling, general and administrative expenses increased by $7.2 million, or 2.6%, to $287.7 million in fiscal 2004 from $280.5 millionin fiscal 2003. The increase resulted primarily from increases in variable store operating expenses and incentive compensation. Theseincreases were offset in part by a decrease in depreciation and amortization of $6.0 million related primarily to computer equipment, and adecrease in catalog selling costs of $3.7 million due primarily to a reduction in pages circulated from 5.8 billion to 5.4 billion. As a percentageof sales, selling, general and administrative expenses decreased from 40.7% in 2003 to 35.8% in 2004, resulting primarily from an increasein operating leverage due to the increase in revenues.Interest Expense Interest expense for Group increased by $23.8 million to $87.6 million in fiscal 2004 from $63.8 million in fiscal 2003. The increaseresulted primarily from the inclusion as interest of dividends on mandatorily redeemable preferred stock for the full year in 2004 as comparedto the inclusion only in the second half of fiscal 2003, which resulted in an increase of $18.9 million. There were also increases in interest of$8.0 million, including amortization of debt issuance discount related to the 16% Senior Discount Contingent Principal Notes due 2008issued in May 2003 and $2.7 million on the 93/4% Senior Subordinated Notes due 2014 issued in December 2004. These increases wereoffset by a reduction of $4.4 million of interest on the 131/8% Senior Discount Debentures due to the exchange offer completed in May 2003and $1.5 million reduction on the 103/8% Senior Subordinated Notes due 2007 due to their redemption in December 2004. Interest expense for Operating increased by $1.1 million to $21.6 million in fiscal 2004 from $20.5 million in fiscal 2003. The increasewas primarily due to $2.7 million of interest on $275 million of the 93/4% Senior Subordinated Notes issued in December 2004, offset inpart by $1.6 million of interest on the 103/8% Senior Subordinated Notes that were redeemed in such transaction.Gain (loss) on Refinancing of Debt The gain (loss) on refinancing of debt was a loss of $49.8 million in fiscal 2004 compared to a gain of $41.1 million in 2003. In the fourthquarter of 2004, we redeemed $150.0 million of 103/8% Senior Subordinated Notes and $169.0 million outstanding amount of 16% SeniorDiscount Contingent Principal Notes. The funds used to redeem these notes were provided by the issuance of $275 million in new termloans and internally available funds. These term loans were subsequently converted into equivalent new 93/4% Senior Subordinated Notesdue 2014 of Operating. This debt refinancing resulted in a loss of $49.8 million at Group in 2004 consisting of (a) redemption premiums of $15.3 million,(b) the write-off of deferred financing costs related to the old debt of $3.2 million, and (c) the write-off of unamortized debt issuance costs of$31.3 related to the 16% Senior Discount Contingent Principal Notes. The loss on refinancing of debt at Operating in fiscal 2004 was$4.0 million consisting of redemption premiums of $2.6 million and the write-off of deferred financing costs of $1.4 million. The gain of $41.1 million in fiscal 2003 resulted from the issuance of the 16% Senior Discount Contingent Principal Notes in May 2003.14Insurance Proceeds Insurance proceeds of $3.8 million in fiscal 2003 and $1.8 million in fiscal 2002 represent recoveries for claims related to the destructionof our World Trade Center store on September 11, 2001. The recovery in fiscal 2003 is the final settlement of this claim.Income Taxes Group files a consolidated federal tax return, which includes all its wholly owned subsidiaries. Each subsidiary files separate state taxreturns in the required jurisdictions. Group and its subsidiaries have entered into a tax sharing agreement providing (among other things)that each of the subsidiaries will reimburse Group for its share of income taxes based on the proportion of such subsidiaries' tax liability on aseparate return basis to the total tax liability of Group. Accordingly, the following discussion pertains to Group. In fiscal 2002, we established a valuation allowance of $21.0 million to reduce the net deferred tax assets to the estimated recoverableamount at February 1, 2003. The valuation allowance was offset by a $9.0 million benefit from the reversal of prior year tax accruals. Thevaluation allowance was recorded in fiscal 2002 as a result of the significance of our net loss in fiscal 2002 and management's projection oftaxable income/loss in the near future. Management had previously concluded that considering all factors, including available tax planningstrategies and projections of future taxable income, it was more likely than not that the net deferred income tax assets would be realized.However, considering our substantially increased losses and declining trends and projections of operating losses in the near future, the factthat our operating results for fiscal 2002 were significantly worse than originally forecasted and the downward revision of the outlook for fiscalyear 2003 and forward, we reassessed the need for a valuation allowance. We believed in fiscal 2002 that the "positive evidence" no longeroutweighed the "negative evidence" and a valuation allowance was, therefore, necessary. The tax accruals were reversed in 2002 based on aproposed IRS settlement of open years and the results of state audits at amounts less than amounts accrued. An additional valuationallowance of $5.0 million was recorded in fiscal 2003 to fully reserve the net deferred tax assets at January 31, 2004. This increase was offsetby additional tax refunds and a reduction in prior year tax accruals as a result of the finalization of certain tax audits. The Company did notrecognize any tax benefits in fiscal 2004 and does not expect to recognize any tax benefits in future operations until an appropriate level ofprofitability is sustained. Fiscal 2004, 2003 and 2002 include state and foreign tax provisions of $0.6 million, $0.5 million and $0.4 million, respectively.Net Loss The net loss of Group in fiscal 2004 was $100.3 million compared to $50.2 million in fiscal 2003. The loss in fiscal 2004 includes a losson the refinancing of debt of $49.8 million while fiscal 2003 included a gain on exchange of debt of $41.1 million and insurance proceeds of$3.8 million. Excluding these items, the net loss for Group for fiscal 2004 would have been $50.5 million compared to a net loss of$95.1 million last year. The improvement in fiscal 2004 results is due primarily to the 16.6% increase in net sales and the improvement ingross margin. Operating had net income of $11.4 million in fiscal 2004 compared to a net loss of $42.0 million in fiscal 2003, animprovement of $53.4 million.Fiscal 2003 Compared to Fiscal 2002Net Sales Net sales in fiscal 2003 decreased by $78.3 million, or 10.2%, to $690.0 million from $768.3 million in fiscal 2002. The decreaseresulted primarily from a decrease in J.Crew Direct sales of $74.5 million, or 30%, resulting from (a) 25% decrease in catalog circulationfrom 7.8 billion pages in 2002 to 5.8 billion pages in 2003 including the elimination of women's only and clearance catalogs in the secondhalf of the year, (b) a decrease in density (items per page) resulting from a 30% reduction in style15counts, and (c) a reduction in promotional practices, including promotional e-mails. Other revenues decreased by $6.6 million resultingprimarily from a decrease in shipping and handling fees as a result of a decline in orders in Direct. These decreases were offset in part by anincrease of $2.8 million in J.Crew Retail sales. A decline of 2.5% in comparable store sales was offset by sales from four stores opened infiscal 2003 and 16 stores opened in 2002 that were open for a full year in fiscal 2003. We believe that the improvement in comparable storesales performance in 2003 was the result of an improving economy and an upgrade in the quality and style of our merchandise assortmentsin the second half of the year.Gross Profit Gross profit decreased by $46.4 million, or 15.7%, to $249.7 million from $296.1 million. Gross margin decreased from 38.5% to36.2%, attributable primarily to a 160 basis point increase in buying and occupancy costs as a percentage of revenues resulting from thespreading of fixed buying and occupancy costs over a lower revenue base, and a decrease of 70 basis points in merchandise marginsprimarily from the liquidation of prior season's inventories in the first half of 2003.Selling, General and Administrative Expenses Selling, general and administrative expenses decreased by $21.2 million, or 7.0%, to $280.5 million from $301.7 million. The decreaseresulted primarily from lower catalog selling costs of $13.2 million related primarily to the reduction in pages circulated, including theelimination of women's only editions and clearance catalogs in the second half of 2003, as well as a decrease in severance and other one-time employment-related charges of $10.0 million. These decreases were offset in part by increased store expenses resulting from additionalstores in operation in 2003. As a percentage of sales, selling, general and administrative expenses increased from 39.3% to 40.7%,resulting primarily from the spreading of fixed overhead expenses over a lower revenue base.Interest Expense Interest expense for Group increased by $22.8 million to $63.8 million from $41.0 million. The increase resulted from (a) the inclusionas interest of $14.2 million of dividends on mandatorily redeemable preferred stock which classification as interest expense commenced inthe third quarter of 2003, and (b) interest on the 16% Senior Discount Contingent Principal Notes of $21.9 million, including amortization ofdebt issuance discount, issued in the exchange offer completed in May 2003. These increases were offset by a reduction of $10.4 million ofinterest on the 131/8% Senior Discount Debentures that were exchanged for the 16% Senior Discount Contingent Principal Notes, and lowerdeferred financing costs which resulted primarily from a write off of $1.8 million related to the refinancing of our working capital credit facilityin fiscal 2002. Interest expense for Operating decreased by $2.7 million to $20.5 million from $23.2 million. The decrease was primarily attributable toa reduction in amortization of deferred financing costs, which resulted primarily from a write off of $1.8 million related to the refinancing of ourworking capital credit facility in fiscal 2002.Gain on Refinancing of Debt The net gain on exchange of debt of $41.1 million in 2003 reflects the difference between the fair value of the 16% Senior DiscountContingent Principal Notes at date of issuance and the carrying value of the 131/8% Senior Discount Debentures of $44.1 million less relatedexpenses which consist of (a) the additional expense of 27/8% from October 15, 2002 to May 6, 2003 paid to the note holders who acceptedthe exchange offer completed in May 2003 ($1.9 million) and (b) the write off of unamortized deferred financing costs related to the debenturesexchanged in the May 2003 exchange offer ($1.1 million).16Insurance Proceeds For the discussion of insurance proceeds, see "Fiscal 2004 compared to Fiscal 2003—Insurance Proceeds."Income Taxes For the discussion of income taxes, see "Fiscal 2004 Compared to Fiscal 2003—Income Taxes".Net Loss The net loss of Group for fiscal 2003 was $50.2 million compared to a net loss of $40.6 million in fiscal 2002. However, the results infiscal 2003 included a gain on the exchange of debt of $41.1 million and an increase in insurance proceeds of $2.0 million. Excluding theseitems, the net loss of Group for fiscal 2003 would have been $95.1 million, an increase of $52.7 million from the prior year. This increase innet loss is primarily attributed to the decrease in gross profit in fiscal 2003, attributable to the sales decline and the increase in interestexpense. The net loss of Operating increased to $42.0 million in fiscal 2003 from $8.8 million in fiscal 2002. This increase resulted primarilyfrom the decrease in gross profit resulting from the sales decline.Liquidity and Capital Resources Our sources of liquidity are primarily cash flows from operations and borrowings under our working capital credit facility. Our primarycash needs are for capital expenditures incurred primarily for opening new stores and system enhancements, debt service requirements andworking capital. On November 21, 2004, Operating entered into a Senior Subordinated Loan Agreement with entities managed by Black CanyonCapital LLC and Canyon Capital Advisors LLC, which provided for a term loan of $275.0 million. The proceeds of the term loan were used toredeem in full Operating's outstanding 103/8% Senior Subordinated Notes due 2007 ($150.0 million) and to redeem, in part, Intermediate's16% Senior Discount Contingent Principal Notes due 2008 ($125.0 million). In January 2005, we redeemed the remaining $44 million ofoutstanding 16% Senior Discount Contingent Principal Notes using internally available funds. On March 18, 2005, the term loan wasconverted into equivalent new 93/4% Senior Subordinated Notes of Operating due 2014 in accordance with the terms of the loan agreement.This refinancing will generate approximately $16.0 million of annual interest savings. On December 23, 2004, Operating entered into an Amended and Restated Loan and Security Agreement, which we refer to as theAmended Wachovia Credit Facility, with Wachovia Capital Markets LLC, as arranger, Wachovia Bank National Association, asadministrative agent, Bank of America N.A., as syndication agent, Congress Financial Corporation, as collateral agent, and a syndicate oflenders, which provides for maximum credit availability of up to $170.0 million (which can be increased to $250.0 million if certain conditionsare met). The Amended Wachovia Credit Facility provides for revolving loans and letters of credit of up to $170.0 million and expires inDecember 2009. The total amount of availability is limited to the sum of invested cash, 90% of eligible receivables, 95% of the net recoverypercentage of inventories (as determined by inventory appraisal) for the period of August 1 through December 15, 92.5% of the net recoverypercentage of inventories for the period December 16 through July 31 and real estate availability of 65% of appraised fair market value. As ofJanuary 29, 2005, there was $27.0 million of excess availability under the Amended Wachovia Credit Facility. The Amended Wachovia Credit Facility includes restrictions, including the incurrence of additional indebtedness, the payment ofdividends and other distributions, the making of investments, the granting of loans and the making of capital expenditures. We are requiredto maintain a minimum of fixed interest charge coverage of 1.1 if excess availability is less than $20.0 million for any 30 consecutive day17period. We have at all times been in compliance with all financial covenants under the Amended Wachovia Credit Facility. The Amended Wachovia Credit Facility permits restricted payments (by way of dividends or other distributions) with respect to, amongother things, our capital stock payable solely in additional shares of our capital stock, our tax sharing agreement, the Series A preferred stockof Group, the Series B preferred stock of Group and the 131/8% Senior Discount Debentures due 2008 of Group. Our ability to declaredividends on our capital stock is also limited by Delaware law, which permits a company to pay dividends on its capital stock only out of itssurplus or, in the event that it has no surplus, out of its net profits for the year in which a dividend is declared or for the immediatelypreceding fiscal year. Under the Amended Wachovia Credit Facility, the assets of Operating and its subsidiaries are restricted. Cash provided by operating activities was $58.8 million in fiscal 2004, $18.2 million in fiscal 2003 and $31.8 million in fiscal 2002. Theincrease in 2004 resulted from the significant increase in operating income. Cash provided in 2003 and 2002 resulted from improvements inworking capital, due primarily to reductions in inventories of $41.3 million in 2003 and $31.6 million in 2002, which offset the operatinglosses in those years. Capital expenditures were $13.4 million in fiscal 2004, $9.9 million in fiscal 2003 and $26.9 million in fiscal 2002. Capitalexpenditures related to new stores were $5.9 million, $5.7 million and $17.2 million during the three years. Anticipated capital expendituresin fiscal 2005 are approximately $25 million, primarily for 10 new stores and information technology initiatives. There were no borrowings under our working capital credit facility at January 29, 2005 and January 31, 2004. Average borrowings underthe credit facility were none in fiscal 2004, $1.0 million in fiscal 2003 and $40.4 million in fiscal 2002. Long-term indebtedness increased by$25.8 million in fiscal 2003 consisting of $20.0 million of TPG-MD Investment LLC notes payable due in 2008 and $5.8 million under theour working capital credit facility, which was paid off in January 2005. Management believes that its current cash position, cash flow from operations and availability under the Amended Wachovia CreditFacility will provide adequate funds for our foreseeable working capital needs, planned capital expenditures and debt service obligations. Ourability to fund our operations and make planned capital expenditures, to make scheduled debt payments, to refinance indebtedness and toremain in compliance with the financial covenants under our debt agreements depends on our future operating performance and cash flow,which in turn, are subject to prevailing economic conditions and to financial, business and other factors, some of which are beyond ourcontrol.Restatement The consolidated statements of cash flows for Group and Operating for the years ended January 31, 2004 and February 1, 2003 havebeen restated to reclassify the proceeds from construction allowances from a reduction of capital expenditures in cash flows from investingactivities to an increase in cash flow from operating activities. There was no effect on the Company's consolidated balance sheet orconsolidated statement of operations.Off Balance Sheet Arrangements We enter into letters of credit to facilitate the international purchase of merchandise. Standby letters of credit are required to secure certainof our obligations, including insurance programs and duties related to import purchases.Letters of Credit Within1 Year 2-3 Years 4-5 Years After5 Years Total Standby $0.7 $— $— $5.0 $5.7 Import 53.0 — — — 53.0 $53.7 $— $— $5.0 $58.7 18Contractual Obligations The following summarizes our contractual obligations as of January 29, 2005 and the effect such obligations are expected to have on ourliquidity and cash flows in future periods. Within1 Year 2-3 Years 4-5 Years After5 Years Total ($ in millions)Long-term debt obligations $— $— $43.7 $275.0 $318.7Redeemable preferred stock — — 258.3 — 258.3Operating lease obligations(1) 54.3 99.3 81.0 98.8 333.4Purchase obligations Inventory commitments 197.7 — — — 197.7 Other 5.7 8.0 — — 13.7 Employment agreements 1.9 3.8 — — 5.7 205.3 11.8 — — 217.1 Total $259.6 $111.1 $383.0 $373.8 $1,127.5 (1)Operating lease obligations represent obligations under various long-term operating leases entered in the normal course of businessfor retail and factory stores, warehouses, office space and equipment requiring minimum annual rentals. Operating lease expense isa significant component of our operating expenses. The lease terms range for various periods of time in various rental markets andare entered into at different times, which mitigates exposure to market changes which could have a material effect on the Company'sresults of operations within any given year.Impact of Inflation Our results of operations and financial condition are presented based upon historical cost. While it is difficult to accurately measure theimpact of inflation due to the imprecise nature of the estimates required, we believe that the effects of inflation, if any, on our results ofoperations and financial condition have been minor. However, there can be no assurance that during a period of significant inflation, ourresults of operations would not be adversely affected.Seasonality We experience two distinct selling seasons, spring comprised of the first and second fiscal quarters and fall comprised of the third andfourth fiscal quarters. Net sales are usually substantially higher in the fall season and selling, general and administrative expenses as apercentage of net sales are usually higher in the spring season. Approximately 33% of annual net sales in fiscal 2004 occurred in the fourthfiscal quarter. Our working capital requirements also fluctuate throughout the year, increasing substantially in September and October inanticipation of the holiday season inventory requirements.Recent Accounting Pronouncements In December 2003, the FASB issued FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable InterestEntities, which addresses how a business enterprise should evaluate whether it has a controlling financial interest in an entity throughmeans other than voting rights and accordingly should consolidate the entity. FIN 46R applies to variable interests in variable interest entitiescreated after December 31, 2003. For variable interests in variable interest entities created before January 1, 2004, the Interpretation appliesbeginning on January 1, 2005. For any variable interest entities that must be consolidated under FIN 46R that were created before January 1,2004, the assets, liabilities and noncontrolling interests of the variable interest entity initially would be19measured at their carrying amounts with any difference between the net amount added to the balance sheet and any previously recognizedinterest being recognized as the cumulative effect of an accounting change. If determining the carrying amounts is not practicable, fair value atthe date FIN 46R first applies may be used to measure the assets, liabilities and noncontrolling interest of the variable interest entity. Theadoption of FIN 46R did not have any effect on the financial statements taken as a whole as of January 29, 2005, and for the year thenended. In December 2004, the FASB issued Statement No. 123 R, Share-Based Payment. This revision to Statement No. 123 requires thatcompensation expense be recognized for the fair value of stock options over their vesting period and changes the method of expenserecognition for performance-based stock awards. The Statement is required to be adopted by the Company for fiscal years beginning afterDecember 15, 2005 and applies to all outstanding stock options and stock awards that have not yet vested at the date of adoption.Management is evaluating the effects of this Statement.Critical Accounting Policies Management's discussion and analysis of financial condition and results of operations is based upon the consolidated financialstatements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation ofthese financial statements requires estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses.We base our estimates on historical experience and other assumptions that are believed to be reasonable under the circumstances andevaluate these estimates on an on-going basis. Actual results may differ from these estimates under different assumptions or conditions. The following critical accounting policies, which we have discussed with our audit committee, reflect the more significant estimates andjudgments used in the preparation of our consolidated financial statements. We do not believe that changes in these assumptions andestimates are likely to have a material impact on our consolidated financial statements.Inventory Valuation Merchandise inventories are carried at the lower of cost or market. We evaluate all of our inventories to determine excess inventoriesbased on estimated future sales. Excess inventories may be disposed of through our factory channel, internet clearance sales and otherliquidations. Based on historical results experienced through various methods of disposition, we write down the carrying value of inventoriesthat are not expected to be sold at or above costs.Deferred Catalog Costs The costs associated with direct response advertising, which consist primarily of catalog production and mailing costs, are capitalizedand amortized over the expected future revenue stream of the catalog mailings, which approximates four months. The expected futurerevenue stream is determined based on historical revenue trends developed over an extended period of time. If the current revenue streamswere to diverge from the expected trend, our future revenue streams would be adjusted accordingly.Asset Impairment We are exposed to potential impairment if the book value of our assets exceeds their future cash flows. The major components of ourlong-lived assets are store fixtures, equipment and leasehold improvements. The impairment of unamortized costs is measured at the storelevel and the unamortized cost is reduced to fair value if it is determined that the sum of expected future net cash flows is less than net bookvalue.20Sales Returns We must make estimates of future sales returns related to current period sales. Management analyzes historical returns, currenteconomic trends and changes in customer acceptance of our products when evaluating the adequacy of the reserve for sales returns.Income Taxes We have significant deferred tax assets resulting from net operating loss carryforwards and temporary differences, which will reducetaxable income in future periods. Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes" states thata 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 allavailable positive and negative evidence needs to be considered, including a company's current and past performance, the marketenvironment in which a company operates, length of carryback and carryforward periods, existing contracts or sales backlog that will result infuture profits, etc. Forming a conclusion that a valuation allowance is not needed is difficult when there is negative evidence such ascumulative losses in recent years. Cumulative losses weigh heavily in the overall assessment. As a result of our assessments, weestablished a valuation allowance to reduce our net deferred tax assets to their estimated realizable value of $5.0 million at February 1, 2003and we provided additional allowances at January 31, 2004 and January 29, 2005 to fully reserve our net deferred tax assets. We do notexpect to recognize any tax benefit in future results of operations until an appropriate level of profitability is sustained.ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our principal market risk relates to interest rate sensitivity, which is the risk that future changes in interest rates will reduce our netincome or net assets. Our variable rate debt consists of borrowings under the Amended Wachovia Credit Facility. The interest rates are afunction of the bank prime rate or LIBOR. A one percentage point increase in the base interest rate would result in approximately $100,000change in income before taxes for each $10 million of borrowings. We have a licensing agreement in Japan that provides for royalty payments based on sales of J.Crew merchandise as denominated inyen. We have entered into forward foreign exchange contracts from time to time in order to minimize this risk. At January 29, 2005, therewere no forward foreign exchange contracts outstanding. We also enter into letters of credit to facilitate the international purchase of merchandise. The letters of credit are primarily denominatedin U.S. dollars. Outstanding letters of credit at January 29, 2005 were $58.7 million, including $5.7 million of standby letters of credit.ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The Financial Statements are set forth herein commencing on page F-1 of this Report.ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None.ITEM 9A. CONTROLS AND PROCEDURES With the participation of the Company's management, including the Chief Executive Officer and the Chief Financial Officer, theCompany has conducted an evaluation of its disclosure controls and procedures as of the end of the period covered by this report. Suchevaluation included a review of the facts and circumstances relating to the correction of certain of the Company's lease accounting21practices. As a result of the February 7, 2005 letter issued by the Office of the Chief Accountant of the Securities and Exchange Commissionto the American Institute of Certified Public Accountants, the Company concluded that certain of its previously established lease accountingpractices were not appropriate and determined to restate its Consolidated Statements of Cash Flows for prior years to report constructionallowances as operating activities, rather than investing activities. There was no impact on net income as a result of the changes. Basedsolely on this change in lease accounting practices, the Company's Chief Executive Officer and the Chief Financial Officer have concludedthat the Company's disclosure controls and procedures were not effective as of the end of the period covered by this report. Such officers also confirm that there were no significant changes in the Company's internal controls over financial reporting during theperiod covered by this report that have materially affected, or are reasonably likely to materially affect, the Company's internal controls overfinancial reporting.22PART III Information required by items 10-14 with respect to Operating has been omitted pursuant to General Instruction I of Form 10-K.Information required by items 10-14 with respect to Group 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 are serving as directors and executive officers of Group as ofApril 1, 2005.Name Age PositionMillard Drexler 60 Chief Executive Officer, Chairman of the Board and DirectorJeffrey Pfeifle 46 PresidentRoxane Al-Fayez 48 Executive Vice President, Catalog & e-CommerceAmanda Bokman 41 Executive Vice President, Chief Financial OfficerTracy Gardner 41 Executive Vice President, Merchandising, Planning & ProductionScott Hyatt 47 Senior Vice President, ManufacturingNicholas Lamberti 62 Vice President, Corporate ControllerRichard Boyce 50 DirectorJonathan Coslet 40 DirectorJames Coulter 45 DirectorSteven Grand-Jean 62 DirectorThomas Scott 39 DirectorStuart Sloan 61 DirectorJosh Weston 76 DirectorEmily Woods 43 Director Millard Drexler. Mr. Drexler became Chief Executive Officer in January 2003 and Chairman of the Board and a Director inMarch 2003. Before joining the Company, Mr. Drexler was 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 also serves on the Board of Directors of Apple Computer Inc. Jeffrey Pfeifle. Mr. Pfeifle became President in February 2003. Before joining the Company, Mr. Pfeifle was Executive Vice President,Product and Design of the Old Navy division of The Gap, Inc. from 1995. Roxane Al-Fayez. Ms. Al-Fayez became Executive Vice President, Catalog & e-Commerce in October 2003. Before joining theCompany, she was Vice President of Operations, Gap, Inc. Direct for six years. Amanda Bokman. Ms. Bokman became Executive Vice-President and Chief Financial Officer in May 2004. Before joining theCompany, Ms. Bokman was Senior Vice-President and Chief Financial Officer of one of the four major segments of Jones ApparelGroup, Inc. from 2001 and Vice-President and Chief Financial Officer of McNaughton Apparel Group, Inc. for nine years prior thereto. Tracy Gardner. Ms. Gardner became Executive Vice President, Merchandising, Planning & Production in March 2004. Prior to joiningthe Company, Ms. Gardner held various positions at The Gap, Inc., including Senior Vice President of Adult Merchandising for GAP brandfrom 2002 to March 2004, Vice-President of Womens' Merchandising for the Banana Republic division from 2001 to 2002, Vice-President ofMens' Merchandising for the Banana Republic division from 1999 to 2001, and Divisional Merchandising Manager of Mens' Wovens for theBanana Republic division prior to 1999.23 Scott Hyatt. Mr. Hyatt has been Senior Vice President, Manufacturing since 1998. Before joining the Company, Mr. Hyatt was VicePresident, Production and Sourcing of the Express division of Limited Brands, a retail apparel company, from 1996 to 1998. Nicholas Lamberti. Mr. Lamberti has been Vice President, Corporate Controller for more than five years. Mr. Lamberti also served asacting Chief Financial Officer from August 2003 until Ms. Bokman joined the Company in May 2004. Richard Boyce. Mr. Boyce has been a Director since 1997 and has periodically served as Chief Executive Officer between 1997 and1999 while also providing operating oversight to the remainder of the Texas Pacific Group portfolio. Mr. Boyce is a Senior Operating Partnerof Texas Pacific Group and joined Texas Pacific Group in 1997. Mr. Boyce is also the Chairman of the Executive Committee of the Board ofDirectors of Burger King Corporation and a Director of ON Semiconductor Corporation, Spirit Group, Ltd. and Kraton Polymers. Jonathan Coslet. Mr. Coslet became a Director in 2003. Mr. Coslet is a senior Partner of Texas Pacific Group and is responsible forthe investment firm's generalist and healthcare investment activities. Prior to joining Texas Pacific Group, Mr. Coslet worked in theinvestment banking department of Donaldson, Lufkin & Jenrette, specializing in leveraged acquisitions and high yield finance from 1991 to1993. Mr. Coslet also serves on the Board of Directors of Burger King Corporation, Petco Animal Supplies, Inc., Quintiles TransnationalCorp., IASIS Healthcare Corp. and Fidelity National Information Services. James Coulter. Mr. Coulter has been a Director since 1997. Mr. Coulter is a founding Partner of Texas Pacific Group, and has beenManaging General Partner of Texas Pacific Group for more than eight years. Mr. Coulter also serves on the Board of Directors of ConexantSystems, Inc., Seagate Technology, Inc. and Zhone Technologies. Steven Grand-Jean. Mr. Grand-Jean became a Director in 2003. Mr. Grand-Jean has been President of Grand-Jean CapitalManagement for more than five years. Thomas Scott. Mr. Scott has been a Director since 2002. Mr. Scott is a founding partner of Plum TV, LLC, a television station networkin select resort markets, and has served as its Chief Executive Officer and Executive Co-Chairman since September 2003. He is also afounding partner of Nantucket Allserve Inc., a beverage supplier, and has served as Co-Chairman thereof since 1989 and Co-Chairman andCo-Chief Executive Officer from 1989 to 2000. Mr. Scott has also served as Co-Chairman of Shelflink, a supply chain software company,since 2000. Mr. Scott is married to Emily Woods, a Director of the Company. Stuart Sloan. Mr. Sloan has been a Director since September 2003. Mr. Sloan is the founder of Sloan Capital Companies, a privateinvestment company, and has been a Principal thereof since 1984. Mr. Sloan also serves on the Board of Directors of AnixterInternational, Inc. and Rite Aid Corp. Josh Weston. Mr. Weston has been a Director since 1998. Mr. Weston has also served as Honorary Chairman of the Board ofDirectors of Automatic Data Processing, a computing services business, since 1998. Mr. Weston was Chairman of the Board of AutomaticData Processing from 1996 until 1998, and Chairman and Chief Executive Officer for more than five years prior thereto. Mr. Weston alsoserves on the Board of Directors of Gentiva Health Services, Inc. and Russ Berrie & Company, Inc. Emily Woods. Ms. Woods served as Chairman of the Board of Directors of Group from 1997 to 2003, and continues to serve as aDirector. Ms. Woods started work at the Company the year that it was founded in 1983 and has also previously served as its Chief ExecutiveOfficer and Vice Chairman. Ms. Woods is married to Thomas Scott, a Director of the Company.24Our Board of Directors Our Board of Directors currently has 9 members. Directors serve until the next annual meeting of shareholders or until his or hersuccessor has been elected and qualified. Directors may be removed at any time, with or without cause, by vote of our shareholders. OurBoard of Directors currently has two standing committees—an Audit Committee and a Compensation Committee. Audit Committee. The primary duties of the Audit Committee include assisting the Board of Directors in its oversight of (i) theintegrity of our financial statements and financial reporting process; (ii) the integrity of our internal controls regarding finance, accounting andlegal compliance; and (iii) the independence and performance of our independent auditors and internal audit function. The Committee alsoreviews our critical accounting policies, our annual and quarterly reports on Form 10-K and Form 10-Q, and our earnings releases before theyare published. The Committee has sole authority to engage, evaluate and replace the independent auditor. The Committee also has theauthority to retain special legal, accounting and other consultants it deems necessary in the performance of its duties. The Committee meetsregularly with our management, independent auditors and internal auditors to discuss our internal controls and financial reporting processand also meets regularly with the independent auditors and internal auditors in private. The current members of the Audit Committee are Messrs. Boyce, Grand-Jean and Weston (Chairperson). The Board of Directors hasdetermined that Josh Weston qualifies as an "audit committee financial expert" and is independent under the applicable rules of theSecurities and Exchange Commission. Compensation Committee. The primary duty of the Compensation Committee is to discharge the responsibilities of the Board ofDirectors relating to compensation practices for our executive officers and other key employees, as the Committee may determine, to ensurethat management's interests are aligned with the interests of our equity holders. The Committee also reviews and makes recommendationsto the Board of Directors with respect to our employee benefits plans, compensation and equity-based plans and compensation of Directors.The current members of the Compensation Committee are Messrs. Coulter (Chairperson) and Sloan and Ms. Woods. Compensation of Directors. Directors who are our employees or representatives of Texas Pacific Group (Messrs. Boyce, Coslet,Coulter and Drexler) do not receive any compensation for their services. All other Directors (Messrs. Grand-Jean, Scott, Sloan and Westonand Ms. Woods) received the following as compensation in 2004: (1) 5,000 shares of restricted Group common stock and (2) a non-qualifiedstock option to purchase 10,000 shares of Group common stock. In lieu of receiving such stock option, a Director could elect to have theCompany make one or more charitable contributions on his or her behalf in a total amount up to $50,000. Mr. Weston alone elected to havethe Company make charitable contributions on his behalf of $50,000. The restricted stock awards have a value based on the fair market valueof the common stock on the effective grant date and vested immediately. The options have an exercise price of $6.82 per share, have a termof 10 years and become exercisable and vest in two equal installments in December 2004 and December 2005. If a Director ceases to serveas a Director for any reason, other than removal for cause, any options vested at the time of termination of his or her services will remainexercisable for 90 days (but no longer than the 10 year term of the options). Our Board of Directors has also approved the following to be paid as compensation to all eligible Directors for their services in 2005: (1) acash retainer of $30,000 and (2) a non-qualified stock option to purchase 10,000 shares of Group common stock. Upon grant, the options willhave an exercise price to be determined at the time of grant, have a term of 10 years and become exercisable and vest in equal installmentsover a two year period. If a Director ceases to serve as a Director for any reason, other than removal for cause, any options vested at the timeof termination of his or her services will25remain exercisable for 90 days (but no longer than the 10 year term of the options). In addition, the Chairman of the Audit Committee willreceive additional cash compensation of $10,000 for his services on such Committee. Directors who are our employees or representatives ofTexas Pacific Group are not entitled to receive any compensation for their services.Code of Ethics and Business Practices We have a Code of Ethics and Business Practices that applies to all of our Directors and employees, including to our chief executiveofficer, chief financial officer, controller and our other senior financial officers. A copy of the Code is filed as an exhibit to this Annual Report onForm 10-K and is available free of charge upon written request to the Corporate Secretary, J.Crew Group, Inc., 770 Broadway, New York, NY10003.ITEM 11. EXECUTIVE COMPENSATION The following table sets forth compensation paid by Group for fiscal 2004, 2003 and 2002:•to our chief executive officer during fiscal 2004 and •to each of the four other most highly compensated executive officers as of the end of fiscal 2004 Long-Term Compensation Annual Compensation Awards Payouts Name And PrincipalPosition FiscalYear Salary($) Bonus($) Other($)(l) RestrictedStockAward(s)(a) Numbers of SecuritiesUnderlyingOptions/SARS(a) LTIPPayouts($) All OtherCompensation($)(b)Millard DrexlerChief Executive Officerand Chairman 200420032002 200,000200,000— ——— 484,500500,000— (c)(c)(c) 25,000—2,231,704(d)——— ———Jeffrey PfeiflePresident 200420032002 760,000760,000— 500,0002,400,000—(e)——— (f)(f)(f) ——390,548(g)800,000400,000— 8,200——Roxane Al-FayezExecutive Vice-President, Catalog & e-Commerce 20042003 377,900115,400 275,000100,000(h)(h)83,800 (i)(i) 10,00035,000 —— 1,700—Tracy GardnerExecutive Vice-President,Merchandising,Planning & Production 2004 398,100 450,000(j)95,500 (k) 90,000 — —Scott HyattSenior Vice President,Manufacturing 200420032002 375,000364,000364,000 160,000—— ——— ——— 10,000—— ——— 8,20010,5009,700(a)There is no established public market for shares of Group common stock. Holders of restricted stock have the same right to receivedividends as other holders of Group common stock. Group has not paid any cash dividends on its common stock. Based oncustomary corporate valuation techniques, including an analysis of the discounted value of Group's potential earnings and cash flow,the valuation of comparable companies and current book value per share, the value of a share of Group common stock was estimatedto be less than $1 as of January 1, 2003. The Company believes that the value is not materially different as of November 2004.26 As of April 1, 2005, the named executive officers held the following aggregate number of restricted shares of Group common stock:Mr. Drexler—463,278 vested shares (of which 55,793 shares are held by a corporation of which Mr. Drexler is a principal) and 476,507unvested shares; Mr. Pfeifle—80,900 vested shares and 105,898 unvested shares; Ms. Al-Fayez—6,250 vested shares and 28,750unvested shares; Ms. Gardner—0 vested shares and 50,000 unvested shares. Mr. Hyatt did not hold any restricted shares of Group commonstock.(b)All amounts represent contributions made by Group on behalf of the named executive officers to its 401(k) plan. (c)In November 2004, Mr. Drexler was granted 75,000 shares of Group common stock, of which 50% will vest on each of November 1,2007 and November 1, 2008. In September 2003, Mr. Drexler was granted 83,689 shares of Group common stock, of which 5,976 shares vested immediately upongrant, 19,429 shares vested on January 27, 2004, and 19,428 shares vested on January 27, 2005, and the remainder will vest in equalannual installments on January 27, 2006 and 2007. In February 2003, Mr. Drexler was granted 725,303 shares of Group common stock, of which 181,326 shares vested on January 27,2004 and 181,325 shares vested on January 27, 2005, and the remainder will vest in equal annual installments on January 27, 2006 and2007. Mr. Drexler paid $800,000 to Group for these shares, which was in excess of their fair market value at the time of grant. A corporationof which Mr. Drexler is a principal was also granted 55,793 shares of Group common stock, all of which vested immediately upon grant.(d)This does not include the grant of certain replacement stock options to Mr. Drexler in May 2004 following the surrender by Mr. Drexlerof the same number of stock options in September 2003. We refer you to "Employment Agreements and Other CompensationArrangements—Employment and Other Agreements" for information on the repricing of Mr. Drexler's premium stock options. (e)This amount represents a $2,000,000 sign-on bonus and a $400,000 guaranteed annual bonus for fiscal 2003. (f)In November 2004, Mr. Pfeifle was granted 25,000 shares of Group common stock, of which 50% will vest on each of November 1,2007 and November 1, 2008. In September 2003, Mr. Pfeifle was also granted 50,213 shares of Group common stock, of which 12,554 shares vested on February 1,2004 and 12,553 shares vested on February 1, 2005, and the remainder will vest in equal annual installments on February 1, 2006 and2007. In February 2003, Mr. Pfeifle was granted 111,585 shares of Group common stock, of which 27,897 shares vested on February 1, 2004and 27,896 shares vested on February 1, 2005, and the remainder will vest in equal annual installments on February 1, 2006 and 2007.(g)This does not include the grant of certain replacement stock options to Mr. Pfeifle in May 2004 following the surrender by Mr. Pfeifle ofthe same number of stock options in September 2003. We refer you to "Employment Agreements and Other CompensationArrangements—Employment and Other Agreements" for information on the repricing of Mr. Pfeifle's premium stock options. (h)In fiscal 2004, this amount represents a $25,000 one-time bonus paid in October 2004 and a $250,000 annual bonus for fiscal 2004.In fiscal 2003, this amount represents a $50,000 sign-on bonus and a $50,000 guaranteed annual bonus for fiscal 2003. (i)In November 2004, Ms. Al-Fayez was also granted 10,000 shares of Group common stock, of which 50% will vest on each ofNovember 1, 2007 and November 1, 2008.27 In October 2003, Ms. Al-Fayez was granted 25,000 shares of Group common stock, of which 6,250 shares vested on October 22, 2004and the remainder will vest in equal annual installments on October 22, 2005, 2006 and 2007.(j)This amount represents a $150,000 sign-on bonus and $300,000 annual bonus for fiscal 2004. (k)In May 2004, Ms. Gardner was granted 50,000 shares of Group common stock, which will vest in equal annual installments onApril 1, 2006, 2007, 2008 and 2009. (l)We have reimbursed Mr. Drexler for our use for corporate business of a private aircraft owned by a company of which Mr. Drexler is aprincipal. The total reimbursements paid for our use of the aircraft in fiscal 2004 was approximately $225,600. The totalreimbursements paid for our use for corporate business of the aircraft and certain third party aircraft charters in fiscal 2003, which wasnot assessed and paid until 2004, was approximately $49,300. All other amounts represent the reimbursement of certain businessexpenses to Mr. Drexler in accordance with the terms of his services agreement. For Ms. Al-Fayez and Ms. Gardner, this includes $83,800 in housing allowances and commuting reimbursements and $95,500 inrelocation compensation, respectively, in fiscal 2004. These include applicable tax gross-up amounts.Option Grants in Last Fiscal Year The following table shows information concerning stock options to purchase shares of Group common stock granted to any of thenamed executive officers during fiscal 2004. Individual Grants Potential Realizable Value atAssumed Annual Rates of StockPrice Appreciation for OptionTerm(b) Number ofSecuritiesUnderlyingOptions Granted(a) Percent of TotalOptions Grantedto Employees inFiscal Year(a) Name ExercisePrice ($/Sh) Expiration Date 5% ($) 10% ($) Millard Drexler 25,000 4%$6.82 2014 0(b)0(b)Roxane Al-Fayez 10,000 2%$6.82 2014 0(b)0(b)Tracy Gardner 50,000 9%$6.82 2014 0(b)0(b)Scott Hyatt 10,000 2%$6.82 2014 0(b)0(b)Jeffrey Pfeifle — — — — — — (a)Group has not granted any SARs. In addition, these figures do not reflect the grants of certain replacement stock options toMessrs. Drexler and Pfeifle in May 2004 following the surrender by them of the same number of stock options in September 2003.We refer you to "Employment Agreements and Other Compensation Arrangements—Employment and Other Agreements" forinformation on the repricing of Messrs. Drexler and Pfeifle's stock options. (b)There is no established public market for shares of Group common stock. Based on customary corporate valuation techniques,including an analysis of the discounted value of Group's potential earnings and cash flow, the valuation of comparable companies andcurrent book value per share, the value of a share of Group common stock was estimated to be less than $1 as of January 1, 2003.The Company believes that the value not materially different as of November 2004. As such, all outstanding options had exerciseprices that exceeded the value of the stock as of such date, and the potential realizable value and value of unexercised in-the-moneyoptions is shown as zero.28Aggregated Option Exercises in Last Fiscal Year and Fiscal Year End Option Values The following table shows the number of stock options held to purchase shares of Group common stock by the named executive officersof Group at the end of fiscal 2004. The named executive officers did not exercise any stock options in fiscal 2004.Name Shares Acquiredon Exercise(#) Value Realized(#) Number of Securities UnderlyingUnexercised Options atFiscal Year EndExercisable/Unexercisable Value of UnexercisedIn-the-Money Options at Fiscal YearEnd($)(a)Exercisable/UnexercisableMillard Drexler(b) 0 557,928/1,698,776 0/0Roxane Al-Fayez 0 8,750/36,250 0/0Tracy Gardner 0 0/90,000 0/0Scott Hyatt 0 31,000/14,000 0/0Jeffrey Pfeifle(b) 0 0/390,548 0/0(a)There is no established public market for shares of Group common stock. Based on customary corporate valuation techniques,including an analysis of the discounted value of Group's potential earnings and cash flow, the valuation of comparable companies andcurrent book value per share, the value of a share of Group common stock was estimated to be less than $1 as of January 1, 2003.The Company believes that the value is not materially different as of November 2004. As such, all outstanding options had exerciseprices that exceeded the value of the stock as of such date, and the potential realizable value and value of unexercised in-the-moneyoptions is shown as zero. (b)On February 1, 2005, Mr. Pfeifle also vested in options to purchase 97,639 shares of Group common stock. In addition, we refer youto "Employment Agreements and other Compensation Arrangements—Employment and Other Agreements" for information on thegrant of certain replacement stock options to Messrs. Drexler and Pfeifle in May 2004 following the surrender by them of the samenumber of stock options in September 2003.Long Term Incentive Plan The following table shows the eligibility of our President to receive long-term incentive compensation pursuant to our employmentagreement with him. Under this arrangement, Mr. Pfeifle received a payment of $400,000 at the end of fiscal 2003 and an additional paymentof $800,000 at the end of fiscal 2004, which constituted the maximum payout under the arrangement. Mr. Pfeifle is not entitled to receive anyfuture payouts of long-term incentive compensation pursuant to our employment agreement with him. We refer you to "EmploymentAgreements and Other Compensation Arrangements—Employment Agreements" for information on this compensation arrangement andpayout schedule.Long Term Incentive Plan/Awards in Last Fiscal Year Estimated Future Payouts under Non-Stock-Price-Based PlansName Number of Shares,Units or OtherRights(#) Performance orOther Period UntilMaturation or Payout Threshold($ or #) Target($ or #) Maximum($ or #)Jeffrey Pfeifle $800,000 1/31/03–4/30/05 — — —29Employment Agreements and Other Compensation ArrangementsEmployment and Other Agreements Millard Drexler. Mr. Drexler has a services agreement with the Company pursuant to which he will serve as Chief Executive Officerfor five years beginning on January 27, 2003, provided that Mr. Drexler can step down as Chief Executive Officer after January 2006 andserve only as Executive Chairman. The agreement provides for a minimum annual base salary of $200,000, an annual bonus based on theachievement of earnings objectives to be determined each year, and reimbursement of business expenses, provided that such totalcompensation not exceed $700,000 per year. The agreement also provides for (i) the grant of options to purchase 557,926 shares of Groupcommon stock at an exercise price equal to $6.82 per share, which we refer to as initial options, and (ii) the grant of premium options topurchase an additional 836,889 shares at an exercise price equal to $25.00 per share and 836,889 shares at an exercise price equal to$35.00 per share, which we refer to as premium options. The initial options and the premium options vest in equal annual installments overfour years commencing on the second anniversary of the grant date. The agreement also provides for the grant of 55,793 immediately vestedshares of Group common stock and the grant of 725,303 shares of Group common stock, which we refer to as the Drexler RestrictedShares. Mr. Drexler paid Group $200,000 for the initial options and $800,000 for the Drexler Restricted Shares. Under the agreement,Mr. Drexler is subject to customary non-solicitation, non-compete and confidentiality covenants. Pursuant to the agreement, if Mr. Drexler's employment is terminated without "cause" or for "good reason" (each as defined in theservices agreement), Mr. Drexler will be entitled to receive his base salary for one year, the immediate vesting of any unvested DrexlerRestricted Shares and the immediate vesting of that portion of the initial options and the premium options that would have become vestedand exercisable on the anniversary of the grant date immediately following the termination date. If such termination occurs after a "change incontrol" (as defined in the services agreement), all of the unvested initial options and premium options will immediately vest and becomeexercisable. In September 2003, Mr. Drexler surrendered all of his premium options to the Company. In consideration of the surrender, we granted toMr. Drexler replacement premium options in May 2004 as follows: options to purchase 836,889 shares at an exercise price equal to $15.00per share and options to purchase an additional 836,889 shares at an exercise price equal to $25.00 per share. The replacement premiumoptions have the same vesting schedule and other terms and conditions as the surrendered premium options. This option repricing wasapproved by a majority of the Board of Directors. We refer you to footnote (c) to the Executive Compensation Table for information on the Drexler Restricted Shares and vesting thereof. Roxane Al-Fayez. Ms. Al-Fayez has an offer letter, dated September 15, 2003, pursuant to which she will serve as Executive Vice-President of Direct Operations. The letter provides for an annual base salary of $375,000, a one-time sign-bonus of $50,000 payable after herstart date and a one-time bonus of $50,000 payable in October 2004, and an annual bonus based on the achievement of earnings objectivesand individual performance goals to be determined each year, provided that the minimum bonus payable for fiscal year 2003 would be$50,000. The agreement also provides for (i) the grant of options to purchase 50,000 shares of Group common stock, which we refer to asinitial options, and (ii) the grant of 25,000 shares of Group common stock, which we refer to as the Al-Fayez Restricted Shares. The initialoptions have an exercise price of $6.82 per share and vest in equal annual installments over four years commencing on the first anniversaryof the grant date. Ms. Al-Fayez received relocation benefits and also receives a monthly housing allowance of $3,000 and reimbursement forcertain commuting expenses.30 We refer you to footnote (i) to the Executive Compensation Table for information on the Al-Fayez Restricted Shares and vesting thereof. Tracy Gardner. Ms. Gardner has an employment agreement with the Company pursuant to which she will serve as Executive Vice-President, Merchandising, Planning and Production for four years beginning in March 2004, subject to renewal upon mutual agreement.The agreement provides for a minimum annual base salary of $450,000, a one-time sign-on bonus of $100,000, and an annual bonus basedon the achievement of earnings objectives and individual performance goals to be determined each year, provided that the minimum bonuspayable for fiscal year 2004 would be $112,500. The agreement also provides for (i) the grant of options to purchase 50,000 shares of Groupcommon stock at an exercise price equal to $6.82 per share, which we refer to as initial options, and (ii) the grant of premium options topurchase an additional 20,000 shares of Group common stock at an exercise price equal to $15.00 per share and 20,000 shares of Groupcommon stock at an exercise price equal to $25.00 per share, which we refer to as premium options. The agreement also provides for thegrant in March 2005 of (x) an additional option to purchase 20,000 shares of Group common stock at an exercise price equal to $15.00 pershare and (y) an additional option to purchase 20,000 shares of Group common stock at an exercise price equal to $25.00 per share, whichwe refer to as the additional premium options. The initial options vest in equal annual installments over four years commencing on the firstanniversary of the grant date. The premium options and the additional premium options vest in equal installments over four yearscommencing on the second anniversary of their respective grant dates. The agreement also provides for the grant of 50,000 shares of Groupcommon stock, which we refer to as the Gardner Restricted Shares. Ms. Gardner also received relocation benefits in connection with herrelocation to the New York area. Under the agreement, Ms. Gardner is subject to customary non-solicitation, non-compete and confidentialitycovenants. We refer you to footnote (k) to the Executive Compensation Table for information on the vesting of the Gardner Restricted Shares andvesting thereof. Pursuant to the agreement, if Ms. Gardner's employment is terminated without "cause" or for "good reason" (each as defined in theemployment agreement), Ms. Gardner will be entitled to receive her base salary for one year and a pro-rated amount of any bonus that shewould have otherwise received for the fiscal year ending before the termination date. However, Ms. Gardner's right to the continuation of herbase salary for one year will terminate upon the date that she becomes employed by a new employer or otherwise begins providing servicesfor another entity, provided that if the cash compensation she receives pursuant thereto is less than her base salary in effect immediatelyprior to her termination date, she will be entitled to receive such incremental amount during the remainder of the severance period. Jeffrey Pfeifle. Mr. Pfeifle has an employment agreement with the Company pursuant to which he will serve as President for fiveyears beginning on February 1, 2003, subject to automatic one-year renewals. The agreement provides for a minimum annual base salary of$760,000, one-time bonuses in the total amount of $2,000,000 payable after his commencement date, an annual bonus based on theachievement of earnings objectives to be determined each year provided that the minimum bonus payable for fiscal year 2003 would be$400,000, a long-term cash incentive payment between $800,000 and $1,200,000 based on the achievement of performance objectives to bedetermined each year payable in installments at the end of fiscal years 2003 and 2004, and reimbursement of business expenses. Theagreement also provides for (i) the grant of options to purchase 167,378 shares of Group common stock at an exercise price equal to $6.82per share, which we refer to as initial options, and (ii) the grant of premium options to purchase an additional 111,585 shares at an exerciseprice equal to $25.00 per share and 111,585 shares at an exercise price equal to $35.00 per share, which we refer to as premium options. Theinitial options and the premium options vest in equal annual installments over four years commencing on the second anniversary of thegrant date. The agreement also provides for the grant of 111,585 shares of Group common stock, which we refer to as the Pfeifle RestrictedShares.31Under the agreement, Mr. Pfeifle is subject to customary non-solicitation, non-compete and confidentiality covenants. Pursuant to the agreement, if Mr. Pfeifle's employment is terminated without "cause" or for "good reason" (each as defined in theemployment agreement), Mr. Pfeifle will be entitled to receive his base salary for two years, a pro-rated amount of any bonus that he wouldhave otherwise received for the fiscal year ending before the termination date, and the immediate vesting of that portion of the initial options,premium options and Pfeifle Restricted Shares that would have become vested and exercisable on the anniversary of the grant dateimmediately following the termination date. If such termination occurs after a "change in control" (as defined in the services agreement) orwithin six months before a "change in control" if in contemplation thereof, all of the unvested initial options, premium options and PfeifleRestricted Shares will immediately vest and become exercisable. If such termination occurs before February 1, 2006, Mr. Pfeifle is entitled toreceive a minimum of $2,000,000 in the form of cash severance compensation. In September 2003, Mr. Pfeifle received surrendered all of his premium options to the Company. In consideration of the surrender, wegranted to Mr. Pfeifle replacement premium options in May 2004 as follows: options to purchase 111,585 shares at an exercise price equal to$15.00 per share and options to purchase an additional 111,585 shares at an exercise price equal to $25.00 per share. The replacementpremium options have the same vesting schedule and other terms and conditions as the surrendered premium options. This option repricingwas approved by a majority of the Board of Directors. We refer you to footnote (f) to the Executive Compensation Table for information on the Pfeifle Restricted Shares and the vesting thereof.Company Bonus Plan On April 12, 2005, the Compensation Committee of the Company's Board of Directors approved the financial goals under the J.CrewGroup, Inc. bonus plan for fiscal 2005 (2005 Plan) for the annual cash bonus awards payable to our eligible employees participating in the2005 Plan with respect to fiscal year 2005, including Messrs. Drexler, Hyatt and Pfeifle and Mss. Al-Fayez and Gardner. The fiscal 2005bonuses payable under the 2005 Plan will be based on to the extent to which we meet or exceed specific financial goals established by theCompensation Committee and individual performance assessments as determined in the our discretion. For Messrs. Drexler, Hyatt andPfeifle and Mss. Al-Fayez and Gardner, the amount of the actual bonus award could range from zero to 100% of his or her annual basesalary, with targets ranging from 35% to 50% of his or her annual base salary.Executive Severance Arrangements Mr. Hyatt has an agreement with the Company which provides that, in the event of a termination without "cause" (as defined in theagreement), he will receive a continuation of his base salary and medical benefits for a period of one year after the termination date and thepayment of any bonus that he would otherwise have received for the fiscal year ending before the termination date.Shareholders Agreements The Drexler Restricted Shares, the Pfeifle Restricted Shares, the Al-Fayez Restricted Shares, the Gardner Restricted Shares and anyshares of Group common stock acquired by any of the named executive officers described above pursuant to the exercise of options aresubject to a shareholders' agreement providing for certain transfer restrictions, registration rights and customary tag-along and drag-alongrights.32 In addition, Mr. Drexler's shareholders' agreement provides him with certain rights to appoint three directors by himself and threeadditional directors by mutual agreement with Texas Pacific Group, right to consent to our operating/capital budgets and certain anti-dilutionand co-investment rights.Compensation Committee Interlocks and Insider Participation In fiscal 2004, the members of our Compensation Committee were Messrs. Coulter (Chairman) and Sloan and Ms. Woods. Ms. Woodsis a former Chairman, former Chief Executive Officer and former Vice-Chairman of the Company.ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth information regarding the beneficial ownership of the common stock of Group as of April 1, 2005 for eachperson who is known to the Company to be the beneficial owner of 5% or more of Group common stock. The holders listed have sole votingpower and investment power over the shares held by them, except as indicated by the notes following the table.Title of Class Name and address ofBeneficial Owner Amount and Nature of BeneficialOwnership Percentof Class Common stock TPG Partners II, L.P.301 Commerce Street,Suite 3300Fort Worth, TX 76102 8,932,291 shares(a)(d)51%Common stock Emily WoodsJ. Crew Group, Inc.770 BroadwayNew York, NY 10003 2,767,377 shares(b)16%Common stock Millard S. DrexlerJ. Crew Group, Inc.770 BroadwayNew York, NY 10003 2,639,700 shares(c)15%(a)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. (b)Includes 497,200 shares not currently owned but which are issuable upon the exercise of stock options awarded under our stockoption plan that are currently exercisable. (c)Includes (i) 200,755 shares owned by Mr. Drexler; (ii) 262,524 restricted shares beneficially owned by a family trust of whichMr. Drexler is a trustee; (iii) 557,928 shares not currently owned but which are issuable upon the exercise of stock options awardedunder our stock option plan that are currently exercisable; and (iv) 1,618,494 shares not currently owned but which are issuable toMr. Drexler's company upon his exercise of a right to exchange a loan made to the Company into shares of Group common stock atan exercise price equal to $6.82 per share anytime prior to its maturity date in 2008. We refer you to "Certain Relationships andRelated Transactions—TPG-MD Investment Notes Payable" for more information. (d)Includes 1,618,494 shares not currently owned but which are issuable to TPG Bacchus II, LLC upon its exercise of a right toexchange a loan made to the Company into shares of Group common stock at an exercise price equal to $6.82 per share anytimeprior to its maturity date in 2008. We refer you to "Certain Relationships and Related Transactions—TPG-MD Investment NotesPayable" for more information.33 The following table sets forth information regarding the beneficial ownership of each class of equity securities of Group as of April 1,2005 for (a) each director, (b) each of the named executive officers and (c) all directors and executive officers as a group. The holders listed have sole voting power and investment power over the shares held by them, except as indicated by the notesfollowing the table.Title of Class Name of Beneficial Owner Amount and Nature ofBeneficial Ownership Percent ofClass Common stock Richard Boyce 55,200(a)* Common stock Jonathan Coslet 8,932,211(b)51%Common stock James Coulter 8,932,211(b)51%Common stock Steven Grand-Jean 12,500(c)* Common stock Thomas Scott 12,500(c)* Common stock Stuart Sloan 12,500(c)* Common stock Josh Weston 32,978(d)* Common stock Emily Woods 2,767,377(e)16%Common stock Millard Drexler 2,639,700(f)15%Common stock Roxane Al-Fayez 15,000(g)* Common stock Tracy Gardner 0 * Common stock Scott Hyatt 31,000(a)* Common stock Jeffrey Pfeifle 178,539(h)1%Common stock All directors and executive officers as a group 14,689,505 84%Series A preferred stock Jonathan Coslet 73,475(b)79%Series A preferred stock James Coulter 73,475(b)79%Series A preferred stock Josh Weston 60 * Series A preferred stock Emily Woods 2,979 3%Series A preferred stock All directors and executive officers as a group 76,514 83% *Represents less than 1% of the class. (a)These are shares not currently owned but which are issuable upon the exercise of stock options awarded under our stock option planthat are currently exercisable or become exercisable within 60 days. (b)Attributes ownership of the shares beneficially owned by TPG Affiliates to Messrs. Coslet and Coulter, who are partners of TexasPacific Group. Includes 1,618,494 shares not currently owned but which are issuable to TPG Bacchus II, LLC upon the exercise of aright to exchange a loan made to the Company into shares of Group common stock at an exercise price equal to $6.82 per shareanytime prior to its maturity date in 2008. We refer you to "Certain Relationships and34Related Transactions—TPG-MD Investment Notes Payable" for more information. Messrs. Coslet and Coulter disclaim beneficialownership of the shares owned by TPG Affiliates.(c)Includes 7,500 shares not currently owned but which are issuable upon the exercise of stock options awarded under our stock optionplan that are currently exercisable or become exercisable within 60 days. (d)Includes 2,500 shares not currently owned by which are issuable upon the exercise of stock options awarded under our stock optionplan that are currently exercisable or become exercisable within 60 days. (e)Includes 497,200 shares not currently owned but which are issuable upon the exercise of stock options awarded under our stockoption plan that are currently exercisable or become exercisable within 60 days. (f)Includes (i) 200,755 shares owned by Mr. Drexler; (ii) 262,524 shares beneficially owned by a family trust of which Mr. Drexler is atrustee; (iii) 557,928 shares not currently owned but which are issuable upon the exercise of stock options awarded under our stockoption plan that are currently exercisable or become exercisable within 60 days; and (iv) 1,618,494 shares not currently owned butwhich are issuable to Mr. Drexler's company upon his exercise of a right to exchange a loan made to the Company into shares ofGroup common stock at an exercise price equal to $6.82 per share anytime prior to its maturity date in 2008. We refer you to "CertainRelationships and Related Transactions—TPG-MD Investment Notes Payable" for more information. (g)Includes 8,750 shares not currently owned but which are issuable upon the exercise of stock options awarded under our stock optionplan that are currently exercisable or become exercisable within 60 days. (h)Includes 97,639 shares not currently owned but which are issuable upon the exercise of stock options awarded under our stock optionplan that are currently exercisable or become exercisable within 60 days. We know of no arrangements, including any pledge by any person of our securities, the operation of which may at a subsequent dateresult in a change in control of the Company.ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Tax Sharing Arrangement Group and its subsidiaries entered into a tax sharing agreement providing (among other things) that each of the subsidiaries willreimburse Group for its share of income taxes determined as if such subsidiary had filed its tax returns on a "separate return" basis.TPG-MD Investment Notes Payable On February 4, 2003, Operating entered into a credit agreement with TPG-MD Investment, LLC, an entity controlled by Texas PacificGroup, our majority shareholder, and Millard Drexler, our Chief Executive Officer and Chairman of the Board, which provides for:•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 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.The loans are guaranteed by certain subsidiaries of Operating.35 The lender has the right, exercisable at anytime prior to the maturity date, to exchange the principal amount of and accrued and unpaidinterest on the loans into shares of common stock of Group at an exercise price of $6.82 per share. The lender also has the right to requireOperating to prepay the Tranche B loan without premium or penalty under certain circumstances. In November 2004, the credit agreement with TPG-MD Investment, LLC was amended to subordinate the Tranche A loan in right ofpayment to Operating's 93/4% Senior Subordinated Notes due 2014 while the Tranche B loan is pari passu in right of payment with suchnotes. Under the terms of TPG-MD Investment, LLC's operating agreement, the distributions payable to Mr. Drexler under this creditagreement go directly to MDJC LLC, an entity whose sole members are Mr. Drexler and Grand-Jean Capital Management, which in turn isowned by Steven Grand-Jean, a Director of the Company. As payment for certain financial advisory services that Mr. Grand-Jean rendered toMr. Drexler and pursuant to MDJC LLC's operating agreement, Mr. Grand-Jean is entitled to distributions under certain circumstances fromhis equity interest in MDJC LLC.University Village Lease Stuart Sloan, a Director, is the President of UV, Inc., which is the general partner of University Village Limited Partnership, the ownerand operator of University Village Shopping Center in Seattle, Washington. On October 14, 2003, we entered into a lease agreement withUniversity Village Limited Partnership with respect to the lease of 7,400 square feet at the University Village Shopping Center for theoperation of one of our retail stores. The term of the lease is 10 years. We received an allowance for tenant's improvements in the amount of$450,000 from University Village Limited Partnership. Annual rent due under the lease is comprised of (i) base rent payment of $296,000 foryears one through five and $320,000 for years six through ten and (ii) contingent rent payment based on the store's sales in excess of aspecified threshold. The lease also requires us to pay real estate taxes, insurance and certain common area costs. We believe that the leasecontains terms reached pursuant to arms-length negotiations. Mr. Sloan's sons are the beneficiaries of trusts that are limited partners ofUniversity Village Limited Partnership.Plum TV Sponsorship Agreement Thomas Scott, a Director, is a founding partner, Chief Executive Officer and Executive Co-Chairman of Plum TV, LLC, a televisionstation network operating in select resort markets. In May 2004, we entered into a sponsorship agreement with Plum TV pursuant to whichPlum TV provided us with airtime on its network to televise commercials. The term of the agreement is one year and is scheduled to expireon May 31, 2005, although we currently plan to extend this arrangement. In fiscal 2004, we paid Plum TV, LLC a total amount of $275,000,which we believe is the fair market value of the services provided. Emily Woods, also a Director, is married to Mr. Scott.ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES Audit Fees. The aggregate fees billed to us by the independent registered public accounting firm, KPMG LLP, for professional servicesrendered in connection with the audit of our financial statements included in this Annual Report on Form 10-K for fiscal 2004, and for reviewof our statements included in our Quarterly Reports on Form 10-Q during fiscal 2004, totaled approximately $740,000. The aggregate feesbilled to us by KPMG for professional services rendered in connection with the audit of our financial statements included in our AnnualReport on Form 10-K for fiscal 2003, and for the review of our financial statements included in our Quarterly Reports on Form 10-Q duringfiscal 2003, totaled approximately $668,350. Audit-Related Fees. The aggregate fees billed to us by KPMG for assurance and related services that are reasonably related to theperformance of the audit and review of our financial statements that36are not already reported in the paragraph immediately above totaled approximately $279,300 for fiscal 2003. These costs primarily related toservices provided in connection with our exchange offer of outstanding 131/8% Senior Discount Debentures for 16% Senior DiscountContingent Principal Notes, which was completed in May 2003. There were no audit-related fees in fiscal 2004. Pre-Approval Policy. The Audit Committee has established policies on the pre-approval of audit and other services that theindependent auditor may perform for the Company. The Committee must pre-approve the annual audit fees payable to the independentauditor on an annual basis. The Committee must also approve on a case-by-case basis their engagement for any other work to be performedfor the Company that is not an integral component of the audit services as well as the compensation payable to the independent auditortherefore.PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a)1. Financial StatementsThe following financial statements are included in Item 8:(i)Report of KPMG LLP, Independent Registered Public Accounting FirmJ. Crew Group, Inc. and subsidiaries(ii)Consolidated Balance Sheets as of January 29, 2005 and January 31, 2004 (iii)Consolidated Statements of Operations—Years ended January 29, 2005, January 31, 2004 and February 1, 2003 (iv)Consolidated Statements of Changes in Stockholders' Deficit—Years ended January 29, 2005, January 31, 2004 andFebruary 1, 2003 (v)Consolidated Statements of Cash Flows—Years ended January 29, 2005, January 31, 2004 and February 1, 2003J. Crew Operating and subsidiaries(vi)Consolidated Balance Sheets as of January 29, 2005 and January 31, 2004 (vii)Consolidated Statements of Operations—Years ended January 29, 2005, January 31, 2004 and February 1, 2003 (xii)Consolidated Statements of Changes in Stockholder's Deficit/Equity—Years ended January 29, 2005, January 31,2004 and February 1, 2003 (xiii)Consolidated Statements of Cash Flows—Years ended January 29, 2005, January 31, 2004 and February 1, 2003Notes to consolidated financial statements2. Financial Statement SchedulesSchedule II Valuation and Qualifying Accounts.3. ExhibitsThe exhibits listed on the accompanying Exhibit Index are incorporated by reference herein and filed as part of this report.(b)Reports on Form 8-K37The Company filed the following reports on Form 8-K during the quarter ended January 29, 2005:Current Report on Form 8-K was filed on November 23, 2004 relating to the Company's entry into a new Senior SubordinatedLoan Agreement with entities managed by Black Canyon Capital LLC and Canyon Capital Advisors LLC (Black Canyon LoanAgreement) and the Company's announced redemption in full of its 103/8% senior subordinated notes and redemption in partof its 16% senior discount contingent principal notes (Redemption).Current Report on Form 8-K was filed on December 1, 2004 relating to the Company's entry into a commitment letter withWachovia Bank, N.A. and Congress Financial Corporation to refinance its existing working capital credit facility.Current Report on Form 8-K was filed on December 9, 2004 relating to the Company's financial results for the period endedOctober 30, 2004.Current Report on Form 8-K was filed on December 23, 2004 relating to the Company's announced redemption of itsremaining 16% senior discount contingent principal notes (Second Redemption).Current Report on Form 8-K was filed on December 28, 2004 relating to the Company's borrowing under the Black CanyonLoan Agreement, entry into related agreements, entry into the Amended Wachovia Credit Facility and the consummation ofthe Redemption.Current Report on Form 8-K was filed on January 24, 2005 relating to the consummation of the Second Redemption.(c)Exhibit Index38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 RegistrationStatement on Form S-4, File No. 333-42427, filed December 16, 1997 (Group Registration Statement).3.2 By-laws of J. Crew Group, Inc., as amended. Incorporated by reference to Exhibit 3.2 to the Form 10-K for the fiscal yearended 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 theRegistration Statement on Form S-4, File No. 333-4243, filed December 16, 1997 (Operating Registration Statement).3.4 By-laws of J. Crew Operating Corp., as amended. Incorporated by reference to Exhibit 3 to the Form 10-Q for the periodended 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 J. Crew Group, Inc., Donaldson, Lufkin &Jenrette Securities Corporation and Chase Securities Inc. Incorporated by reference to Exhibit 4.10 to the Group RegistrationStatement.4.4 Stockholders' Agreement, dated as of October 17, 1997, between J. Crew Group, Inc. and the Stockholder signatoriesthereto. Incorporated by reference to Exhibit 4.1 to the Group Registration Statement.4.5(a)Stockholders' Agreement, dated as of October 17, 1997, among J. Crew Group, Inc., TPG Partners II, L.P. and EmilyWoods. 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 J. Crew Group, Inc., TPG Partners II, L.P.and Emily Woods. Incorporated by reference to Exhibit 4.1 of the Form 8-K filed on February 7, 2003.4.6 Stockholders' Agreement, dated as of September 9, 2002, between J. Crew Group, Inc., TPG Partners II, L.P. and KennethPilot. Incorporated by reference to Exhibit 4.6 to the Form 10-K for fiscal year ended February 1, 2003.4.7 Stockholders' Agreement, dated as of January 24, 2003, among J. Crew Group, Inc., TPG Partners II, L.P. and MillardDrexler. Incorporated by reference to Exhibit 4.1 of the Form 8-K filed on February 3, 2003.4.8 Stockholders' Agreement, dated as of February 20, 2003, among J. Crew Group, Inc., TPG Partners II, L.P. and JeffreyPfeifle. Incorporated by reference to Exhibit 4.1 of the Form 8-K filed on February 26, 2003. 394.9 Stockholders' Agreement, dated as of February 12, 2003, among J. Crew Group, Inc., TPG Partners II, L.P. and ScottGilbertson. Incorporated by reference to Exhibit 4.1 of the 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. asGuarantors, Wachovia Bank, National Association as Arranger, Congress Financial Corporation as Administrative andCollateral Agent, and the Lenders. Incorporated by reference to Exhibit 10.1 of the 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 toExhibit 10.1 of the 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 10.1of the Form 8-K filed on April 8, 2003.10.1(d)Amendment No. 3, dated as of November 21, 2004, to the Loan and Security Agreement. Incorporated by reference toExhibit 4.5 of the Form 8-K filed on December 28, 2004.10.1(e)Amended and Restated Loan and Security Agreement, dated as of December 23, 2004, by and among J.Crew Group, Inc.,J. Crew Intermediate LLC, J. Crew Operating Corp. and certain subsidiaries thereof, Wachovia Capital Markets LLC assole lead arranger and sole lead bookrunner, Wachovia Bank, National Association as Arranger, Congress FinancialCorporation as Administrative Agent and Collateral Agent, and the Lenders. Incorporated by reference to Exhibit 4.6 of theForm 8-K filed on December 28, 2004.10.2(a)Credit Agreement, dated as of February 4, 2003, by and between J.Crew Group, Inc., J.Crew Operating Corp., and certainsubsidiaries thereof, and TPG-MD Investment, LLC. Incorporated by reference to Exhibit 10.1 of the Form 8-K filed onFebruary 7, 2003.10.2(b)Amendment No. 1, dated as of November 21, 2004, to the Credit Agreement. Incorporated by reference to Exhibit 4.4 of theForm 8-K filed on December 28, 2004.10.3 Senior Subordinated Loan Agreement, dated as of November 21, 2004, among J. Crew Operating Corp. as Borrower, andcertain subsidiaries of J. Crew Operating Corp. as Guarantors, the Lenders, and U.S. Bank National Association asAdministrative Agent. Incorporated by reference to Exhibit 4.1 of the Form 8-K filed on December 28, 2004.10.4 Security Agreement, dated as of November 21, 2004, among J. Crew Operating Corp., the grantors named therein andU.S. Bank National Association as Collateral Agent. Incorporated by reference to Exhibit 4.2 of the Form 8-K filed onDecember 28, 2004.10.5 Intercreditor Agreement, dated as of November 21, 2004, among J. Crew Operating Corp., J.Crew Intermediate LLC andcertain subsidiaries of J. Crew Operating Corp., Congress Financial Corporation as Senior Credit Agent, and U.S. BankNational Association as Collateral Agent.Management Contracts and Compensatory Plans and Arrangements10.6 Amended and Restated J. Crew Group, Inc. 1997 Stock Option Plan. Incorporated by reference to Exhibit 10.1 to theForm 10-Q for the period ended August 3, 2002. 4010.7(a)J. Crew Group, Inc. 2003 Equity Incentive Plan (the "2003 Plan"). Incorporated by reference to Exhibit 10.4 to the Form 10-K for the fiscal year ended February 1, 2003.10.7(b)Amendment No. 1 to the 2003 Plan. Incorporated by reference to Exhibit 10.4(b) to Form 10-K for the fiscal year endedJanuary 31, 2004.10.8 Separation Agreement, dated April 29, 2002, between the Company and Mark Sarvary. Incorporated by reference toExhibit 10.5(d) to the Form 10-K for the fiscal year ended February 1, 2003.10.9(a)Services Agreement, dated January 24, 2003, between the Company, Millard S. Drexler, Inc. and Millard Drexler.Incorporated by reference to Exhibit 10.9 to the Form 10-K for the fiscal year ended February 1, 2003.10.9(b)Option Surrender Agreement, dated September 25, 2003, between the Company and Millard Drexler. Incorporated byreference to Exhibit 10.9(b) to the Form 10-K for the fiscal year ended January 31, 2004.10.9(c)Stock Option Grant Agreement with respect to certain replacement options, dated as ofMay 12, 2004, between the Company and Millard Drexler. Incorporated by reference to Exhibit 10.1 to Form 10-Q for thequarter ended July 31, 2004.10.10(a)Employment Agreement, dated January 24, 2003, between the Company and Jeffrey Pfeifle. Incorporated by reference toExhibit 10.10 to the Form 10-K for the fiscal year ended February 1, 2003.10.10(b)Option Surrender Agreement, dated September 25, 2003, between the Company and Jeffrey Pfeifle. Incorporated byreference to Exhibit 10.10(b) to the Form 10-K for the fiscal year ended January 31, 2004.10.10(c)Stock Option Grant Agreement with respect to certain replacement options, dated as ofMay 12, 2004, between the Company and Jeffrey Pfeifle. Incorporated by reference to Exhibit 10.2 to Form 10-Q for thequarter ended July 31, 2004.10.11 Separation Agreement, dated January 20, 2004, between the Company and Scott Gilbertson. Incorporated by reference toExhibit 10.11(b) to Form 10-K for the fiscal year ended January 31, 2004.10.12 Form of Executive Severance Agreement between the Company and certain executives thereof. Incorporated by reference toExhibit 10.14 to Form 10-K for the fiscal year ended February 2, 2002.10.13 Employment Agreement, dated January 23, 2004, between the Company and Tracy Gardner. Incorporated by reference toExhibit 10.14 to Form 10-K for the fiscal year ended January 31, 2004.10.14 Separation Agreement, dated December 23, 2003, and letter agreement dated, January 26, 2004, between the Companyand Kathy Boyer. Incorporated by reference to Exhibit 10.15 to Form 10-K for the fiscal year ended January 31, 2004.10.15 Employment Agreement, dated April 10, 2004, between the Company and Amanda Bokman. Incorporated by reference toExhibit 10.16 to Form 10-K for the fiscal year ended January 31, 2004.10.16*Offer letter, dated September 15, 2003, from the Company to Roxane Al-Fayez.10.17*Separation Agreement, dated October 22, 2004, between the Company and Paul Fusco. 4110.18*Lease Agreement, dated October 14, 2004, between a subsidiary of J. Crew Group, Inc. and University Village LimitedPartnership relating to the Company's store in the University Village Shopping Center in Seattle, WA, and Guaranty ofJ. Crew Group, Inc.Other Exhibits14 Code of Ethics and Business Practices of the Company. Incorporated by reference to Exhibit 14 to Form 10-K for the fiscalyear ended January 31, 2004.21.1 Subsidiaries of J. Crew Group, Inc. Incorporated by reference to Exhibit 21.1 to Form 10-K for the fiscal year endedJanuary 31, 2004.23.1*Consent of KPMG LLP, Independent Registered Public Accounting Firm.31.1*Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2*Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1*Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Actof 2002.*Filed herewith42SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, each registrant has duly caused this reportto be signed on its behalf by the undersigned, thereunto duly authorized.Date: April 29, 2005 J. CREW GROUP, INC.J. CREW OPERATING CORP. By:/s/ MILLARD S. DREXLER Millard S. DrexlerChief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons onbehalf of each registrant and in the capacities indicated, on April 29, 2005.Signature Title /s/ MILLARD DREXLER Millard Drexler Chairman of the Board, Chief Executive Officer and a Director (PrincipalExecutive Officer)/s/ AMANDA BOKMAN Amanda Bokman Executive Vice President and Chief Financial Officer (Principal FinancialOfficer)/s/ NICHOLAS LAMBERTI Nicholas Lamberti Vice President and Corporate Controller(Principal Accounting Officer)/s/ RICHARD BOYCE Richard Boyce Director/s/ JONATHAN COSLET Jonathan Coslet Director/s/ JAMES COULTER James Coulter Director/s/ STEVEN GRAND-JEAN Steven Grand-Jean Director 43/s/ THOMAS SCOTT Thomas Scott Director/s/ STUART SLOAN Stuart Sloan Director/s/ JOSH WESTON Josh Weston Director/s/ EMILY WOODS Emily Woods Director44INDEX TO FINANCIAL STATEMENTS Report of KPMG LLP, Independent Registered Public Accounting Firm F-2J. Crew Group, Inc. and subsidiaries: Consolidated Balance Sheets as of January 29, 2005 and January 31, 2004 F-3Consolidated Statements of Operations—Years Ended January 29, 2005, January 31, 2004 and February 1, 2003 F-4Consolidated Statements of Changes in Stockholders' Deficit—Years Ended January 29, 2005, January 31, 2004 andFebruary 1, 2003 F-5Consolidated Statements of Cash Flows—Years Ended January 29, 2005, January 31, 2004 and February 1, 2003 F-6J. Crew Operating Corp. and subsidiaries: Consolidated Balance Sheets as of January 29, 2005 and January 31, 2004 F-7Consolidated Statements of Operations—Years Ended January 29, 2005, January 31, 2004 and February 1, 2003 F-8Consolidated Statements of Changes in Stockholders' Equity (Deficit)—Years Ended January 29, 2005, January 31, 2004 andFebruary 1, 2003 F-9Consolidated Statements of Cash Flows—Years Ended January 29, 2005, January 31, 2004 and February 1, 2003 F-10Notes to Consolidated Financial Statements F-11Financial Statement Schedules: Schedule II—Valuation and Qualifying Accounts—Years Ended January 29, 2005, January 31, 2004 and February 1, 2003 F-27F-1REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors and StockholdersJ. Crew Group Inc, and J. Crew Operating Corp. We have audited the consolidated financial statements of J. Crew Group Inc. ("Group") and J. Crew Operating Corp., a wholly ownedsubsidiary of Group ("Operating") (together referred to as the "Companies") as listed in the accompanying index. In connection with ouraudits of the consolidated financial statements, we also have audited the financial statement schedule listed in the accompanying index.These consolidated financial statements and financial statement schedule are the responsibility of the Companies management. Ourresponsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits. We conducted our audits in accordance with auditing standards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free ofmaterial misstatement. The Companies are not required to have, nor were we engaged to perform, an audit of their internal controls overfinancial reporting. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financialstatements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well asevaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position ofGroup and Operating as of January 29, 2005, and January 31, 2004 and the results of their operations and their cash flows for each of theyears in the three-year period ended January 29, 2005, in conformity with accounting principles generally accepted in the United States ofAmerica. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financialstatements taken as a whole, presents fairly, in all material respects, the information set forth therein. As discussed in Note 6 to the consolidated financial statements, in the third quarter of fiscal 2003, Group adopted Statement of FinancialAccounting Standard No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity". As discussed in Note 2, the Companies restated the consolidated statements of cash flows for the years ended January 31, 2004 andFebruary 1, 2003, to reclassify the proceeds from construction allowances from cash flows from investing activities to cash flows fromoperating activities.KPMG LLPNew York, New YorkApril 4, 2005F-2J.CREW GROUP, INC. ANDSUBSIDIARIES Consolidated Balance Sheets January 29, 2005 January 31, 2004 (in thousands) Assets Current assets: Cash and cash equivalents $23,647 $49,650 Merchandise inventories 88,093 66,028 Prepaid expenses and other current assets 22,217 20,733 Refundable income taxes 9,320 9,320 Total current assets 143,277 145,731 Property and equipment—at cost 259,098 284,945 Less accumulated depreciation and amortization (138,285) (146,565) 120,813 138,380 Other assets 14,104 13,500 Total assets $278,194 $297,611 Liabilities and Stockholders' Deficit Current liabilities: Current portion of long-term debt $— $1,164 Accounts payable 68,569 49,386 Other current liabilities 61,148 47,789 Federal and state income taxes 1,392 1,175 Total current liabilities 131,109 99,514 Deferred credits 59,064 56,723 Long-term debt 576,933 516,640 Preferred stock 92,800 92,800 Stockholders' deficit (581,712) (468,066) Total liabilities and stockholders' deficit $278,194 $297,611 See accompanying notes to consolidated financial statements.F-3J.CREW GROUP, INC. ANDSUBSIDIARIES Consolidated Statements of Operations Years Ended January 29, 2005 January 31, 2004 February 1, 2003 (in thousands) Revenues: Net sales $778,295 $660,628 $732,279 Other 25,921 29,337 36,065 804,216 689,965 768,344 Cost of goods sold, including buying and occupancy costs 478,829 440,276 472,262 Gross profit 325,387 249,689 296,082 Selling, general and administrative expenses 287,745 280,464 301,718 Income/(loss) from operations 37,642 (30,775) (5,636)Interest expense—net 87,571 63,844 40,954 Insurance proceeds — (3,850) (1,800)(Gain)/loss on refinancing of debt (net of expenses of $2,922 in 2003) 49,780 (41,085) — Loss before income taxes (99,709) (49,684) (44,790)Income taxes (provision)/benefit (600) (500) 4,200 Net loss $(100,309)$(50,184)$(40,590) See accompanying notes to consolidated financial statements.F-4J.CREW GROUP, INC. ANDSUBSIDIARIES Consolidated Statements of Changes in Stockholders' Deficit (in thousands, except shares) Common Stock Additionalpaid-incapital Accumulateddeficit Treasurystock Deferredcompensation Stockholders'deficit Shares Amount Balance at February 2, 2002 12,238,189 $122 $70,690 $(387,186)$(2,351)$(318)$(319,043) Net loss — — — (40,590) — — (40,590)Preferred stock dividends — — — (33,578) — — (33,578)Issuance of common stock 12,318 1 283 — — — 284 Issuance of restricted stock 1,109,266 11 1,100 — — (311) 800 Amortization of restrictedstock — — — — — 464 464 Balance at February 1, 2003 13,359,773 134 72,073 (461,354) (2,351) (165) (391,663) Net loss — — — (50,184) — — (50,184)Preferred stock dividends — — — (26,260) — — (26,260)Issuance of restricted stock 224,402 2 163 — — (165) — Amortization of restrictedstock — — — — — 41 41 Forfeiture of restricted stock — — — — (62) 62 — Balance at January 31, 2004 13,584,175 136 72,236 (537,798) (2,413) (227) (468,066) Net loss — — — (100,309) — — (100,309)Preferred stock dividends — — — (13,456) — — (13,456)Issuance of restricted stock 196,000 1 144 — — (145) — Amortization of restrictedstock — — — — — 119 119 Balance at January 29, 2005 13,780,175 $137 $72,380 $(651,563)$(2,413)$(253)$(581,712) See accompanying notes to consolidated financial statements.F-5J.CREW GROUP, INC. ANDSUBSIDIARIES Consolidated Statements of Cash Flows Years Ended January 29,2005 January 31,2004 February 1,2003 (restated) (restated) (in thousands) Cash flows from operating activities: Net loss $(100,309)$(50,184)$(40,590)Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation and amortization 37,061 43,075 43,197 Amortization of deferred financing costs 2,425 2,179 4,435 Non-cash interest expense (including redeemable preferred stockdividends of $33,106 in 2004 and $14,206 in 2003) 63,536 40,991 12,313 Deferred income taxes — 5,000 7,421 Non-cash compensation expense 119 41 (589) (Gain)/loss on refinancing of debt 49,780 (41,085) — Changes in operating assets and liabilities: Merchandise inventories (22,065) 41,290 31,600 Prepaid expenses and other current assets (1,484) 4,153 2,140 Other assets 664 832 (2,470) Accounts payable and other liabilities 28,819 (23,211) (13,531) Federal and state income taxes 217 (4,845) (12,140) Net cash provided by operating activities 58,763 18,236 31,786 Cash flow from investing activities: Capital expenditures (13,431) (9,908) (26,920) Cash flow from financing activities: Proceeds from long-term debt 275,000 25,820 — Costs incurred in refinancing debt (22,137) (2,617) (3,256) Repayment of long-term debt (324,198) (776) — Proceeds from the issuance of common stock — — 1,084 Net cash provided by (used in) financing activities (71,335) 22,427 (2,172) Increase (decrease) in cash and cash equivalents (26,003) 30,755 2,694 Cash and cash equivalents at beginning of year 49,650 18,895 16,201 Cash and cash equivalents at end of year $23,647 $49,650 $18,895 Supplementary cash flow information: Income taxes paid $411 $345 $453 Interest paid $23,270 $20,400 $19,380 Non-cash financing activities: Dividends on preferred stock (charged directly to stockholder's deficit) $13,456 $26,260 $33,578 Interest payable on 131/8% Senior Discount Debentures at February 1, 2003capitalized and added to the principal amount of the debt — $4,416 — Exchange of 16% Senior Discount Contingent Principal Notes of J.CrewIntermediate LLC with a fair value of $87,006 for $131,083 carrying value of131/8% Senior Discount Debentures of J.Crew Group, Inc. — — — See accompanying notes to consolidated financial statements.F-6J.CREW OPERATING CORP. ANDSUBSIDIARIES Consolidated Balance Sheets January 29,2005 January 31,2004 (in thousands) Assets Current assets: Cash and cash equivalents $23,647 $49,650 Merchandise inventories 88,093 66,028 Prepaid expenses and other current assets 22,217 20,733 Refundable income taxes 9,320 9,320 Total current assets 143,277 145,731 Property and equipment—at cost 259,098 284,945 Less accumulated depreciation and amortization (138,285) (146,565) 120,813 138,380 Due from J.Crew Group, Inc. 178,757 — Other assets 13,971 11,091 Total assets $456,818 $295,202 Liabilities and Stockholder's Deficit Current liabilities: Current portion of long-term debt $— $1,164 Accounts payable 68,569 49,386 Other current liabilities 60,314 46,942 Federal and state income taxes 1,392 1,175 Total current Liabilities 130,275 98,667 Deferred credits 59,064 56,723 Long-term debt 297,000 174,880 Due to J.Crew Group, Inc. — 5,897 Stockholder's deficit (29,521) (40,965) Total liabilities and stockholder's deficit $456,818 $295,202 See accompanying notes to consolidated financial statements.F-7J.CREW OPERATING CORP. ANDSUBSIDIARIES Consolidated Statements of Operations Years Ended January 29,2005 January 31,2004 February 1,2003 (in thousands) Revenues: Net sales $778,295 $660,628 $732,279 Other 25,921 29,337 36,065 804,216 689,965 768,344 Costs of goods sold, including buying and occupancy costs 478,829 440,276 472,262 Gross profit 325,387 249,689 296,082 Selling, general and administrative expenses 287,704 280,423 301,254 Income/(loss) from operations 37,683 (30,734) (5,172)Interest expense—net 21,615 20,496 23,200 Loss on refinancing of debt 4,024 — — Insurance proceeds — (3,850) (1,800) Income/(loss) before income taxes 12,044 (47,380) (26,572)Income taxes—(provision)/benefit (600) 5,410 17,750 Net income/(loss) $11,444 $(41,970)$(8,822) See accompanying notes to consolidated financial statements.F-8J.CREW OPERATING CORP. ANDSUBSIDIARIES Statement of Changes in Stockholder's Equity/(Deficit) (in thousands) Balance at February 2, 2002 $19,147 Net loss (8,822) Balance at February 1, 2003 10,325 Net loss (41,970)Dividends to affiliates (9,320) Balance at January 31, 2004 (40,965)Net income 11,444 Balance at January 29, 2005 $(29,521) Note: Operating Corp. has authorized 100 shares of common stock, par value $.01 per share, all of which were issued and outstanding during the three year period ended January 29, 2005.See accompanying notes to consolidated financial statements.F-9J.CREW OPERATING CORP. ANDSUBSIDIARIES Consolidated Statements of Cash Flows Years Ended January 29,2005 January 31,2004 February 1,2003 (restated) (restated) (in thousands) Cash flows from operating activities: Net income (loss) $11,444 $(41,970)$(8,822)Adjustments to reconcile net income/(loss) to net cash provided in operatingactivities: Depreciation and amortization 37,061 43,075 43,197 Amortization of deferred financing costs 1,855 1,724 4,202 Deferred income taxes — (910) (4,694) Non-cash compensation expense — — (1,053) Non-cash interest expense 1,000 1,000 — Loss on refinancing of debt 4,024 — — Changes in operating assets and liabilities: Merchandise inventories (22,065) 41,290 31,600 Prepaid expenses and other current assets (1,484) 4,153 2,140 Other assets 664 832 (2,470) Accounts payable and other liabilities 28,860 (23,267) (18,719) Federal and state income taxes 217 (4,845) (13,409) Net cash provided by operating activities 61,576 21,082 31,972 Cash flow from investing activities: Capital expenditures (13,431) (9,908) (26,920) Cash flow from financing activities: Proceeds from long-term debt 275,000 25,820 — Transfers to affiliate (184,654) (5,463) 898 Costs incurred in refinancing debt (9,450) — (3,256) Repayment of long-term debt (155,044) (776) — Net cash provided by/(used in) financing activities (74,148) 19,581 (2,358)Increase/(decrease) in cash and cash equivalents (26,003) 30,755 2,694 Cash and cash equivalents at beginning of year 49,650 18,895 16,201 Cash and cash equivalents at end of year $23,647 $49,650 $18,895 See accompanying notes to consolidated financial statements.F-10J.CREW GROUP, INC. AND SUBSIDIARIES J.CREW OPERATING CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Fiscal Year Ended January 29, 2005Dollars in thousands, unless otherwise indicated 1. Nature Of Business And Summary Of Significant Accounting Policies(a)Basis of Presentation The consolidated financial statements included herein are:(1)J.Crew Operating Corp. and its wholly-owned subsidiaries (Operating), which consist of the accounts of J.Crew OperatingCorp and its wholly owned subsidiaries. (2)J.Crew Group, Inc. and its wholly owned subsidiaries (the Company or Group), which consist of the accounts of J.CrewGroup, Inc. and its wholly-owned subsidiaries, including J.Crew Intermediate LLC (Intermediate) and Operating. Intermediatewas formed in March 2003 as a limited liability company. Effective May 2003 Group transferred its investment in Operating toIntermediate. All significant intercompany balances and transactions are eliminated in consolidation. Except where otherwise specified all notes to the consolidated financial statements apply to both Operating and Group.(b)Business The Company designs, contracts for the manufacture of, markets and distributes men's and women's apparel, shoes and accessoriesunder the J.Crew brand name. The Company's products are marketed, primarily in the United States, through various channels ofdistribution, including retail and factory outlet stores, catalogs, and the Internet. The Company is also party to a licensing agreement whichgrants the licensee exclusive rights to use the Company's trademarks in connection with the manufacture and sale of products in Japan. Thelicense 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 andoperating results generally to be lower in the first and second quarters than in the third and fourth quarters (which include the back-to-schooland holiday seasons) of each fiscal year. A significant amount of the Company's products are produced in Asia 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 whichthese contractors are located or by the imposition of additional duties or regulations relating to imports or by the contractor's inability to meetthe 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.F-11(d)Fiscal Year The Company's fiscal year ends on the Saturday closest to January 31. The fiscal years 2004, 2003 and 2002 ended on January 29,2005, January 31, 2004 and February 1, 2003 and each fiscal year consisted of 52 weeks.(e)Cash Equivalents For purposes of the consolidated statements of cash flows, the Company considers all highly liquid debt instruments, with maturities of90 days or less when purchased, to be cash equivalents. Cash equivalents, which were $14,192 and $43,312 at January 29, 2005 andJanuary 31, 2004, respectively, 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 andwarehousing costs in inventory and these costs are included in cost of goods sold as the inventories are sold.(g)Advertising and Catalog Costs Direct response advertising, which consists primarily of catalog production and mailing costs, are capitalized and amortized over theexpected 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 theratio that current period revenues for the catalog cost pool bear to the total of current and estimated future period revenues for that catalog costpool. The capitalized costs of direct response advertising are amortized, commencing with the date catalogs are mailed, over the duration ofthe expected revenue stream, which was four months for the fiscal years 2002, 2003 and 2004. Deferred catalog costs, included in prepaidexpenses and other current assets, as of January 29, 2005 and January 31, 2004 were $6,478 and $6,411, respectively. Catalog costs,which are reflected in selling and administrative expenses, for the fiscal years 2004, 2003 and 2002 were $41,258, $43,978 and $56,695,respectively. 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 andimprovements are depreciated over estimated useful lives of twenty years. Furniture, fixtures and equipment are depreciated over estimateduseful lives, ranging from three to ten years. Leasehold improvements (including rent capitalized during the construction period) areamortized over the shorter of their useful lives or related lease terms (without consideration of optional renewal periods). Systems development costs are capitalized and amortized on a straight-line basis over periods ranging from three to five years.F-12(i)Debt Issuance Costs Debt issuance costs (included in other assets) are amortized over the term of the related debt agreements. Unamortized debt issuancecosts are as follows: January 29,2005 January 31,2004Group $132 $2,409Operating 7,897 3,966 Total $8,029 $6,375 (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 theasset and liability method, deferred taxes are determined based on the difference between the financial reporting and tax bases of assets andliabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. The provision for income taxesincludes taxes currently payable and deferred taxes resulting from the tax effects of temporary differences between the financial statementand 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.Shipping terms for catalog and internet sales are FOB shipping point, and title passes to the customer at the time and place of shipment.Prices for all merchandise are listed in the Company's catalogs and website and are confirmed with the customer upon order. The customerhas no cancellation privileges other than customary rights of return that are accounted for in accordance with SFAS No. 48 "RevenueRecognition When Right of Return Exists." The Company accrues a sales return allowance for estimated returns of merchandisesubsequent to the balance sheet date that relate to sales prior to the balance sheet date. Amounts billed to customers for shipping andhandling fees related to catalog and internet sales are included in other revenues at the time of shipment. Royalty revenue is recognized as itis earned based on contractually specified percentages applied to reported sales. Advance royalty payments are deferred and recorded asrevenue when the related sales occur. Other revenues include estimated amount of unredeemed gift card liability based on Company specifichistorical trends, which amounted to $1,410, $1,676 and $1,962 in fiscal years 2004, 2003, and 2002, respectively.(l)Operating Expenses Cost of goods sold (including buying and occupancy costs) includes the direct cost of purchased merchandise, inbound freight, design,buying and production costs, occupancy costs related to store operations and all shipping and handling and delivery costs associated with ourJ.Crew Direct business.F-13 Selling, general and administrative expenses include all operating expenses not included in cost of goods sold, primarily catalogproduction and mailing costs, certain warehousing expenses, which aggregated $10,816, $9,860 and $10,440 for fiscal years 2004, 2003and 2002, respectively, administrative payroll, store expenses other than occupancy costs, depreciation and amortization and credit card fees.(m)Store Pre-opening Costs Costs associated with the opening of new retail and factory outlet stores are expensed as incurred.(n)Derivative Financial Instruments Derivative financial instruments have been used by the Company from time to time to manage its interest rate and foreign currencyexposures. The Company does not enter into derivative financial instruments for speculative purposes. 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 reducethe risk from exchange rate fluctuations.(o)Use of Estimates in the Preparation of Financial Statements The preparation of financial statements in conformity with generally accepted accounting principles requires management to makeestimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at thedate of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differfrom those estimates.(p)Impairment of Long-Lived Assets The Company reviews long-lived assets and certain identifiable intangibles for impairment whenever events or changes incircumstances indicate that the carrying amount of an asset may not be recoverable. The Company assesses the recoverability of suchassets based upon estimated cash flow forecasts. Charges of $146, $675 and $137 were incurred in fiscal 2004, 2003 and 2002 to write-down the carrying value of certain long-lived assets.(q)Stock Based Compensation The Company accounts for stock-based compensation using the intrinsic value method of accounting for employee stock options aspermitted by SFAS No. 123, "Accounting for Stock-Based Compensation". Accordingly, compensation expense is not recorded for optionsgranted 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 valuerecognition provisions of SFAS No. 123, the effect on net income would not be material. Restricted stock awards result in the recognition of deferred compensation, which is charged to expense over the vesting period of theawards. Deferred compensation is presented as a reduction of stockholders' equity. Total compensation expense recorded with respect tostock-based compensation, all of which related to restricted stock awards, amounted to $119, $41 and $464 in 2004, 2003 and 2002,respectively.F-14(r)Deferred rent and lease incentives Rental payments under operating leases are charged to expense on a straight-line basis after consideration of step rent provisions andescalation clauses. Differences between rental expense and actual rental payments are recorded as deferred rent and included in deferredcredits. The Company capitalizes rent expense during the period from possession date through the completion of store construction. Rent isexpensed subsequent to the end of construction. Capitalized rent is amortized over the lease term (without consideration of optional renewalperiods). The Company receives construction allowances upon entering into certain store leases. These construction allowances are recorded asdeferred credits and are amortized as a reduction of rent expense over the term of the related lease. Deferred construction allowances were$39,250 and $43,668 at January 29, 2005 and January 31, 2004, respectively.(s)Reclassification Certain prior year amounts have been reclassified to conform with current year's presentation.2. Restatement During the fourth quarter of fiscal 2004, the Company determined that it had misclassified proceeds from construction allowances in theconsolidated statement of cash flows. As a result, the consolidated statements of cash flows for Group and Operating for the years endedJanuary 31, 2004 and February 1, 2003 have been restated to reclassify the proceeds from construction allowances from cash flows frominvesting activities to cash flows from operating activities. There was no effect on the Company's consolidated balance sheet or consolidatedstatement of operations.F-15 The effects of the reclassification are as follows: Year Ended January 31,2004 February 1,2003 Accounts payable and other liabilities: Group: As reported $(25,233)$(20,033) As restated $(23,211)$(13,531) Operating: As reported $(25,289)$(25,221) As restated $(23,267)$(18,719) Cash flows from operating activities: Group: As reported $16,214 $25,284 As restated $18,236 $31,786 Operating: As reported $19,060 $25,470 As restated 21,082 31,972 Proceeds from construction allowances: Group and Operating As reported $2,022 $6,502 As restated $— $— Cash flows from investing activities: Group: As reported $(7,886)$(20,418) As restated $(9,908)$(26,920) Operating: As reported $(7,886)$(20,418) As restated $(9,908)$(26,920) F-163. Insurance Proceeds The terrorist events of September 11, 2001 resulted in the destruction of the Company's retail store located at the World Trade Center inNew York City, resulting in the loss of inventories and store fixtures, equipment and leasehold improvements. These losses and theresulting business interruption were covered by insurance policies maintained by the Company. The statement of operations for the years ended January 31, 2004 and February 1, 2003 include gains of $3,850 and $1,800 as a resultof additional insurance recoveries. No additional insurance recoveries are payable to the Company relating to this loss.4. Property and Equipment Property and equipment, net consists of: January 29, 2005 January 31, 2004Land $1,710 $1,710Buildings and improvements 11,712 11,705Fixtures and equipment 68,811 90,898Leasehold improvements 173,725 176,740Construction in progress 3,140 3,892 259,098 284,945Less accumulated depreciation and amortization 138,285 146,565 $120,813 $138,380 5. Other Current Liabilities Other current liabilities consist of: January 29, 2005 January 31, 2004Customer liabilities $14,095 $9,089Accrued catalog and marketing costs 801 2,505Taxes, other than income taxes 3,115 3,046Accrued interest(a) 3,664 5,330Accrued occupancy 1,141 817Reserve for sales returns 4,831 2,988Accrued compensation 8,465 3,535Other 25,036 20,479 $61,148 $47,789 (a)includes $2,830 and $4,483 related to OperatingF-176. Lines of Credit On December 23, 2004, Operating entered into an Amended and Restated Loan and Security Agreement with Wachovia CapitalMarkets LLC, as arranger, Wachovia Bank, National Association, as administrative agent, Bank of America NA, as syndication agent, andCongress Financial Corporation, as collateral agent, and a syndicate of lenders (the "Amended Wachovia Credit Facility") which provides fora maximum credit availability of up to $170.0 million (which may be increased to $250.0 million subject to certain conditions). The Amended Wachovia Credit Facility provides for revolving loans and letter of credit accommodations. The Amended Wachovia CreditFacility expires in December 2009. The total amount of availability is subject to limitations based on specified percentages of eligiblereceivables, inventories and real property. As of January 29, 2005 excess availability under the Amended Wachovia Credit Facility was$27.0 million. Borrowings are secured by a perfected first priority security interest in all the assets of Intermediate and its subsidiaries and bear interest,at the Company's option, at the prime rate plus a margin of up to 0.25% or the Eurodollar rate plus a margin ranging from 1.25% to 2.00%.The Company is required to pay a monthly unused line fee ranging from .25% to .375%. Fees for outstanding commercial letters of creditrange from .625% to 1.0% and fees for outstanding standby letters of credit are 1.25%. The Amended Wachovia Credit Facility includes restrictions, including the incurrence of additional indebtedness, the payment ofdividends and other distributions, the making of investments, the granting of loans and the making of capital expenditures. The AmendedWachovia Credit Facility permits restricted payments (by way of dividends or other distributions) with respect to, among other things, theCompany's capital stock payable solely in additional shares of its capital stock, the Company's tax sharing agreement, the Series A PreferredStock of Group, the Series B Preferred Stock of Group and the 131/8% Senior Discount Debentures due 2008 of Group. The ability ofOperating to declare dividends on its capital stock is also limited by Delaware law, which permits a company to pay dividends on its capitalstock only out of its surplus or, in the event that it has no surplus, out of its net profits for the year in which a dividend is declared or for theimmediately preceding fiscal year. Under the Amended Wachovia Credit Facility, Operating is required to maintain a fixed interest chargecoverage ratio of 1.1 if excess availability is less than $20.0 million for any 30 consecutive day period. Operating has at all times been incompliance with all financial covenants. Maximum borrowings under our working capital credit agreements were none, $10,000 and $63,000 and average borrowings werenone, $1,020 and $40,400 during fiscal years 2004, 2003 and 2002, respectively. There were no borrowings outstanding at January 29,2005 and January 31, 2004. Outstanding letters of credit established primarily to facilitate international merchandise purchases at January 29, 2005 and January 31,2004 amounted to $58,700 and $39,500.F-187. Long-Term Debt and Preferred Stock January 29, 2005 January 31, 2004 Operating: 93/4% senior subordinated notes(a) $275,000 $— 5% notes payable(b) 22,000 21,000 103/8% senior subordinated notes(c) — 150,000 Wachovia credit facility — 5,044 Less amount due within one year — (1,164) Total Operating long-term debt 297,000 174,880 Intermediate: 16% senior discount contingent principal notes (net of unamortizeddebt issuance discount of $38,677)(d) — 108,389 Group: 131/8% senior discount debentures(e) 21,667 21,667 Mandatorily redeemable preferred stock(f) 258,266 211,704 Total Group long-term debt 576,933 516,640 Group preferred stock(f) 92,800 92,800 Total Group long-term debt and preferred stock $669,733 $609,440 The scheduled payments of long term debt are $43.7 million in 2008, $258.3 million in 2009 and $275.0 million in 2014. (a) On November 21, 2004, Operating entered into a Senior Subordinated Loan Agreement with entities managed by Black CanyonCapital LLC and Canyon Capital Advisors LLC, which provided for a term loan of $275 million. The proceeds of the term loan were used toredeem in full Operating's outstanding 103/8% senior subordinated notes due 2007 ($150 million) and to redeem in part Intermediate's 16%senior discount contingent principal notes due 2008 ($125 million). On March 18, 2005, the term loan was converted into equivalent new93/4% senior subordinated notes of Operating due 2014 (93/4% senior subordinated notes) in accordance with the terms of the loanagreement. The 93/4% senior subordinated notes are general senior subordinated obligations of the Operating and certain subsidiaries of Operatingand Intermediate, are subordinated in right of payment to their existing and future senior debt, are pari passu in right of payment with any oftheir future senior subordinated debt and are senior in right of payment to any of their future subordinated debt. Operating's existing domesticsubsidiaries, other than non-guarantor subsidiaries, are guarantors of the 93/4% senior subordinated notes. The 93/4% senior subordinatednotes are secured by the assets of Operating and certain subsidiaries of Operating and by Operating's common stock owned byF-19Intermediate and such security interest is junior in priority to that securing first-lien obligations, including those under the AmendedWachovia Credit Facility. Interest on the notes accrues at the rate of 93/4% per annum and is payable semi-annually in arrears on each June 23 andDecember 23. The notes mature on December 23, 2014. The notes may be redeemed at the option of the issuer, in whole or in part, at101% of the principal amount at any time until June 23, 2006 and thereafter, at any time on or after December 23, 2009 at prices rangingfrom 104.875% to 100% of the principal amount, in each case, plus accrued and unpaid interest on the notes. The indenture governing the 93/4% senior subordinated notes contains covenants that, among other things, limit the ability of Operatingand certain subsidiaries of Operating to incur additional indebtedness or issue disqualified stock or preferred stock, pay dividends or makeother distributions on, redeem or repurchase the capital stock of Operating, make certain investments, create certain liens, guaranteeindebtedness, engage in transactions with affiliates and consolidate, merge or transfer all or substantially all of the assets of Operating andcertain subsidiaries of Operating. Under the indenture governing the 93/4% senior subordinated notes, Operating may declare cash dividends payable to Group in anamount sufficient to enable Group to make the regularly scheduled payment of interest in respect of the senior discount debentures of Groupso long as no default or event of default has occurred and is continuing under the indenture. The ability of Operating to declare dividends onits capital stock is also limited by Delaware law, which permits a company to pay dividends on its capital stock only out of its surplus or, in theeven that it has no surplus, out of its net profits for the year in which a dividend is declared or for the immediately preceding fiscal year. Inorder to pay dividends in cash, Operating must have surplus or net profits equal to the full amount of the cash dividend at the time suchdividend is declared. In determining Operating's ability to pay dividends, Delaware law permits the board of directors of Operating to revalueits assets and liabilities from time to time to their fair market value in order to create a surplus. (b) On February 4, 2003, Group and Operating entered into a credit agreement with TPG-MD Investment, LLC, a related party, whichprovides for a Tranche A loan to Operating in an aggregate principal amount of $10.0 million and a Tranche B loan to Operating in anaggregate principal amount of $10.0 million. The loans are due in February 2008 and bear interest at 5.0% per annum payable semi-annuallyin arrears on January 31 and July 31, commencing on July 31, 2003. Interest will compound and be capitalized and added to the principalamount on each interest payment date, resulting in an effective interest rate of 5.6%. The outstanding amount of these loans is convertibleinto shares of common stock of Group at $6.82 per share. These loans are subordinated in right of payment to the prior payment of all seniordebt. On November 21, 2004, this credit agreement was amended to subordinate the Tranche A loan in right of payment to Operating's93/4% senior subordinated notes while the Tranche B loan is pari passu in right of payment with such notes. (c) The 103/8% senior subordinated notes were redeemed in full in December 2004.F-20 (d) On May 6, 2003, Group completed an offer to exchange 16% senior discount contingent principal notes due 2008 of Intermediate(new notes) for its outstanding 131/8% senior discount debentures due 2008 (existing debentures). Approximately 85% of the outstandingdebentures were tendered for exchange. Group exchanged $87,006 fair value of new notes for $131,083 face amount (including accruedinterest of $10,750) of existing debentures. The difference between the fair value of the new notes and the carrying value of the existingdebentures of $44,077 was included as a gain in the statement of operations for the year ended January 31, 2004. The outstanding 16% senior discount contingent principal notes were redeemed in full through two separate redemption events inDecember 2004 and January 2005. (e) The 131/8% senior discount debentures are senior unsecured obligations of Group and mature on October 15, 2008. Interest ispayable in arrears on April 15 and October 15 of each year subsequent to October 15, 2002. The 131/8% senior discount debentures may beredeemed at the option of Group at 1.0219 of principal until October 15, 2005 and 100% thereafter. (f) The restated certificate of incorporation authorizes Group to issue up to:(1) 1,000,000 shares of Series A cumulative preferred stock; par value $.01 per share; and (2) 1,000,000 shares of Series B cumulative preferred stock; par value $.01 per share. At January 29, 2005 and January 31, 2004, 92,800 shares of Series A preferred stock and 32,500 shares of Series B preferred stockwere issued and outstanding. Each series of the preferred stock accumulates dividends at the rate of 14.5% per annum (payable quarterly) for periods ending on orprior to October 17, 2009. Dividends compound to the extent not paid in cash. A default in the payment of the Series A preferred stockredemption price will trigger dividends accruing and compounding quarterly at a rate of (i) 16.50% per annum with respect to periods endingon or before October 17, 2009 and (ii) 18.50% with respect to periods starting after October 17, 2009. A default in the payment of the Series Bpreferred stock redemption price will trigger dividends accruing and compounding quarterly at a rate of 16.50% per annum. On October 17, 2009, Group is required to redeem the Series B preferred stock and to pay all accumulated but unpaid dividends on theSeries A preferred stock. Thereafter, the Series A preferred stock will accumulate dividends at the rate of 16.5% per annum. Subject torestrictions imposed by certain indebtedness of the Company, Group may redeem shares of the preferred stock at a redemption price equal to100% of liquidation value plus accumulated and unpaid dividends. In certain circumstances (including a change of control of Group), subject to restrictions imposed by certain indebtedness of theCompany, Group may be required to repurchase shares of the preferred stock at liquidation value plus accumulated and unpaid dividends. IfGroup liquidates, dissolves or winds up, whether voluntary or involuntary, no distribution shall be made either (i) to those holders of stockranking junior to the preferred stock, unless prior thereto the holders of the preferred stock receive the total value for each share of preferredstock plus an amount equal to all accrued dividends thereon as of the date of such payment or (ii) to the holders of stock ranking pari passuwith theF-21preferred stock (which we refer to as the "parity stock"), except distributions made ratably on the preferred stock and all such parity stock inproportion to the total amounts to which the holders of all such shares are entitled upon liquidation, dissolution or winding up of Group. Effective at the beginning of the third quarter of 2003, the Company adopted SFAS No. 150 "Accounting for Certain FinancialInstruments with Characteristics of both Liabilities and Equity". This pronouncement required the reclassification to long term debt of theliquidation value of Group Series B preferred stock and the related accumulated and unpaid dividends and the accumulated and unpaiddividends related to the Series A preferred stock since these amounts are required to be redeemed in October 2009. The preferred dividendsrelated to the liquidation value of the Series B preferred stock and to the accumulated and unpaid dividends of the Series A and Series Bpreferred stock for the third and fourth quarters of 2003 and fiscal 2004 are included in interest expense. The Series A preferred stock is onlyredeemable in certain circumstances (including a change of control at Group) and does not qualify for reclassification under SFAS No. 150.Accordingly, the dividends related to the Series A preferred stock are deducted from stockholders' deficit. Accumulated but unpaid dividends amounted to $225,766 at January 29, 2005.8. Gain (loss) on Refinancing of Debt During the fourth quarter of 2004, the Company redeemed in full the outstanding 103/8% senior subordinated notes due 2007($150.0 million) and redeemed the outstanding 16% senior discount contingent principal notes due 2008 ($169.1 million). Funds used for theredemption were generated from the proceeds of a $275 million term loan and internally available funds. This refinancing resulted in a loss of $49.8 million for Group in fiscal 2004, which consisted of: (a) redemption premiums of$15.3 million, (b) the write-off of deferred financing costs of $3.2 million and (c) the write-off of deferred debt issuance costs of $31.3 millionrelated to the 16% senior discount contingent principal notes issued in May 2003. The loss on refinancing of debt for Operating in fiscal 2004 was $4.0 million consisting of redemption premiums of $2.6 million and thewrite off of deferred financing costs of $1.4 million. Refer to Note 7(d) for explanation of gain on exchange of debt in fiscal 2003.9. Common Stock The restated certificate of incorporation authorizes Group to issue up to 100,000,000 shares of common stock; par value $.01 per share.At January 29, 2005, shares issued were 13,780,175 and shares outstanding were 13,207,086. At January 31, 2004, shares issued were13,584,175 and shares outstanding were 13,011,086.F-2210. Commitments and Contingencies(a)Operating Leases As of January 29, 2005, Operating was obligated under various long-term operating leases for retail and factory outlet stores,warehouses, office space and equipment requiring minimum annual rentals. These operating leases expire on varying dates through 2014. At January 29, 2005 aggregate minimum rentals are, as follows:Fiscal year Amount2005 $54,2572006 50,6362007 48,7132008 43,1152009 37,841Thereafter 98,772 Certain of these leases include renewal options and escalation clauses and provide for contingent rentals based upon sales and requirethe lessee to pay taxes, insurance and other occupancy costs. Rent expense for fiscal 2004, 2003 and 2002 was $46,583, $42,997 and $41,657, respectively, including contingent rent, based onstore sales, of $1,700, $814 and $1,187.(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 outcomeof these claims cannot be predicted with certainty, management does not believe that it is reasonably possible that resolution of these legalproceedings will result in unaccrued losses that would be material.11. Employee Benefit Plan The Company has a thrift/savings plan pursuant to Section 401 of the Internal Revenue Code whereby all eligible employees maycontribute up to 15% of their annual base salaries subject to certain limitations. The Company's contribution is based on a percentageformula set forth in the plan agreement. Company contributions to the thrift/savings plan were $1,306, $1,288 and $1,834 for fiscal 2004,2003 and 2002, respectively.12. License Agreement Operating has a licensing agreement through January 2007 with Itochu Corporation, a Japanese trading company. The agreementpermits Itochu to distribute J.Crew merchandise in Japan.F-23 Operating earns royalty payments under the agreement based on the sales of its merchandise. Royalty income, which is included inother revenues, for fiscal 2004, 2003, and 2002 was $2,757, $2,456 and $2,280, respectively.13. Other Revenues Other revenues consist of the following: 2004 2003 2002Shipping and handling fees $21,624 $25,205 $31,823Royalties 2,757 2,456 2,280Other 1,540 1,676 1,962 $25,921 $29,337 $36,065 14. Financial Instruments The fair value of the Company's long-term debt (including redeemable preferred stock) is estimated to be approximately $576,933 and$501,400 at January 29, 2005 and January 31, 2004, respectively, and is based on dealer quotes or quoted market prices of the same orsimilar instruments. The carrying amounts of long-term debt were $576,933 and $517,804 at January 29, 2005 and January 31, 2004,respectively. The carrying amounts reported in the consolidated balance sheets for cash and cash equivalents, accounts payable and othercurrent liabilities approximate fair value because of the short-term maturity of those financial instruments. The estimates presented hereinare not necessarily indicative of amounts the Company could realize in a current market exchange.15. Income Taxes Group files a consolidated federal tax return, which includes all its wholly owned subsidiaries. Each subsidiary files separate state taxreturns in the required jurisdictions. Group and its subsidiaries have entered into a tax sharing agreement providing (among other things)that each of the subsidiaries will reimburse Group for its share of income taxes based on the proportion of such subsidiaries' tax liability on aseparate return basis to the total tax liability of Group.F-24Group The income tax provision/(benefit) of Group consists of: 2004 2003 2002 Current: Foreign $300 $250 $193 Federal — (3,744) (12,014) State and local 300 (1,006) 200 600 (4,500) (11,621)Deferred — 5,000 7,421 Total $600 $500 $(4,200) A reconciliation between the provision/(benefit) for income taxes based on the U.S. Federal statutory rate and the Company's effectiverate, is as follows: 2004 2003 2002 Federal income tax rate (35.0)%(35.0)%(35.0)%State and local income taxes, net of federal benefit 0.4 0.8 — Valuation allowance 5.6 64.0 47.0 Additional NOL carryback — (7.4)— Reversal of prior tax accruals — (2.6)(20.9)Non-deductible expenses and other (primarily preferred dividends) 18.6 8.4 (.5)Non-recognized gain on exchange of debt 11.0 (27.2)— Effective tax rate 0.6 %1.0 %(9.4)% F-25 The tax effect of temporary differences which give rise to deferred tax assets and liabilities are: January 29, 2005 January 31, 2004 Deferred tax assets: Original issue discount $3,600 $33,660 Rent 17,800 17,514 Federal NOL carryforwards 47,200 19,600 State and local NOL carryforwards 4,500 4,485 Reserve for sales returns 1,900 1,207 Other 4,700 5,057 79,700 81,523 Valuation allowance (63,400) (57,838) 16,300 23,685 Deferred tax liabilities: Prepaid catalog and other prepaid expenses (6,600) (8,555) Difference in book and tax basis for property and equipment (9,700) (15,130) (16,300) (23,685) Net deferred income tax asset $— $— Operating The income tax provision/(benefit) of Operating consists of: 2004 2003 2002 Current: Foreign $300 $250 $193 Federal — (3,744) (13,449) State and local 300 (1,006) 200 600 (4,500) (13,056)Deferred — (910) (4,694) Total $600 $(5,410)$(17,750) F-26 A reconciliation between the provision/(benefit) for income taxes based on the U.S. Federal statutory rate and the Company's effectiverate is as follows: 2004 2003 2002 Federal income tax rate 35.0% (35.0)%(35.0)%State and local income taxes, net of federal benefit 3.4 0.8 — Valuation allowance (32.3)36.9 — Additional NOL carryback — (7.8)— Reversal of prior tax accruals — (2.7)(38.6)Non-deductible expenses and other (.9)(3.6)6.8 Effective tax rate 5.2% (11.4)%(66.8)% The tax effect of temporary differences which give rise to deferred tax assets and liabilities are: January 29, 2005 January 31, 2004 Deferred tax assets: Federal NOL carryforwards $6,200 $17,540 State and local NOL carryforwards 4,500 4,485 Reserve for sales returns 1,900 1,207 Rent 17,800 17,514 Other 4,700 5,459 35,100 46,205 Valuation allowance (18,800) (22,520) 16,300 23,685 Deferred tax liabilities: Prepaid catalog and other prepaid expenses (6,600) (8,555) Difference in book and tax basis for property and equipment (9,700) (15,130) (16,300) (23,685) Net deferred income tax asset $— $— 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 isrequired 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 andnegative evidence needs to be considered, including a company's current and past performance, the market environment in which acompany 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 asF-27cumulative losses in recent years. Cumulative losses weigh heavily in the overall assessment. As a result of our assessment, weestablished a valuation allowance for the net deferred tax assets at February 1, 2003. The valuation allowance was increased at January 31,2004 and January 29, 2005 to fully reserve net deferred tax assets at such dates. The Company did not recognize any tax benefits in fiscal2004 and 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 PlansAmended and Restated 1997 Stock Option Plan Under the terms of the Amended and Restated 1997 Stock Option Plan (1997 Plan), an aggregate of 1,910,000 shares of Groupcommon stock are available for grant to key employees and consultants in the form of non-qualified stock options. The options have terms ofseven to ten years and become exercisable over a period of four to five years. Options granted under the 1997 Plan are subject to variousconditions, including under some circumstances, the achievement of certain performance objectives.2003 Equity Incentive Plan In January 2003, the Board of Directors of Group approved the adoption of the 2003 Equity Incentive Plan (2003 Plan). Under the termsof the 2003 Plan, an aggregate of 4,798,160 shares of Group common stock are available for award to key employees and consultants in theform 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 or fair market value, whichever isgreater; •1,115,812 shares are reserved for the issuance of stock options at an exercise price of $25.00 or fair market value, whichever isgreater; •1,115,812 shares are reserved for the issuance of stock options at an exercise price of $35.00 or fair market value, whichever isgreater; •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. Under the Plan, theCompensation Committee of the Board of Directors of Group has the discretion to modify the exercise price and the number of sharesreserved for the issuance of stock options and restricted shares.F-28 A summary of stock option activity for the three years ended January 29, 2005, is as follows: 2004 2003 2002 Shares Weightedaverageexercise price Shares Weightedaverageexercise price Shares Weightedaverageexercise priceOutstanding, beginning of year 2,410,606 $8.37 4,474,469 $18.22 1,808,790 $9.97Granted 2,515,848 17.07 377,750 6.85 3,263,239 21.35Exercised — — — Cancelled (344,189) 8.33 (2,441,613) 26.19 (597,560) 10.29 Outstanding, end of year 4,582,265 $13.15 2,410,606 $8.37 4,474,469 $18.22 Options exercisable at end of year 1,508,850 $9.84 849,302 $10.59 842,340 $9.81 The following table summarizes information about stock options outstanding as of January 29, 2005: Outstanding ExercisableRange Number ofoptions Weightedaverageoption price Weightedaverageremainingcontractual life(in months) Number ofoptions Weightedaverageoption price$6.82–$8.53 2,131,731 $6.85 86 777,723 $6.82$10.00–$35.00 2,450,534 18.62 88 731,127 13.06 $6.82–$35.00 4,582,265 $13.15 87 1,508,850 $9.84 Under the 2003 Plan, 1,004,266, 224,402 and 196,000 restricted shares were issued in fiscal 2002, 2003 and 2004, respectively, and83,689 restricted shares were forfeited in fiscal 2003. On January 29, 2005, there were 1,340,979 restricted shares outstanding, of which509,979 shares were vested.17. Recent Accounting Pronouncements In December 2003, the FASB issued FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable InterestEntities, which addresses how a business enterprise should evaluate whether it has a controlling financial interest in an entity throughmeans other than voting rights and accordingly should consolidate the entity. FIN 46R applies to variable interests in variable interest entitiescreated after December 31, 2003. For variable interests in variable interest entities created before January 1, 2004, the Interpretation appliesbeginning on January 1, 2005. For any variable interest entities that must be consolidated under FIN 46R that were created before January 1,2004, the assets, liabilities and noncontrolling interests of the variable interest entity initially would be measured at their carrying amountswith any difference between the net amount added to the balance sheet and any previously recognized interest being recognized as thecumulative effect of an accountingF-29change. If determining the carrying amounts is not practicable, fair value at the date FIN 46R first applies may be used to measure theassets, liabilities and noncontrolling interest of the variable interest entity. The adoption of FIN 46R did not have any effect on the financialstatements taken as a whole as of January 29, 2005, and for the year then ended. In December 2004, the FASB issued Statement No. 123 R, Share-Based Payment. This revision to Statement No. 123 requires thatcompensation expense be recognized for the fair value of stock options over their vesting period and changes the method of expenserecognition for performance-based stock awards. The Statement is required to be adopted by the Company for fiscal years beginning afterDecember 15, 2005 and applies to all outstanding stock options and stock awards that have not yet vested at the date of adoption.Management is evaluating the effects of this Statement.18. Quarterly Financial Information (Unaudited) 13 weeksended5/3/03 13 weeksended8/2/03(a) 13 weeksended11/1/03 13 weeksended1/31/04 52 weeksended1/31/04 ($in millions) Net sales $152.6 $159.2 $146.4 $202.4 $660.6 Gross profit 57.9 51.3 59.9 80.6 249.7 Net income/(loss)—Group (20.2) 15.0 (24.5) (20.5) (50.2)Net income/(loss)—Operating (15.5) (18.0) (9.2) .7 (42.0) 13 weeksended5/1/04 13 weeksended7/31/04 13 weeksended10/30/04 13 weeksended1/29/2005(b) 52 weeksended1/29/05 Net sales $140.6 $182.1 $200.9 $254.7 $778.3 Gross profit 60.7 74.2 89.0 101.5 325.4 Net loss—Group (23.7) (13.8) (9.9) (52.9) (100.3)Net income/(loss)—Operating (7.7) 3.2 7.5 8.4 11.4 (a)Net income of Group includes a pre-tax gain on the exchange of debt of $41.1 million. (b)Net loss of Group includes a pre-tax loss on the refinancing of debt of $49.8 million and net income of Operating includes a pre-taxloss of $4.0 million related to the refinancing of debt.F-30SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS beginningbalance charged tocost andexpenses(a) charged toother accounts deductions(a) endingbalance (in thousands)Inventory reserve (deducted from inventories) Fiscal year ended: February 1, 2003 $8,367 $4,053 $— $— $12,420January 31, 2004 12,420 — — 7,380 5,040January 29, 2005 5,040 — — 557 4,483Allowance for sales returns (included in other current liabilities) Fiscal year ended: February 1, 2003 $6,475 $— $— $1,162 $5,313January 31, 2004 5,313 — — 2,309 3,004January 29, 2005 3,004 1,827 — — 4,831(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 ofoperations as incurred.F-31QuickLinksPART I BUSINESSITEM 2. PROPERTIESITEM 3. LEGAL PROCEEDINGSITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERSPART IIITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERSITEM 6. SELECTED FINANCIAL DATAITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATAITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSUREITEM 9A. CONTROLS AND PROCEDURESPART IIIITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANTITEM 11. EXECUTIVE COMPENSATIONITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENTITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONSITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICESPART IVITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-KEXHIBIT INDEXSIGNATURESINDEX TO FINANCIAL STATEMENTSREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMJ.CREW GROUP, INC. AND SUBSIDIARIES Consolidated Balance SheetsJ.CREW GROUP, INC. AND SUBSIDIARIES Consolidated Statements of OperationsJ.CREW GROUP, INC. AND SUBSIDIARIES Consolidated Statements of Changes in Stockholders' Deficit (in thousands, except shares)J.CREW GROUP, INC. AND SUBSIDIARIES Consolidated Statements of Cash FlowsJ.CREW OPERATING CORP. AND SUBSIDIARIES Consolidated Balance SheetsJ.CREW OPERATING CORP. AND SUBSIDIARIES Consolidated Statements of OperationsJ.CREW OPERATING CORP. AND SUBSIDIARIES Statement of Changes in Stockholder's Equity/(Deficit)J.CREW OPERATING CORP. AND SUBSIDIARIES Consolidated Statements of Cash FlowsJ.CREW GROUP, INC. AND SUBSIDIARIES J.CREW OPERATING CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS Fiscal Year Ended January 29, 2005 Dollars in thousands, unless otherwise indicatedSCHEDULE II VALUATION AND QUALIFYING ACCOUNTSQuickLinks -- Click here to rapidly navigate through this documentEXHIBIT 10.16 September 15, 2003Roxane Al-Fayez[address omitted]Dear Roxane, We are pleased to extend an offer to join our team as Executive Vice President of Direct Operations, reporting to Millard S. Drexler. We will provide you with professional challenges, education and ongoing support as you continue your career with J.Crew. Yourcompensation will include a base salary of $375,000 annualized ($14,423.08 biweekly), payable in accordance with J.Crew's normal payrollpractices. In addition, our competitive benefits package includes the following:30 paid time off days each subsequent fiscal year (beginning February 2004)medical, vision & dental insuranceshort & long term disabilitylife insurance and long term care401(k) tax deferred savings plan (after 1 year with us)tax deferred flexible spending accounts for health, dependent care & commutationtuition reimbursement30 percent merchandise discount (in stores, online & through the catalog) You will be eligible to receive a $50,000 sign-on bonus payable two weeks after your start date. All bonus payments are subject toapplicable tax withholdings and are contingent upon you being an active associate on the date of actual disbursement. If you voluntarilyterminate your employment for any reason within one year after your start date, you agree to repay to the Company a prorated amount of thisbonus based on your last date of active employment. You must repay this amount within thirty days thereafter of your last date of activeemployment. For fiscal year 2003, we will pay you a minimum guaranteed bonus equal to $50,000 payable April, 2004. For fiscal year 2003 andbeyond, you will be eligible to receive an annual bonus under the company's bonus plan based upon a range of 25% - 100% of your annualbase salary, with a target of 50%. Bonus payments are conditioned upon the company's achievement of certain performance objectives andyour individual performance and are pro-rated based upon date of hire. It is company policy to make bonus payments after the close of ourfiscal year, usually mid-April, and all bonus payments are subject to applicable tax withholdings and are contingent upon you being an activeassociate on the date of actual disbursement. In addition, you will receive a $25,000 bonus payment payable in October of 2004. All bonus payments are subject to applicable taxwithholdings and are contingent upon you being an active associate on the date of actual disbursement. You will be eligible to participate in our Stock Option Plan. Subject to approval of the provisions set forth in the Plan and your StockOption Grant Agreement, the Company will grant to you a non-qualified stock option to purchase 35,000 shares of J.Crew Group, Inc.Common Stock. The Stock Option Grant Agreement will provide the exercise price, vesting schedule, expiration and other relevant terms. You will also receive a grant of 25,000 restricted shares of Common Stock. The terms and conditions, including the vesting schedule, ofthe Restricted Shares shall be evidenced by a separate Restricted Stock Agreement. J.Crew will provide you with a monthly housing allowance of $3,000 for as long as you are an active employee. You will be notifiedthrough our Relocation Services to aid you in this process. If your employment is terminated by us for reasons other than cause prior to theearlier of (1) 12 months afterthe effective date of your housing lease or (2) 18 months after your start date with us, J.Crew will continue to reimburse you for your actualmonthly rental payments up to $3,000 per month for the remaining term of your 12-month lease (the "Remaining Term"). In the event thatyou sublease, transfer or terminate your lease anytime during the Remaining Term, J. Crew's obligations to reimburse you as set forthherein shall terminate immediately. You represent to J.Crew that you do not have any other agreements, arrangements or commitments with any other person or entity thatconflict with accepting this offer or performing your obligations and that you will not disclose to J.Crew or use any proprietary information ortrade secrets of another person or entity. You also agree that you will keep all proprietary, confidential information of J.Crew strictlyconfidential and not disclose any such information during or after your employment without J.Crew's prior written consent, and that you willabide by all J.Crew policies, including, but not limited to, those contained in the Code of Ethics and Business Practices. Through the interview process we had the chance to get to know each other. We know that you will add value to our team and hope thatyou decide to join the crew. While we believe that this will be a mutually beneficial relationship, your employment is "at will" and may beterminated by you or the Company at any time. This offer is contingent upon the successful completion of a background screen and referencecheck. If you agree that J.Crew and this offer are right for you, kindly sign a copy of this letter and fax it to my attention at [fax number omitted]or mail it to the address below. Please do not hesitate to contact me by phone [phone number omitted] or email [email address omitted] if youhave any questions or require additional information. We look forward to hearing from you soon.Regards, Agreed to and Accepted: /s/ MILLARD S. DREXLER Millard S. DrexlerChief Executive Officer770 BroadwayNY, NY 10003 /s/ ROXANE AL-FAYEZ Roxane Al-Fayez 9/15/03Date 2January 5, 2004Roxane Al-Fayez[address omitted]Dear Roxane, This is an addendum to your offer letter of September 15, 2003. J.Crew will reimburse you or your husband for weekly commutation to and from your principal residence in Ohio for the term of youremployment with the company. Agreed to and Accepted: /s/ LYNDA MARKOE Lynda MarkoeVP, Human Resources 1/6/04Date /s/ ROXANE AL-FAYEZ Roxane Al-Fayez DateEVP, Direct Operations 1/6/04Date QuickLinksEXHIBIT 10.16QuickLinks -- Click here to rapidly navigate through this documentEXHIBIT 10.17 October 7, 2004 Mr. Paul Fusco[address omitted]Dear Paul: This letter will confirm our understanding of the arrangements under which your employment with the Company is terminated. Theterms and conditions of the termination 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 October 22, 2004(the "Termination Date"). 2.Subject to this Agreement becoming effective (as described in Paragraph 18 hereof), the Company will continue to pay you your basesalary of $275,000 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 continueto have medical coverage during the Severance Period on the same terms and conditions as medical coverage is then made availableto the employees of the Company. The foregoing payments shall be reduced by any required tax withholdings and shall not be takeninto account as compensation and no service credit shall be given after the Termination Date for purposes of determining the benefitspayable under any other plan, program, agreement or arrangement of the Company. You acknowledge that, except for the foregoingpayments, you are not entitled to any payment by the Company in the nature of either severance or termination pay or othercompensation of any kind. 3.As of the Termination Date, you have vested options to purchase 3,200 shares of Common Stock ("Common Stock") of J. CrewGroup, Inc. ("Parent") at $10.00 per share, 8,800 shares of Common Stock at $11.00 per share, 3,000 shares of Common Stock at$19.18 per share, 4,000 shares of Common Stock at $10.65 per share and 3,750 shares of Common Stock at $6.82 per share(collectively, the "Vested Options"). In addition, you have unvested options to purchase 800 shares of Common Stock at $10.00 pershare, 2,200 shares of Common Stock at $11.00 per share, 2,000 shares of Common Stock at $19.18 per share, 6,000 shares ofCommon Stock at $10.65 per share and 16,250 shares of Common Stock at $6.82 per share (collectively, the "Unvested Options").You acknowledge that all of the Vested Options will terminate 90 days after the Termination Date and that all of the Unvested Optionsterminate effective immediately, in accordance with the provisions of your stock option agreements with Parent and the J. CrewGroup, Inc. 1997 Stock Option Plan, as amended (the "Option Plan"). All of the shares of Common Stock that may be acquired byyou pursuant to your vested options shall be subject to the Stockholders' Agreement attached to the Option Plan as Exhibit B. 4.By signing this Agreement, you agree that in exchange for the consideration set forth herein, you hereby voluntarily, fully andunconditionally 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, planadministrators, officers and agents, individually and in their official capacities (collectively, the "Releasees"), from any and allcharges, actions, causes of action, demands, debts, dues, bonds, accounts, covenants, contracts, liabilities, or damages of anynature whatsoever, whether now known or claimed, to whomever made, which you have or may have against any or all of theReleasees for or by reason of any cause, nature or thing whatsoever, up to the present time, arising out of or related to youremployment with the Company or the termination of such employment, including, by way of examples and without limiting thebroadest application of the foregoing, any actions, causes of action, or claims under any contract or federal, state or local decisionallaw, 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 perceiveddisability, age, sex, race or any other factor (including, without limitation, any claim pursuant to Title VII of the Civil Rights Act of1964, Americans with Disabilities Act of 1990, the Age Discrimination in Employment Act of 1967, as amended, the Family andMedical Act of 1993, the Equal Pay Act of 1963, the Fair Labor Standards Act, the State, City and local laws of New York, and theequal employment law or laws of the state and/or city in which you work), any claim pursuant to any other applicable employmentstandards 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 withan 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 tocommence 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 toany 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 limityou from enforcing your rights under this Agreement, and in the event any action is commenced to enforce your rights under thisAgreement, each party shall bear its own legal fees and expenses; and provided further, however, that this is not intended to interferewith your right to file a charge with the Equal Employment Opportunity Commission ("EEOC") in connection with any claim youbelieve you may have against any Releasee. However, by signing this Agreement, you agree to waive any right to recover in anyproceeding you may bring before the EEOC (or any state human rights commission) or in any proceeding brought by the EEOC (orany 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 itstermination.5.You acknowledge that the payments described in Section 2 above that you are receiving in connection with the foregoing release are inaccordance with your letter agreement, dated June 18, 2001 ("Letter Agreement"). 6.You hereby agree and acknowledge that you shall be bound by and comply with the restrictive covenants provided in Section 3 of theLetter Agreement (the "Restrictive Covenants"), and that such Restrictive Covenants are hereby made part of this Agreement as ifspecifically restated herein and that the payments described in Section 2 above that you are receiving are subject to and contingentupon your compliance with Restrictive Covenants. You also agree to be available to answer any questions and otherwise cooperatewith the Company as reasonable during the Severance Period to assist in any necessary transitions. 7.You acknowledge and agree that, notwithstanding any other provision of this Agreement, if you breach any of your obligations underthis Agreement or any Restrictive Covenant, (a) you will forfeit your right to receive the payments and benefits described in Section 2above (to the extent the payments were not theretofore paid) and the Company shall be entitled to recover any payments already madeto 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, ifexercised as of the date of such breach, you shall immediately reimburse the Company for the profit upon exercise (such profitcalculated as the difference between the (i) greater of either the Fair Market Value (as defined in the Option Plan) of a share ofCommon Stock on the date of exercise or the amount paid by the2Company to you per share of Common Stock for the purchase of the shares acquired upon exercise, and (ii) exercise price, times thenumber of options exercised).8.You hereby agree that the breach of any Restrictive Covenant may cause the Company to suffer irreparable harm for which moneydamages would not be an adequate remedy and therefore, if you breach a Restrictive Covenant, the Company would be entitled totemporary and permanent injunctive relief in any court of competent jurisdiction (without the need to post any bond) without prejudiceto 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, respondor 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 General Counsel ofyour receipt of such process or request to testify or produce documents; and (3) provide to the Company's General Counsel byovernight delivery service a copy of all legal papers and documents served upon you. You further agree that in the event you areserved with such process, you will meet and confer with the Company's designee(s) in advance of giving such testimony orinformation. You also agree to cooperate fully with the Releasees in connection with any existing or future litigation against theReleasees, whether administrative, civil or criminal in nature, in which and to the extent the Releasees deem your cooperationnecessary. The Company agrees to reimburse you for your reasonable out-of-pocket expenses incurred in connection with theperformance 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 andrepresentatives. 12.This Agreement, together with your stock option agreements with Parent and the Option Plan, constitute the entire understanding ofthe Company and you with respect to the subject matter hereof and supersedes all prior understandings, written or oral. The terms ofthis Agreement may be changed, modified or discharged only by an instrument in writing signed by the parties hereto. A failure of theCompany or you to insist on strict compliance with any provision of this Agreement shall not be deemed a waiver of such provision orany other provision hereof. If any provision of this Agreement is determined to be so broad as to be unenforceable, such provisionshall 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 Agreementand has contributed to its revision. Accordingly, the rule of construction to the effect that ambiguities are resolved against the draftingparty shall not be employed in the interpretation of this Agreement. Rather, the terms of this Agreement shall be construed fairly as toboth 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 whichcounterpart, when so executed and delivered, shall be deemed to be an original and all of which counterparts, taken together, shallconstitute 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 belegally bound thereby.317.You acknowledge that you have received this Agreement on or before October 7, 2004. You understand that you may considerwhether to agree to the terms contained herein for a period of twenty-one (21) days after the date hereof. However, the operation of theprovisions of Sections 2 through 4 above may be delayed until you execute this Agreement and return it to the Company and itbecomes effective as provided below. You acknowledge that you have consulted with an attorney prior to your execution of thisAgreement 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 hereofby indicating in writing to the Vice President of Human Resources your intention to revoke. If you exercise your right to revokehereunder, you shall forfeit your right to receive any of the payments and other benefits provided for herein, and to the extent suchpayments or benefits have already been made, you agree that you will immediately reimburse the Company for the value of suchpayments and benefits. If the foregoing correctly reflects our understanding, please sign the enclosed copy of this letter agreement, whereupon it will become abinding agreement between us. J. CREW OPERATING CORP. By:/s/ Lynda MarkoeLynda MarkoeVice PresidentHuman ResourcesAgreed to and accepted:By:/s/ Paul FuscoPaul Fusco Dated: 10/18, 2004Acknowledgment STATE OF New York) ss:COUNTY OF New York) On the 18th day of October, 2004, before me personally came Paul Fusco who, being by me duly sworn, did depose and say that heresides at [address omitted], and did acknowledge and represent that he has had an opportunity to consult with attorneys and other advisersof his choosing regarding the Agreement set forth above, that he has reviewed all of the terms of the Agreement and that he fully understandsall of its provisions, including without limitation, the general release and waiver set forth therein./s/ ROSEMARY RODRIGUEZ Notary Public Date:10/18/04 4QuickLinksEXHIBIT 10.17Exhibit 10.18 UNIVERSITY VILLAGE LEASE AGREEMENT THIS LEASE is made and entered into this 14th day of October, 2003 between UNIVERSITY VILLAGE LIMITED PARTNERSHIP, a Washingtonlimited partnership (“Landlord”), whose address is 2673 Northeast University Village Mall, Suite 7, Seattle, Washington 98105, and GRACE HOLMES,INC., a Delaware corporation (“Tenant”), whose address is 770 Broadway, New York, NY 10003. Landlord owns the real property and improvements located thereon as described in Subsection 2.1 (“University Village”). Landlord desires to lease certain space in University Village more particularly described on Exhibit D attached hereto and by this referenceincorporated herein (the “Leased Premises”) to Tenant and Tenant desires to take and lease such space from Landlord. NOW THEREFORE, for and in consideration of the rents reserved hereunder, the terms and conditions hereof and other good and valuableconsideration, the receipt and sufficiency of which is hereby acknowledged, Landlord hereby leases to Tenant and Tenant leases from Landlord, the LeasedPremises upon the following terms and conditions: 1. LEASE TERMS AND EXHIBITS. The following terms as used herein shall have the meanings set forth below unless specifically modified elsewhere in this Lease: 1.1 Leased Premises: That certain space in University Village known as Space “19” and more particularly described on Exhibit D attachedhereto and by this reference incorporated herein. 1.2 Minimum Rent: Years 1-5: $40.00 per square foot of the Area of Leased Premises per annumYears 6-10: $44.00 per square foot of the Area of Leased Premises per annum 1.3 Lease Term: Ten (10) Lease Years plus a “partial year” (if any) from the Commencement Date to January 31 of the following year. TheLease Term shall commence as provided in Section 3 below, and shall end on the January 31 next following the 10th anniversary of the Commencement Date(“Expiration Date”). 1.4 Area of Leased Premises: Approximately 7,400 square feet, consisting of 5,700 square feet on the ground level and 1,700 square feet ofmezzanine space, and containing approximately 45 lineal feet of frontage. The exact size of the Leased Premises will be determined following remeasurementpursuant to Section 20.4 below.  1.5 Tenant’s Fraction: A fraction, the numerator of which is the ground level portion of the Area of Leased Premises and the denominator ofwhich is the sum of the numerators (gross leasable areas) used in all leases in University Village (whether or not leases are actually in effect for all of suchspace) in determining University Village Expenses payable by the tenants under such leases, provided the same shall include not less than 90% of the totalleasable retail area in University Village. 1.6 Percentage Rent Rate: Five Percent (5%) 1.7 Percentage Rent Period: Lease Year. 1.8 Lease Year: The twelve month period ending each January 31 during the Lease Term. 1.9 Retail Trade Area: [none] 1.10 Security Deposit: [none] 1.11 Permitted Use: Tenant shall use the Leased Premises solely for the retail sale of men’s, women’s and children’s ready-to-wear apparel,accessories, footwear, outerwear, related items sold under the J. Crew label, facial and body care products and home furnishings (the display of which shallnot be more than 30% of the retail sales floor area), and for the retail sale of any other item featured in any catalogue offered by Tenant, its parent(s), affiliate(s)or subsidiary(ies) and any other item manufactured by or for Tenant, its parent(s), affiliate(s) or subsidiary(ies) provided such other item (i) is offered for salein the majority of J. Crew retail stores, (ii) carries the J. Crew name/label and (iii) is complementary in nature to the J. Crew retail store at the time of theCommencement Date, and for no other purpose whatsoever. 1.12 Tenant’s Trade Name: J. Crew 1.13 Name and Address of Tenant’s Guarantor: [none] 1.14 Default Rate: The “Default Rate” is that rate of interest per annum equal to two percent (2%) over the prime rate of interest charged,quoted or published by Bank of America or its successor or, if Bank of America or its successor should fail to publish such information, by a comparablebank. 1.15 Exhibits: The Exhibits attached to this Lease are incorporated in this Lease by this reference. Each party agrees to perform anyobligations on its part stated in any of such Exhibits: Exhibit A. Legal Description of University Village Exhibit B. Site Plan of University Village 2 Exhibit C. Description of Landlord’s and Tenant’s Work Exhibit D. Plan of Leased Premises (which shall establish the floor area (“Floor Area”) contained therein). Exhibit 15.2 Similarly Situated Tenants 2. PREMISES. 2.1 University Village. (a) Definition. Landlord is the owner of University Village, which is legally described in Exhibit A and depicted in the Site Plan ofUniversity Village attached hereto as Exhibit B. University Village shall include any adjacent property acquired by the Landlord from time to time during theterm of this Lease, whether owned or leased by Landlord as a tenant under a ground lease or sublease, or which is otherwise operated on an integrated basiswith University Village, whether or not the same is owned or controlled by Landlord. (b) No Representations. The depiction of University Village in Exhibit B does not constitute a representation, covenant orwarranty of any kind by Landlord, and subject to Section 13.2 below, Landlord reserves the right from time to time to change the size and dimensions ofUniversity Village; locate, relocate, alter and/or modify the number and location of buildings, building dimensions, the number of floors in any of thebuildings, parking areas, driveways and entrances and exits to and from adjoining streets and ways, store dimensions, identity and type of other stores andtenancies and the common areas located from time to time in or on University Village. The term “University Village” as used herein shall refer to UniversityVillage described and depicted in Exhibits A and B, respectively, and as so changed, relocated, altered and/or modified. Landlord further agrees that it willmake no change in the layout of the Leased Premises or University Village which will materially reduce the size, dimensions or usable area of the LeasedPremises or materially adversely affect access to the Leased Premises. Landlord will make reasonable efforts to minimize the impact of any noise, dust, dirtand the like caused by Landlord’s improvements or alterations on Tenant’s business. 2.2 Leased Premises. Landlord hereby leases and demises to Tenant, and Tenant hereby accepts from Landlord, subject to and with thebenefit of the terms and provisions of this Lease, the Leased Premises depicted in Exhibit D. The gross leasable area of the Leased Premises is as stated inSection 1.4 above. 3. TERM. 3.1 Lease Term. This Lease shall be for the term stated in Section 1.3 above (the “Term” or “Lease Term”) and shall commence on the earlierof (a) one hundred twenty (120) days following the latest to occur of (i) Landlord’s approval of Tenant’s plans for Tenant’s Work (defined below) providedTenant submits plans for Tenant’s Work to Landlord no later than November 1, 2003 and thereafter timely responds to comments from Landlord, (ii)Landlord’s delivery of the 3 Leased Premises to Tenant in a broom clean condition, free of all violations and the personal property and signage of any previous occupant, with SubstantialCompletion of Landlord’s Work (as defined in Section 3.2(a) below) and (iii) the date Tenant receives a building permit for the construction of Tenant’s Workprovided Tenant submits plans for Tenant’s Work to the City of Seattle no later than December 1, 2003 and thereafter timely responds to comments from theCity of Seattle or (b) the day that Tenant opens for business (the “Commencement Date”). It is anticipated that Landlord will deliver possession of the LeasedPremises to Tenant on March 1, 2004 (the “Anticipated Delivery Date”), however, Landlord’s failure to do so shall not result in any liability to Landlord orotherwise affect Tenant’s obligations under this Lease except as otherwise set forth below. If for any reason Landlord is unable to deliver possession of theLeased Premises on the Anticipated Delivery Date, Landlord must provide written documentation to Tenant no later than forty-five (45) days prior to theAnticipated Delivery Date. If Landlord is unable to deliver possession of the Leased Premises on the Anticipated Delivery Date and Landlord fails to providesuch notification to Tenant when required, then Landlord shall pay to Tenant, as liquidated damages, $750.00 per day for each day of delay (the “Late Fee”). If such delay continues beyond July 1, 2004, then, in addition to any Late Fee that may be due Tenant, Tenant shall have the right to terminate this Lease uponnotice to Landlord delivered no later than the earlier of (i) July 15, 2004 and (ii) the date of Landlord’s Delivery of the Leased Premises to Tenant. In the eventTenant terminates this Lease in accordance with the preceding sentence, Landlord shall reimburse Tenant for the reasonable out-of-pocket costs incurred byTenant in preparation and/or review of Tenant’s plans and specifications for the Leased Premises. In no event shall Tenant be required to accept delivery ofpossession of the Leased Premises prior to the Anticipated Delivery Date. Notwithstanding anything to the contrary contained herein, Tenant shall not be required to begin construction or initially open for business in theLeased Premises unless (a) tenants occupying ninety percent (90%) or more of the retail portion of University Village and (b) Crate & Barrel, Apple, Victoria’sSecret and Talbots (the “Named Tenants”) have signed leases and are scheduled to open no later than sixty (60) days following the date Tenant is required toopen for business hereunder. Landlord shall verify the foregoing in writing and provide a leasing plan showing the names, square foot areas and opening datesof the Named Tenants no later than forty-five (45) days prior to the date Tenant is scheduled to commence construction. 3.2 Landlord’s and Tenant’s Work. (a) If the Leased Premises are not presently complete, Landlord shall deliver to Tenant, and Tenant agrees to accept from Landlord,possession of the Leased Premises forthwith upon Substantial Completion of Landlord’s Work as described in Exhibit C hereto (“Landlord’s Work”). Landlord shall, at its sole cost and expense, as soon as it is reasonably possible after the execution of this Lease, commence and pursue to completion theLandlord’s Work shown on and/or described in the attached Exhibit C. “Substantial Completion of Landlord’s Work” occurs when Landlord, or its projectarchitect, notifies Tenant in writing that the Leased Premises are substantially complete to the extent of Landlord’s Work specified in Exhibit C hereof, with theexception of such work as Landlord cannot complete until Tenant performs necessary portions of its work. Tenant shall commence the installation of fixtures, 4 equipment and any of its work as set forth in Exhibit C (“Tenant’s Work”) promptly upon Substantial Completion of Landlord’s Work, and Tenant shalldiligently pursue such work to completion. There shall be no chargebacks to Tenant for the cost of any item included in Landlord’s Work and/or performedprior to delivery of the Leased Premises to Tenant (i.e., so-called “back charges”) and Tenant shall not be obligated to pay any additional construction chargesor fees such as, without limitation, barricade charges, freight elevator fees, dumpster or other trash fees, sprinkler system shut-down fees or other suchcharges for work which is not included in Tenant’s Work. Prior to installation of a temporary barricade in front of the Leased Premises, Tenant shall provideLandlord with barricade appropriate artwork for an “opening soon” advertisement thereon. (b) Punchlist. Not later than thirty (30) days after Substantial Completion of Landlord’s Work, Tenant shall deliver to Landlord a“punchlist” of defects in Landlord’s Work. Landlord shall promptly cure such defects at Landlord’s sole cost and expense. Latent defects appearing as aresult of Landlord’s Work shall not be deemed waived until the first anniversary of the Commencement Date. Upon the first anniversary of theCommencement Date, all latent defects shall be waived unless Tenant shall have given notice of the same to Landlord prior to such first anniversary. However, Landlord shall warrant all repairs made in response to any notice of latent defects within the one (1) year period for a period of one (1) year from thedate of repair. Notwithstanding such waiver, Landlord’s obligations to make repairs set forth explicitly elsewhere in this Lease shall not be subject to the one-year limitation described in this paragraph. 3.3 Statement as to Lease Term. When the Commencement Date has been determined as provided in Section 3.1, Landlord and Tenantshall execute, acknowledge and deliver a written statement specifying the Commencement Date and Expiration Date. 4. RENT. 4.1 Minimum Rent. Tenant shall pay to Landlord, without notice or demand and without any set-off or deduction whatsoever (except as setforth in Section V of Exhibit C attached hereto), the Minimum Rent set forth in Section 1.2 above (the “Minimum Rent”), which shall be paid in advance onor before the first day of each calendar month of the Lease Term. If the Lease Term commences on a day other than the first day of a calendar month or expireson a day other than the last day of a calendar month, the Minimum Rent for such month shall be paid together with the Minimum Rent for the first fullmonth, and shall be a prorated portion of the monthly Minimum Rent, based upon a thirty (30) day month. Notwithstanding anything to the contrarycontained herein, provided Tenant is not then in default of this Lease beyond any applicable notice and cure periods, Minimum Rent shall be abated (i) for theone hundred eighty (180) day period following Landlord’s delivery of the Leased Premises to Tenant and (ii) during the months of January and February,2005. (a) Future Expansion. [omitted] (b) Renovation or Expansion of Common Areas. [omitted] 5 4.2 Landlord’s Security. [omitted] 4.3 Percentage Rent. (a) Percentage Rent. In addition to the Minimum Rent to be paid by Tenant pursuant to Section 4.1 above, Tenant shall pay toLandlord Percentage Rent in a sum equal to five percent (5%) of the amount of Tenant’s Gross Sales as defined below, during each Lease Year of the LeaseTerm in excess of the “Breakpoint.” Commencing with the first month of the Lease Year when total Gross Sales for the Lease Year exceed the applicableBreakpoint for such Lease Year, Tenant shall pay to Landlord, within twenty (20) days after the end of each calendar month, the Percentage Rent for suchcalendar month. The Breakpoint during any Lease Year shall be the Minimum Rent payable with respect to such Lease Year divided by .05 (the “NaturalBreakpoint”). For example if the Minimum Rent is $296,000, then the Breakpoint is $296,000/.05 = $5,920,000. It is acknowledged by the parties that theBreakpoints applicable to a given full lease year are computed by dividing the Minimum Rent payable by Tenant for that same Lease Year by five percent(5%). All computation and/or reconciliation of Percentage Rent payable by Tenant for a full Lease Year shall be determined in accordance with and governedby the foregoing sentence. Notwithstanding anything to the contrary herein, for the purposes of calculating the Breakpoint only, Minimum Rent shall bedeemed paid in full during any portion of the rent abatement period described in Section 4.1 that Tenant is open for business in the Leased Premises. Percentage Rent for any partial Lease Year shall be established by multiplying the percentage rental due for the twelve month period following theCommencement Date with respect to a partial lease year at the beginning of the term or the 12 month period preceding the expiration date with respect to apartial lease year at the end of the term by a fraction, the numerator of which shall be the number of days in the partial lease year and the denominator ofwhich shall be 365. (b) Tenant’s Statements Regarding Gross Sales. Tenant shall provide Landlord with an unaudited monthly statement of GrossSales within twenty (20) days after the end of each calendar month, certified by Tenant to be correct, which shall show Gross Sales and an itemization of anyexclusions or deductions therefrom for such month, as well as year-to-date amounts for the current Lease Year. If any Percentage Rent is due for such month,the payment shall accompany such statement. In addition to such regular monthly statements, Tenant shall provide an annual statement within sixty (60)days after the end of each Lease Year, which shall show the total amount of Gross Sales for such Lease Year, and shall be certified to be true, complete andcorrect by Tenant, or in Landlord’s reasonable discretion following occurrence of an Event of Default as a result of Tenant’s failure to comply with Section4.3, an independent certified public accountant reasonably satisfactory to Landlord. If such annual statement shows that Tenant underpaid Percentage Rentfor such Lease Year, Tenant shall include the additional amount, together with interest at the Default Rate with such statement, and if such statement showsthat Tenant overpaid Percentage Rent, Landlord shall provide a credit or refund. (c) Tenant’s Records. Tenant shall keep full, complete and proper books, 6 records and accounts prepared in accordance with generally accepted accounting principles (collectively, “Tenant’s Records”) of its daily Gross Sales in,upon, or from the Leased Premises. Original sales records shall be separately maintained for the Leased Premises and shall include: (i) daily dated sealed,continuous, cash register tapes, (ii) serially numbered sales slips, (iii) settlement report sheets of transactions with subtenants, concessionaires and licensees,(iv) bank statements, (v) general ledger or summary record of all receipts and disbursements from operations in, at or from the Leased Premises, (vi) state andlocal sales and use tax returns, and (vii) such other records that would normally be kept pursuant to generally accepted accounting principles, or as theLandlord may reasonably require in order to determine Gross Sales hereunder. Tenant shall be permitted to use such cash registers and maintain its businessrecords in the same manner as all of Tenant’s other stores. Landlord and its agents and employees shall have the right at any and all reasonable times uponfourteen (14) days prior written notice to Tenant, to examine and inspect all of the books and records of Tenant, including any sales tax reports pertainingexclusively to the business of Tenant conducted in, upon or from the Leased Premises, for the purpose of investigating and verifying the accuracy of anystatement of Gross Sales, but in no event more than one (1) time per year. Tenant may excise any portions of such sales tax reports pertaining to other storesowned or operated by Tenant. Tenant shall keep all such records for a period of three (3) years. All records shall be maintained by Tenant on the LeasedPremises, or at the corporate office of Tenant. (d) Audit. Landlord may from time to time (but not more frequently than once each calendar year), upon fourteen (14) days priorwritten notice to Tenant, cause a complete audit or examination to be made of Tenant’s Records and such books and records of any subtenant, licensee orconcessionaire for all or any part of the three Lease Years immediately preceding such notice. During such audit, Landlord or its authorized representativesshall have full and free access to Tenant’s Records and the right to require that Tenant, its agents and employees furnish such information or explanation withrespect to such items as may be necessary for a proper examination and audit thereof. Tenant may, however, excise any portions of tax returns pertaining toother stores owned or operated by Tenant. If such audit or examination discloses that any of Tenant’s statements of Gross Sales understates Gross Sales madeduring any Lease Year by three percent (3%) or more which resulted in underpayment of Percentage Rent, or if Tenant shall have failed to furnish Landlordany monthly Gross Sales statements during any Lease Year or shall have failed to prepare and maintain Tenant’s Records as required herein, Tenant shall payLandlord the reasonable cost of such audit or examination, including reasonable travel and related expenses, and any deficiency in Percentage Rent, withinterest at the Default Rate. If such audit or examination shall disclose an understatement of more than ten percent (10%) which results in underpayment ofPercentage Rent, upon the second occurrence of such understatement of more than 10% which results in underpayment of Percentage Rent, Landlord shall alsohave the right to cancel this Lease by written notice given to Tenant within six (6) months after such audit. Landlord’s acceptance of Percentage Rent shall bewithout prejudice to the Landlord’s examination, audit and other rights hereunder. Any information obtained by Landlord pursuant to its audit shall be treatedas confidential and shall not be disclosed except (i) in connection with litigation with Tenant, (ii) to prospective purchasers or lenders of University Village and(iii) as may be required by law. 7 (e) Gross Sales Defined. “Gross Sales” shall mean the entire amount of the actual sale price, whether for cash, credit or otherwise,of all sales of goods and services and all other income and receipts whatsoever of all business conducted at, on or from the Leased Premises, including,without limitation: (i)mail, telephone, facsimile, E-mail, Internet and other orders originating in, at, from or arising out of the use of the Premises,(ii)deposits not refunded to purchasers(iii)gross receipts from vending and game machines, except those for exclusive use of employees (inclusion of this definition shallnot to be construed to authorize vending or game machines)(iv)sale price of gift and merchandise certificates(v)payments from other parties for shelf or advertising space at or respecting the Leased Premises(vi)the full value of all consideration other than money received(vii)all other gross income or receipts from any business or operation at, on or from the Leased Premises(viii)Gross Sales by any sublessee, concessionaire or licensee. However, Gross Sales shall not include (but Tenant’s Records shall itemize): (a)returns to shippers or manufacturers(b)any cash or credit refunds made upon any sale in or from the Leased Premises where the merchandise is returned by thecustomer,(c)any sales, use or excise tax imposed by any duly constituted governmental authority (provided that no income or franchise tax,capital stock tax, tax based upon assets or net worth, or similar tax shall be deducted from Gross Sales)(d)sales to employees at a discount (not to exceed 2.5% of Gross Sales)(e)the exchange of merchandise between the stores and warehouses of Tenant, if any, where such exchange of merchandise is madesolely for the convenient operation of the business of Tenant and not for the purpose of consummating a sale that was made in orfrom the Leased Premises(f)postage, parcel post freight, express or other delivery charges paid in connection with any sale(g)discounts, allowances and refunds to customers(h)layaways until the sale is completed or the deposit abandoned by the customer(i)bad debts written off by Tenant for income tax purposes (not to exceed in the aggregate 1% of Gross Sales), provided that if latercollected, the amount shall be included in Gross Sales in the year in which collected(j)luxury and excise taxes levied upon the purchase of merchandise manufactured by Tenant(k)bulk sales of inventory, including damaged or aged merchandise, sales of fixtures and equipment, and sales to jobbers(l)charges for repairs, alterations, delivery and gift wrapping of merchandise, 8 (m)proceeds of claims for damaged merchandise(n)catalog sales of goods not stocked on the Leased Premises, not to exceed three percent (3%) of Gross Sales(o)workroom, alteration, shipping and delivery charges, and charges for check cashing and wrapping, at no profit to Tenant No deduction shall be allowed for any uncollected or uncollectible amounts or reserves therefor, nor for cost of products or services sold, or other costs,charges or expenses of purchasing, financing, selling, transportation, overhead or taxes except as set forth above. (f) No Partnership. It is understood and agreed that the fixing of a portion of the rental on a percentage of the sales of the businessto be done by Tenant does not create a partnership or joint venture relationship between the parties hereto, that Landlord assumes no liability hereunder for theoperation of the business of Tenant, and that the provisions with reference to rents herein are for the sole purpose of fixing and determining the total rents to bepaid by Tenant to Landlord. (g) No Waiver. The acceptance by Landlord of any monies paid to Landlord by Tenant pursuant to this Section 4.3 shall not be anadmission by Landlord of the accuracy of any monthly or annual statement furnished by Tenant during the month or year reported therein, or of thesufficiency of the amount of any such payment. Landlord shall be entitled to inspect the books and records of Tenant and receive any additional sums duefrom Tenant disclosed by such inspection, as described above. (h) No Diversion. To ensure that the Leased Premises will produce an optimum volume of gross sales, Tenant covenants not todivert elsewhere any business, trade or commerce which would ordinarily be transacted by Tenant at, in, on, from or arising out of the Leased Premises. (i) Opening for Business; Continuous Operations. Because of the difficulty and impossibility of determining Landlord’sdamages by way of loss of anticipated Percentage Rent from Tenant or from other tenants or occupants of University Village or by way of loss of value of theproperty, if Tenant, subject to Section 30.12 hereof, shall fail to take possession of the Leased Premises and open for business within thirty (30) days of thetime provided herein, or shall abandon the Leased Premises, cease operating or conducting Tenant’s business therein, or fail to maintain business hours inaccordance with the terms of this Lease following 48 hours notice from Landlord, then Landlord shall have the right, in addition to any or all other rights orremedies under this Lease or at law or in equity, to collect not only Minimum Rent and all other items of Additional Rent herein, but also Additional Rent equalto Two Hundred Fifty Dollars ($250.00) per day for each day or portion thereof Tenant is required to be open and is not open, subject to Section 30.12 hereof(provided that in the case where Tenant has opened its store to the public, but is late opening on a particular business day, the $250 Additional Rent shall notapply until the second such late opening following notice by Landlord to Tenant of the first late opening each Lease Year). Such Additional Rent shall bedeemed to be liquidated damages in lieu of any Percentage Rent that might have been paid during such period. 9 Acceptance by Landlord of such liquidated damages shall not be deemed permission for Tenant to continue such violation, and shall not preclude Landlordfrom seeking any other remedy for such violation, including, but not limited to, specific performance or termination of this Lease. 4.4 Tenant to Share Expenses. It is intended that this shall be a “net lease” in that tenants in University Village collectively shall pay alloperating, repair and maintenance costs and expenses of any kind or nature. In addition to the Minimum Rent, Tenant shall pay to Landlord, as AdditionalRent (defined below), in the manner provided in Subsection 4.4(e) below, Tenant’s share of all operating, maintenance and repair costs, charges and expensesincurred by Landlord with respect to University Village, except as otherwise specified herein, including, without limitation, the items described in Subsections4.4(a) through (d) below (herein collectively called “Other Charges”). For purposes of this Section, the term “Accounting Period” shall mean each consecutivetwelve (12) month period during the Lease Term commencing July 1 and expiring the following June 30 or, if so determined by Landlord at any time during theTerm of this Lease, the calendar year. (a) Tenant’s Share of Taxes. Tenant shall pay to Landlord, as Additional Rent, in the manner provided in Section 4.4(e),Tenant’s share of the total amount of real estate taxes (“Taxes”) on University Village. For purposes of this Section, the term “Taxes” shall be an amountequal to all real estate taxes and assessments (including but not limited to local improvement district, road improvement district and water improvement districtassessments provided such assessments do not relate to the initial development of University Village), if any, that are levied upon or assessed againstUniversity Village during the Lease Term. Tenant’s share of Taxes shall be an amount equal to the total Taxes due and payable during each calendar year ofthe Lease Term with respect to the lands and improvements comprising University Village, deducting any contribution toward Taxes and Insurance by otherparties who are not paying a proportionate share of same, multiplied by Tenant’s Fraction; provided, however, that if any tenants in any building or buildingspay real estate taxes directly to any taxing authority as may be provided in their leases, their square footage shall not be deemed a part of the denominator usedfor purposes of computing Tenant’s share of Taxes. Tenant shall not be required to reimburse Landlord for taxes based upon the following: (1) rent taxes(except to the extent that same are directly assessed against the tenants by the taxing authority, (2) gross receipts taxes levied on gross receipts of landlord, (3)income taxes, (4) franchise taxes, (5) transfer taxes, (6) inheritance taxes, and (7) capital stock taxes. Tenant shall not be obligated to reimburse Landlord forany penalty or interest for the late payment by Landlord of taxes. Landlord shall promptly pay or credit to Tenant, Tenant’s proportionate share of anyrefunds or rebate of Taxes after deducting reasonable expenses incurred by Landlord in obtaining same. (b) Tenant’s Share of Insurance. Tenant shall pay to Landlord, as Additional Rent, in the manner provided in Section 4.4(e),Tenant’s share of the cost of insurance for University Village. The cost of insurance (“Insurance”) shall include all insurance premiums for fire, all riskendorsement coverage, earthquake, liability, loss of rental income, and any other insurance that Landlord deems necessary or desirable to cover UniversityVillage. Tenant’s share of Insurance shall be an amount equal to the total of such premiums paid during each Accounting Period or portion thereof of the LeaseTerm, after deducting any contribution toward Taxes and 10 Insurance by other parties who are not paying a proportionate share of same, multiplied by Tenant’s Fraction. (c) University Village Expenses. Tenant shall pay to Landlord, as Additional Rent, in the manner provided in Section 4.4(e),Tenant’s share of the operating costs (“University Village Expenses”) of University Village, including all common areas and facilities (collectively, the“Common Area”). Tenant’s share of University Village Expenses shall be an amount equal to the total University Village Expenses during each actualAccounting Period, or portion thereof, during the Lease Term multiplied by Tenant’s Fraction. “University Village Expenses” shall mean, without duplication, all expenses, costs and amounts of every kind and nature (to the extent not a capitalexpense) which Landlord shall pay during any calendar year any portion of which occurs during the Term in connection with the management, repair,maintenance, replacement, insurance and operation of University Village, including, without limitation, any amounts paid for: (a)utilities serving the common areas, including but not limited to electricity, power, gas, steam, oil or other fuel, water, sewer, lighting,heating, air conditioning and ventilating(b)permits, licenses and certificates necessary to operate and manage University Village, and costs of complying with other legalrequirements, including, without limitation, the Americans with Disabilities Act, 42 U.S.C. 12101 et seq. and the regulationspromulgated thereunder(c)supplies, materials, tools, equipment, and vehicles used in the operation, repair, maintenance and security, floor care and cleaning,landscaping, and other services for University Village, including rental, installment purchase and financing agreements therefor andinterest thereunder(d)reasonable accounting, legal, inspection, consulting and other services for services performed for University Village(e)wages, salaries, bonuses, and other compensation and benefits for any on-site manager, personnel and other parties engaged in theoperation, maintenance or security of University Village, and employer’s Social Security taxes, unemployment taxes or insurance, andany other taxes which may be levied on such wages, salaries, compensation and benefits, data or payroll processing expenses relatingthereto (if the manager or other personnel are located off-site and handle other properties, the foregoing expenses shall be allocatedappropriately between University Village and such other properties)(f)payments under any easement, operating agreement, declaration, restrictive covenant, or instrument pertaining to the sharing of costs inany development of which University Village is part(g)alarm monitoring and security service, janitorial service, trash removal, removal of ice and snow (and salting and sanding in connectiontherewith)(h)parking surcharges or fees that may result from any environmental or other law or guideline, and the cost of obtaining, providing andoperating public transportation or shuttle bus systems to bring customers or workers to or from University Village if 11 required by such laws or guidelines, or if otherwise deemed desirable by Landlord(i)the costs of operating and maintaining any on-site office at University Village, including without limitation, the fair rental value thereof,telephone charges, postage, stationery and photocopying expenses(j)music programs and equipment, whether rented or purchased(k)telephone directory listings for University Village(l)appropriate reasonable reserves for operation of University Village and for covering uninsured portions, including deductible amounts, ofcasualty damage and general liability claims relating to the University Village(m)operation, maintenance, repair, installation and replacement (to the extent not a capital expense), inspection, testing, painting, decoratingand cleaning of: (i) elevators, escalators, fire exits, pedestrian bridges, skywalks, skybridges, arrival zones and stairways, (ii)sidewalks, curbs, gutters, guardrails, bumpers, fences, flagpoles, flags, banners, bicycle racks, University Village identification andpylon signs, directional signs, hand-out pamphlet directories, traffic signals and markers, including those located off-site but installedfor the benefit of University Village, (iii) parking structures, parking lots, loading and service areas and driveways (including sweeping,cleaning, re-striping, repairing, sealing, re-surfacing and replacement), (iv) storm and sanitary drainage systems, including disposalplants, lift stations and detention ponds and basins, (v) irrigation systems, (vi) any Systems and Equipment, (which shall mean anyplant, machinery, transformers, ducts, cables, wires, and other equipment, facilities, and systems designed to supply light, heat,ventilation, air conditioning and humidity or any other services or utilities, or comprising or serving as any component or portion of anyelectrical, gas, steam, plumbing, water, sewer, sprinkler, communications, alarm, security, or fire/life/safety systems or equipment, orany other mechanical, electrical, electronic, computer or other systems or equipment for University Village and depreciation relatingthereto, (except to the extent that any of the same serves any tenant exclusively or is subject to shared tenant use), (vii) exterior planting,replanting and replacement of flowers, shrubbery, plants, trees, grass, sod, plants in hanging baskets, and other landscaping, (viii) allportions of buildings, both interior and exterior, in the University Village, including without limitation, Common Areas and fixtures,equipment and other items therein or thereon, including but not limited to floors, floor coverings, corridors, ceilings, foundations, walls,wall-coverings, restrooms, lobbies, canopies, skylights, trash and ash cans and receptacles, trash compactors, planters, waterfalls,fountains, pools, benches, furniture, doors, locks and hardware, windows, glass and glazing, (ix) gutters and downspouts, roofflashings and roofs (including repairs and replacements)(n)an amount equal to fifteen percent (15%) of all of the foregoing costs and expenses (excluding insurance premiums, utilities and taxes) asa liquidation of Landlord’s general overhead (which amount shall be in addition to the compensation and related expenses for the managerand other aforementioned expenses). The foregoing provision is for definitional purposes only and shall not be construed to impose anyobligation upon Landlord to incur such expenses. The following items are to be excluded from such operating expenses: 12 A)Costs attributable to seeking and obtaining new tenants as well as retaining existing tenants - such as advertising, brokeragecommissions, architectural, engineering, attorney’s fees, renovations and improvements; B)Costs that are reimbursed to the Landlord by tenants as a result of provisions contained in their specific leases; C)Costs for alterations and additions that are in the nature of capital improvements; D)Costs for capital improvements and repairs; E)Costs incurred due to violations by the Landlord of any of the terms and conditions of any leases in the center; F)Interest on any mortgages of the Landlord and rental under any ground or underlying lease; G)Rentals and other related expenses incurred in leasing air conditioning systems, elevators or other equipment ordinarilyconsidered to be of a capital nature, except equipment used in providing janitorial services not affixed to the building; H)All items and services for which other tenants have reimbursed Landlord or have paid third persons directly; I)Advertising and promotional expenditures in excess of those amounts provided in Section 27 below, unless part of a specificmarketing plan agreed upon by the tenants; J)Repairs and other work occasioned by fire, windstorm or other casualty to the extent that the Landlord is reimbursed byinsurance that was required to be carried under the lease; K)Costs incurred in operating and maintaining the project’s parking facilities if the Landlord charges for parking, unless Landlorduses the income from the parking facility as a credit against operating expenses; L)Any costs, fines or penalties incurred due to violations by Landlord of any governmental rule or authority; M)Costs for sculpture, paintings or other objects of art to the extent such are items of a capital nature; 13N)Costs attributable to repairing items that are covered by warranties to the extent such costs are reimbursed pursuant to suchwarranties; andO)Repairs and maintenance performed in a tenant’s exclusive space and not in the common areas. Provided the Term of the Lease commences in the 2004 calendar year, Tenant’s share of the following Other Charges shall not exceed the caps setforth herein for the first twelve (12) months of the Term. In the event that the Term commences in a calendar year subsequent to the 2004 calendar year, thenthe following caps shall be increased by five percent (5%) for each calendar year thereafter until the Term commences. All Other Charges stated on a persquare foot basis shall be calculated on the ground level portion of the Area of Leased Premises only. University Village Expenses:$6.20 per square footInsurance:$0.97 per square footTaxes:$3.53 per square foot (d) Heating and Air Conditioning Charge. Tenant shall contract for service and maintenance checks and filter changes for theheating and air conditioning system serving the Leased Premises, and Tenant shall pay the cost thereof. Tenant shall provide to Landlord, upon Landlord’sreasonable request for the same, copies of all work orders and other documents necessary to verify that the heating and air conditioning system serving theLeased Premises has been and is being adequately serviced, maintained and inspected on a regular basis, which need not exceed once every calendar quarter. IfTenant shall fail to contract for such service and maintenance to be performed, Landlord, following reasonable notice to Tenant, may elect to perform suchservice and maintenance and Tenant shall pay to Landlord the costs thereof immediately upon receipt of billing therefor. Such payments shall be deemedAdditional Rent hereunder. (e) Payment of Other Charges. Within sixty (60) days after the expiration of each Accounting Period of the Lease Term (or assoon thereafter as such information becomes available), Landlord will notify Tenant in writing of Landlord’s estimate of Tenant’s share of the Other Chargesdue for the then current Accounting Period. Landlord’s estimate shall be based upon the actual amount of the Other Charges for the previous AccountingPeriod plus Landlord’s reasonable estimate of the increase in such operation costs for the then current Accounting Period. Notwithstanding Landlord’s actualestimate, in no event shall Tenant’s payment to Landlord for the portion of University Village Expenses payable by Tenant increase by more than five percent(5%) per year on a non-cumulative basis. Tenant shall pay the estimated Tenant’s share in advance in equal monthly installments on the first day of eachmonth of such Accounting Period. Within sixty (60) days after the end of each Accounting Period, Landlord will compute Tenant’s share for such AccountingPeriod based upon the actual amount of the Other Charges for that Accounting Period. Landlord shall furnish Tenant with a reasonably detailed statement ofTenant’s proportionate share, and if the total amount paid by Tenant for such Accounting Period is less than the actual amount of Tenant’s share for suchAccounting Period, Tenant shall pay Landlord any deficiency, subject to the 5% cap on annual increases described above. If the 14 total amount paid by Tenant for such Accounting Period exceeds the actual amount of Tenant’s share, Landlord shall credit such excess to the next monthlypayments of Tenant’s share which thereafter come due. Any excess payments made by Tenant of taxes, common area maintenance expenses, promotionalfund payments, Merchants’ Association Dues or any other items of Additional Rent, shall be refunded to Tenant within thirty (30) days followingreconciliation of the accounting period for which such payments were made, unless credited to the next Rent due. If this Lease expires at a time other than theexpiration date of an Accounting Period, Tenant shall be obligated to pay immediately any deficiencies which shall be computed at the expiration of thatAccounting Period. If the estimated amount Tenant has paid for that Accounting Period exceeds the actual amount of Tenant’s share, and if Tenant hasotherwise complied with all of the terms and provisions of this Lease, Landlord shall refund such excess to Tenant. If at any time during an AccountingPeriod after the first Lease Year, the amount of the Other Charges increases over the actual amount thereof for the preceding Accounting Period, Landlord may,at its election, but not more than once in any Accounting Period and subject to the cap on increases, adjust the amount of monthly estimated installments dueduring the balance of that calendar year to reflect such increase. Any increased payments required to be made pursuant to this Section shall be made withinthirty (30) days after Landlord has notified Tenant thereof. Tenant’s obligations under this Section shall survive the expiration or termination of this Lease. Landlord shall provide Tenant with a receipted copy of the tax bill upon Tenant’s written request. (f) Disputes. Within two (2) years after receipt by Tenant of any statement from Landlord with respect to payment of chargespursuant to this Section 4.4, if Tenant disagrees with such statement for any reason, Tenant shall notify Landlord in writing stating the basis of suchobjection. Failure to object in writing during such two year period shall be deemed Tenant’s agreement with such statement and Tenant waives the right todispute any such statement after the expiration of such two year period. In the event of any dispute regarding the applicability, amount, or other matter relatingto Other Charges hereunder, such dispute shall be resolved on the basis of an investigation, analysis and report prepared by Landlord’s independent certifiedpublic accounting firm, which report shall be conclusive and binding upon the parties. 5. USE OF PREMISES AND OPERATION OF TENANT’S BUSINESS. 5.1 Permitted Uses. Tenant shall not use or permit or suffer the use of the Leased Premises for any business or purpose or under any othertrade name other than the Permitted Uses set forth at Section 1.11 above and Tenant’s Trade Name set forth in Section 1.12 above or under such other nameas is used by Tenant for a majority of its stores, including all of its stores in the Pacific Northwest (defined as Northern California, Oregon and Washington),without the prior written consent of Landlord. Tenant expressly understands and acknowledges that its Permitted Use is nonexclusive and that other tenants oroccupants within University Village may sell items similar to those sold by Tenant. Permitted Use is a material consideration to Landlord in order to maintainan appropriate tenant mix in University Village and achieve maximum gross sales for all tenants and to insure continual operation of a full-service shoppingcenter. Landlord shall have no obligation to consent to any change in the Permitted Uses for the Leased Premises. 5.2 Permitted Trade Name. Landlord does not represent that Tenant may use the 15 Tenant’s permitted trade name and Tenant shall indemnify Landlord against any claims, suits, costs, liabilities and expenses, including attorneys’ fees,arising from use of Tenant’s permitted trade name by Tenant, including any infringement claims. Tenant warrants that it has the full and unfettered right touse Tenant’s trade name for the entire term of this Lease and such use will not in any way infringe on the rights of others. 5.3 Uses Prohibited. Tenant shall not do or permit anything to be done in or about the Leased Premises nor bring or keep anything thereinwhich will in any way increase the existing rate of, or affect, any fire or other insurance upon the Leased Premises or the building of which the LeasedPremises are a part, or cause a cancellation of any insurance policy covering the Leased Premises or building or any part thereof or any of its contents. Tenantshall not do or permit or suffer anything to be done in or about the Leased Premises which will in any way obstruct or interfere with the rights of other tenantsor occupants of University Village or injure or harass them, nor shall the Tenant use or allow the Leased Premises to be used for any purpose which isobjectionable or offensive in Landlord’s reasonable judgment or is unlawful. If Tenant permits or engages in any activity which, in Landlord’s reasonablejudgment, is objectionable, offensive or otherwise constitutes a nuisance to the customers or other tenants of University Village, Tenant shall, within thirty (30)days after written notice from Landlord, discontinue such practice. Tenant’s failure to comply shall constitute a default under this Lease and entitle Landlordto pursue its remedies for default or, in the alternative, perform such work required on behalf of Tenant and recover, as Additional Rent, the cost thereof, plusinterest thereon at the Default Rate on the first day of each month, commencing on the date due through the date of payment. Such Additional Rent shallbecome due and payable to Landlord twenty (20) days following completion of the work and delivery of an invoice for same to Tenant. Tenant shall not use,occupy, suffer or permit any portion of the Leased Premises to be used as an office (other than incidental office use in connection with the Permitted Uses),living, sleeping or lodging quarters. Tenant shall not display any merchandise or sign outside the Leased Premises or in any way obstruct the malls orsidewalks adjacent thereto or otherwise solicit business within the Common Areas except as specifically allowed in writing by Landlord. Landlord reservesand retains the right not to approve or consent to any proposed exterior display of goods or signs. Tenant shall not, without the prior written consent ofLandlord, use the name of University Village for any purpose other than the address of the Leased Premises. In any event, Tenant shall not acquire any rightsin or to such name. 5.4 Operation of Business. Tenant shall conduct its business on the Leased Premises during the entire Lease Term hereof with diligence andefficiency, consistent with prudent business practices, so as to produce the optimum amount of gross sales which may be produced by such business, unlessprevented from doing so by causes beyond Tenant’s control. Tenant shall keep the store shelves on the Leased Premises fully and continuously stocked withall standard merchandise and products for the purpose of operating its business and shall maintain an adequate sales force. Subject to the provisions of thisLease, Tenant shall continuously during the entire Lease Term hereof conduct and carry on Tenant’s business in the Leased Premises and shall keep theLeased Premises open for business during at least the days, nights and hours designated from time to time by Landlord as the hours of operation forUniversity Village (which are currently Monday through Saturday 10:00 a.m. to 8:00 p.m. and Sunday 11:00 a.m. to 6:00 p.m.), 16 provided at least ninety percent (90%) of all other retail tenants are open such hours; provided, however, that this provision shall not apply if the LeasedPremises should be closed and the business of Tenant temporarily discontinued thereon on account of strikes, lockouts or similar causes beyond thereasonable control of Tenant. Notwithstanding anything to the contrary herein or any amendments hereto, nothing in this Lease shall be construed, interpretedor deemed to authorize the cessation of Tenant’s operations in the Leased Premises nor to authorize Tenant to “Go Dark” at any time during the Lease Term, asit may be extended. Tenant’s failure to open for business or to maintain business hours in accordance with this Section 5.4 shall be subject to payment ofAdditional Rent as provided in Section 4.3(i) above, without limitation of any other remedies available to Landlord with respect to such default under thisLease, at law or otherwise. Tenant shall not be required to participate in any “midnight madness” or “sidewalk sales” or any similar type of sale that Tenantreasonably deems inappropriate with its corporate image. Notwithstanding any other requirements set forth in this Lease, Tenant shall have the right to closeits store for business on the following days: New Year’s Day, Thanksgiving Day and Christmas Day and one (1) other day each year for the taking ofinventory and up to ten (10) days during the Term for repairs and renovations; provided that Tenant shall give Landlord at least 10 days prior written notice ofsuch closures for repairs. 5.5 Compliance with Laws. Tenant shall not use the Leased Premises in any way (or permit or suffer anything to be done in or about theLeased Premises) which will conflict with any law, statute, ordinance or governmental rule or regulation or any covenant, condition or restriction (whether ornot of public record) affecting University Village, now in force or which may hereafter be enacted or promulgated. Tenant shall, at its sole cost and expense,promptly comply with (a) all laws, statutes, ordinances, and governmental rules and regulations, now in force or which may hereafter be in force, including,without limitation, the Americans with Disabilities Act, 42 U.S.C. 12101 et seq. and the regulations promulgated thereunder, (b) all requirements, covenants,conditions and restrictions, now in force or which may hereafter be in force, and (c) all requirements (now in force or which may hereafter be in force) of anyboard of fire underwriters or other similar body now or hereafter constituted relating to or affecting the condition, use or occupancy of the Leased Premises. The judgment of any court of competent jurisdiction or the admission by Tenant in any action against Tenant, whether Landlord be a party thereto or not, thatTenant has violated any law, statute, ordinance, governmental rule or regulation or any requirement, covenant, condition or restriction shall be conclusive ofthe fact as between Landlord and Tenant. Landlord shall comply with legal requirements applicable to the Leased Premises, including without limitation, theAmericans with Disabilities Act, 42 U.S.C. 12101 et seq. and the regulations promulgated thereunder, insofar as they require structural repairs,improvements or alterations to the roof, foundation, columns, load-bearing walls, lintels, beams or any exterior portion of the Leased Premises. 5.6 Deliveries. Tenant shall load and unload merchandise, supplies, fixtures, equipment and furniture, and cause the collection of rubbish,only through rear service door or doors of the Leased Premises. Notwithstanding the foregoing, deliveries by UPS and overnight courier may be made throughthe front of the Leased Premises. Tenant shall not permit trailers or trucks servicing the Leased Premises to remain parked in University Village beyondperiods necessary to service Tenant’s operations. 17 5.7 Other Stores. Tenant shall not during the first five (5) years following Tenant’s opening for business at the Leased Premises, open a “J.Crew” store at the Northgate Mall in Seattle, Washington. 5.8 Co-Tenancy. If at any time during the Lease Term less than eighty-five percent (85%) of the retail portion of University Village is leasedand open for business for a continuous period of more than one hundred eighty (180) days, Tenant shall have the option to pay the lesser of (i) MinimumRent, Percentage Rent and Other Charges, or (ii) ten percent (10%) of Gross Sales in substitution for Minimum Rent, Percentage Rent and Other Charges untilsuch time as Landlord notifies Tenant that at least eighty-five percent (85%) of the retail portion of University Village is leased and open for business. Landlord shall, upon written request of Tenant, verify in writing the names and square foot areas of all tenants open and operating in University Village. 6. UTILITIES. 6.1 Tenant’s Obligation. Tenant shall pay before delinquency, at its sole cost and expense, all charges for water, gas, heat, electricity,power, garbage removal, telephone service, and sewer service charges, charged or attributable to the Leased Premises, and all other services or utilities used in,upon or about the Leased Premises during the Lease Term and the cost of installing meters therefor; provided, however, that if any such services or utilitiesshall be billed to Landlord and are not separately metered to the Leased Premises, the amount thereof shall be prorated, and Tenant shall pay to Landlord upondemand, as Additional Rent hereunder, an amount equal to that proportion of the total charges therefor which the amount of utility services consumed on theLeased Premises bears to the total amount of utility services consumed in the area covered by such combined charges. In no event shall Landlord be liable forservices consumed in the area covered by such combined charges. In no event shall Landlord be liable for an interruption or failure in the supply of any suchutilities to the Leased Premises unless and to the extent caused by the negligence or willful misconduct of Landlord, its employees, agents or contractors. Tenant shall not overburden or exceed the capacity of any of the utilities serving the Leased Premises. Any interruption or failure of utilities will not constitutea termination or constructive eviction of Tenant. No garbage shall be placed outside of the Leased Premises at any time except in proper, approved containersin designated garbage collection areas. Tenant shall store all trash and refuse in appropriate containers within the Leased Premises and attend to the dailydisposal thereof in the manner designated by Landlord. If Landlord supplies utilities to Tenant, Tenant shall purchase such utilities from Landlord, atLandlord’s request, at rates not exceeding the amount Tenant would otherwise be required to pay to the applicable utility company. In the event that Landlordno longer desires to supply any utility service, Landlord agrees to continue to provide such service until suitable arrangements have been made for a publicutility to assume the obligation. 6.2 Interruption. Landlord may, with reasonable notice to Tenant, or without notice in the case of an emergency, discontinue gas, water,electricity and any and all other utilities whenever such discontinuance is necessary to make repairs or alterations to the Leased Premises or University Villageor for the protection of persons or property. No such action by Landlord 18 shall be construed as an eviction or a disturbance of the possession of the Tenant or an election by Landlord to terminate this Lease nor shall Landlord be inany way liable therefor. Notwithstanding the foregoing, in the event Landlord discontinues utility service or such utility service is interrupted by the negligenceor willful misconduct of Landlord, its employees, agents or contractors, in excess of 48 hours, Minimum Rent shall abate until service is restored. 7. TENANT TO PAY PERSONAL PROPERTY TAXES. Tenant shall pay, or cause to be paid, before delinquency, any and all taxes levied orassessed during the Lease Term upon all Tenant’s leasehold improvements, equipment, furniture, fixtures, and any other personal property located in theLeased Premises. In the event any or all of the Tenant’s leasehold improvements, equipment, furniture, fixtures, and other personal property shall be assessedand taxed with the real property, Tenant shall pay to Landlord its share of such taxes within twenty (20) days after delivery to Tenant by Landlord of astatement in writing setting forth the amount of such taxes applicable to Tenant’s property. There shall be no duplication of taxes between Sections 4.4 and 7hereof. 8. LICENSES AND TAXES. 8.1 Tenant’s Obligation. Subject to Section 4.4(a), Tenant shall be liable for, and shall pay throughout the Lease Term, all license and excisefees and occupation taxes covering the business conducted on the Leased Premises. Subject to Section 4.4(a), if any governmental authority or unit under anypresent or future law effective at any time during the Lease Term hereof shall in any manner levy a tax on rents payable under this Lease or rents accruingfrom use of the Leased Premises or a tax in any form against Landlord because of or measured by revenue derived by Landlord from the leasing or rental ofsuch property or any amounts payable by Tenant hereunder (such as an excise, sales or rental tax), such tax shall be paid by Tenant, either directly or throughLandlord, and upon Tenant’s default therein, Landlord shall have the same remedies as for failure to pay rent. It is understood and agreed, however, thatTenant shall not be liable to pay any net income tax imposed on Landlord. 8.2 Additional Rent. As used herein, “Additional Rent” shall refer to any amounts payable by Tenant to Landlord under this Lease otherthan Minimum Rent and Percentage Rent. Additional Rent shall include any such sums whether or not designated as Rent or Additional Rent hereunder. Landlord shall have, with respect to any failure to pay Additional Rent hereunder, all of the remedies as for the failure to pay Minimum or Percentage Rent. 9. ALTERATIONS. 9.1 Acceptance of Leased Premises. Upon completion of Landlord’s Work, and except as otherwise provided in Section 3.2(b) hereof,Tenant shall accept the Leased Premises in their then condition “AS IS” and waives the right to make any claim against Landlord for any matter directly orindirectly arising out of the condition of the Leased Premises, appurtenances thereto, the improvements thereon and the equipment thereof, and Tenant shallthereafter save and hold Landlord harmless from liability as provided in Section 14 of this Lease. Except as set forth in Section 3.2(b), Landlord shall not beliable for any latent or patent defects within the 19 Leased Premises. Tenant acknowledges neither Landlord nor any agent or employee of Landlord has made any representation with respect to the suitability ofthe Leased Premises or University Village to the conduct of Tenant’s business, nor has Landlord agreed to undertake any modifications, alterations orimprovements of the Leased Premises except as expressly and specifically provided in Exhibit C to this Lease. 9.2 Alterations by Tenant. (a) Consent. Tenant shall not attach any fixtures, equipment or other items to the Leased Premises, or make any alterations,additions or improvements in or to the Leased Premises without the prior written consent of Landlord, which consent may be subject to such conditions asLandlord may reasonably deem appropriate. Notwithstanding the foregoing, Tenant shall have the right to make interior, non-structural design changes to theLeased Premises without Landlord’s consent so long as such changes do not affect the mechanical or electrical systems outside of the Leased Premises and inthe aggregate cost less than $50,000. Subject to Section 5.5. Tenant shall make any alterations in or to the Leased Premises which are required to cause theLeased Premises to comply with applicable governmental laws, rules, ordinances or regulations. Any alterations, additions or improvements consented to byLandlord shall be made at Tenant’s sole cost and expense. Tenant shall secure any and all governmental permits, approvals or authorizations required inconnection with any such work, and shall hold Landlord harmless from any liability, costs, damages, expenses (including reasonable attorneys’ fees) andany liens resulting therefrom. Except as otherwise provided herein, upon expiration or sooner termination of this Lease, all alterations, additions andimprovements (and expressly including all light fixtures and floor coverings), shall become the property of the Landlord, except trade fixtures, appliances andequipment which do not become a part of the Leased Premises. (b) Removal upon Termination. Upon the expiration or sooner termination of the term hereof, Tenant shall, at Tenant’s sole costand expense remove its movable trade fixtures, appliances and equipment, and Tenant shall at its sole cost and expense, repair any damage to the LeasedPremises caused by such removal. (c) Plans. No alterations, additions or improvements in or to the Leased Premises shall be done until all of Tenant’s plans andspecifications have been submitted to and approved by Landlord in writing, all required permits therefor have been obtained from appropriate governmentalauthorities. (d) Work. All Work shall be performed: (i) in a thoroughly first class, professional and workmanlike manner, (ii) only withmaterials that are new, high quality, and free of material defects, (iii) strictly in accordance with plans and specifications approved by Landlord in advance inwriting, (iv) not to adversely affect any systems and equipment or structure within University Village, (v) diligently to completion and so as to cause the leastpossible interference with other tenants and the operation of University Village, and (vi) in compliance with all laws and other provisions of this Lease. Uponcompletion, the Landlord shall be provided complete “as-built” drawings and specifications for all alterations and additions 20 to the Leased Premises made by Tenant. (e) Failure to Prosecute. In the event Tenant is required or undertakes to perform or complete any construction work, installationof fixtures or other construction pursuant to this Lease, either before or after the Commencement Date, if Tenant shall neglect, fail or refuse to commence itswork as required or thereafter to diligently proceed and complete such work, then Landlord, in addition to any other rights or remedies it may have, may (i)after thirty (30) days prior written notice to Tenant, complete Tenant’s Work at Tenant’s expense; (ii) commence or recommence all of Tenant’s paymentobligations pursuant to this Lease, notwithstanding incompletion of such work; and/or (iii) proceed pursuant to Section 16 with respect to any default underthis Lease. (f) Completion. Within ninety (90) days after the date upon which Tenant opens for business in the Leased Premises, or followingcompletion of any material alterations, additions or improvements to the Leased Premises, Tenant shall deliver to Landlord the following material: (i) Tenant’scertificate stating that the work to be performed by Landlord and Tenant pursuant to the terms of this Lease has been completed in compliance with approvedplans and specifications; that no security interest or other lien or claim is outstanding or has been filed with respect to the Leased Premises or the Tenant’sinterest therein; which certificate may be relied upon by Landlord and any lender or purchaser of University Village; (ii) a certificate of the general contractorperforming Tenant’s work stating that all subcontractors, laborers and materialmen who have performed work or furnished materials to the Leased Premiseshave been paid in full and that all liens or rights or claims of lien have been discharged of record or waived; (iii) complete releases and waivers of lien fromTenant’s general contractor and from all subcontractors with contracts of $5,000 or more in recordable form and otherwise in compliance with all applicableWashington law; (iv) Tenant’s written acceptance of the Leased Premises; (v) a certificate of occupancy for the Leased Premises issued by the City of Seattle;and (vi) Tenant shall provide a statement as to the dollar value of leasehold improvements (as opposed to equipment and trade fixtures) made by Tenant atTenant’s sole cost and expense to the Leased Premises. 10. MAINTENANCE AND REMODEL OF LEASED PREMISES. 10.1 Maintenance and Repair by Tenant. Tenant shall at all times throughout the Lease Term at its sole cost and expense keep the non-structural portions of the Leased Premises (including exterior doors and entrances, all windows and moldings and trim of all doors and windows) and allpartitions, door surfaces, fixtures, equipment and appurtenances thereof (including lighting, heating and air conditioning systems which exclusively serve theLeased Premises) in good order, condition and repair, damage by unavoidable casualty excepted (but not excluding damage from burglary or attemptedburglary of the Leased Premises). Without limiting the generality thereof, Tenant shall keep the glass of all windows, doors, and showcases clean andpresentable and free of graffiti; replace immediately all broken glass in the Leased Premises; at reasonable intervals as may be required to keep the LeasedPremises in a first class condition, paint or refinish the interior of the Leased Premises and the store front, including entrances; make any necessary repairs to,or replacements of, all door closure apparatuses and 21 mechanisms; keep all plumbing within and exclusively serving the Leased Premises, or where Tenant has caused blockage or some other problem outside theLeased Premises (in which case Landlord may repair such blockage or problem and charge Tenant for the same as provided herein,) clean and in good state ofrepair including pipes, drains, toilets and basins at Landlord’s request, assist Landlord to remove all snow and ice from the sidewalk in front of the LeasedPremises; and keep all utilities within and exclusively serving the Leased Premises, or where Tenant has caused blockage or some other problem outside theLeased Premises (in which case Landlord may repair such blockage or problem and charge Tenant for the same as provided herein), in a good state of repair. Tenant shall maintain the Leased Premises free of insects, rodents, and other pests and shall employ a pest exterminating contractor to service the LeasedPremises at such intervals as Landlord may reasonably require. Tenant shall maintain the heating, ventilating and air conditioning (“HVAC”) equipment andplumbing and electrical installations within and exclusively serving the Leased Premises or where Tenant has caused blockage or some other problem outsidethe Leased Premises in accordance with such reasonable standards for regular maintenance and repair thereof as Landlord may provide to Tenant from time totime. Tenant shall contract for in its own name and shall pay for a qualified service contractor to inspect, adjust, clean and repair HVAC equipment,including changing filters on a quarterly basis. If Tenant’s use of the Leased Premises requires a grease trap, Tenant shall contract for in its own name andshall pay for a qualified service contractor to inspect, clean and repair such grease trap at such intervals as may be required by Tenant’s use, but not lessfrequently than monthly. In the event such grease trap services Tenant and other tenants in University Village, Landlord may elect to perform such inspection,cleaning and repairing and Tenant shall pay to Landlord its proportionate share of the costs thereof immediately upon receipt of billing therefor based on thenumber of tenants serviced by such grease trap. Such payments shall be deemed Additional Rent hereunder. 10.2 Failure to Maintain. If Tenant fails to keep and preserve the Leased Premises as set forth in Section 10.1 above, Landlord may at itsoption (following ten (10) business days’ notice except in case of emergency) cause the same to be repaired, and in such case, upon receipt of writtenstatements from Landlord, Tenant shall promptly pay the entire cost thereof as Additional Rent. Landlord shall have the right, without liability, to enter theLeased Premises for the purpose of making such repairs upon the failure of Tenant to commence repairs following ten (10) business days notice (except in caseof emergency, where Landlord may, but shall not be obligated to, make such repairs immediately). 10.3 Repairs by Landlord. Landlord shall keep the floor slab, columns, the roof, exterior and load bearing walls (other than Tenant’sstorefront), common utility lines to the point of connection for Tenant, all conduits passing through the Leased Premises servicing exclusively others.foundations and building structure of the Leased Premises in a good state of repair, and shall accomplish such repairs as may be needed reasonably promptlyafter receipt of written notice from Tenant. Subject to the mutual waiver of subrogation, should such repairs be required by reason of Tenant’s negligent actsor failure to act, Tenant shall promptly pay Landlord for the cost thereof as Additional Rent. Except as otherwise specifically provided herein, there shall beno abatement of rent and no liability of Landlord by reason of any injury to or interference with Tenant’s business arising from the making of any repairs,alterations or improvements in or to 22 any portion of the Leased Premises, the building of which the Leased Premises is a part, or in or to fixtures, appurtenances and equipment therein. 10.4 Tenant’s Obligation to Remodel the Leased Premises. [omitted] 10.5 Surrender of Leased Premises. At the expiration or sooner termination of this Lease, Tenant shall return the Leased Premises, broomclean, to Landlord in the same condition as received (or, if altered by Landlord or by Tenant with the Landlord’s consent, or where consent is not required, insuch altered condition), reasonable wear and tear, or damage by casualty leading to termination of this Lease excepted. Tenant shall remove all trade fixtures,appliances and equipment which do not become a part of the Leased Premises, and shall restore the Leased Premises to the condition they were in prior to theinstallation of such items. Tenant’s obligation to perform this covenant shall survive the expiration or termination of this Lease. If Tenant fails to remove anyof its property required to be removed hereunder, Landlord may remove and store the same at the expense of Tenant. Any of such property may be sold tocover the expenses of removal and storage if not paid for by Tenant. 11. LIENS AND ENCUMBRANCES. 11.1 Liens. Tenant shall keep the Leased Premises and University Village free from any liens or encumbrances arising out of any workperformed, materials furnished or obligations incurred by Tenant, and shall indemnify and hold Landlord harmless from any and all costs, liability orexpenses (including reasonable attorneys’ fees) arising therefrom. Tenant shall place such contractual provisions as Landlord may reasonably request in allcontracts and subcontracts for Tenant’s improvements assuring Landlord that no mechanics liens will be asserted against Landlord’s interest in the LeasedPremises or University Village. Said contracts and subcontracts shall provide, among other things, the following: That notwithstanding anything in saidcontracts or subcontracts to the contrary, Tenant’s contractors, subcontractors, suppliers and materialmen (hereinafter collectively referred to as“Contractors”) will perform the work and furnish the required materials on the sole credit of Tenant; that no lien for labor or materials will be filed or claimedby the Contractors against Landlord’s interest in the Leased Premises or University Village; that the Contractors will immediately discharge any such lien filedby any of the Contractor’s suppliers, laborers, materialmen or subcontractors; and that the Contractors will indemnify and save Landlord harmless from anyand all costs and expenses, including reasonable attorneys’ fees, suffered or incurred as a result of any such lien against Landlord’s interest that may be filedor claimed in connection with or arising out of work undertaken by the Contractors. 11.2 Claims. If any lien is filed against the Leased Premises or University Village by any person claiming through Tenant, Tenant shalldischarge the same by payment or by providing a bond in form and amount and issued by a surety reasonably satisfactory to Landlord adequate to dischargethe same as a lien against the Leased Premises and University Village. If Tenant shall fail to cause such lien to be discharged of record, within thirty (30) daysfollowing written notice from Landlord, Landlord may pay or otherwise discharge the same by paying the amount claimed to be due and the amount so paidby Landlord, including reasonable attorneys’ fees incurred by Landlord in defending against such lien or in procuring its payment or discharge, shall be dueand 23 payable by Tenant as Additional Rent. 12. ASSIGNMENT AND SUBLETTING. 12.1 Assignment or Sublease. Tenant shall not, directly or indirectly, assign, transfer, mortgage, pledge, hypothecate or encumber this Leaseor any interest therein, nor permit the Leased Premises to be occupied by anyone other than Tenant or sublet the whole or any part of the Leased Premises, norshall this Lease or any interest hereunder be assignable or transferable by operation of law or by any process or proceeding of any court, or otherwise, withoutthe prior written consent of Landlord. Notwithstanding the foregoing, Tenant shall be permitted to assign this Lease, or sublet the Leased Premises without landlord’s consent to an affiliateof Tenant (affiliate meaning an entity which controls Tenant, is controlled by tenant, or under common control with Tenant, including any subsidiary orparent of Tenant), or to a corporation resulting from a merger or consolidation with Tenant, or to any person or entity which acquires substantially all of theassets of Tenant, or to any person or entity which acquires substantially all of the stock of Tenant. Following any assignment or sublease pursuant to thisparagraph, Tenant will remain liable hereunder. The public sale or transfer of the common stock of Tenant shall not constitute an assignment under thisLease. If Tenant desires at any time to enter an assignment of this Lease or a sublease of the Leased Premises or any portion thereof, where Landlord’sconsent is required, Tenant shall first give written notice to Landlord of Tenant’s desire to do so, which notice shall contain (a) the name of the proposedassignee or subtenant, (b) the proposed merchandising plan for the assignee’s or subtenant’s business to be carried on in the Leased Premises in accordancewith the uses permitted under Section 5 hereof, (c) the terms and provisions of the proposed assignment or sublease, (d) such financial information and pastmerchandising experience as Landlord may reasonably request concerning the proposed assignee or subtenant, including a resume of the principals of theproposed assignee or subtenant, and (e) a check made payable to the order of Landlord for Seven Hundred Fifty and No/100 Dollars ($750.00) as a deposittoward Landlord’s costs incurred in conjunction with the processing and documentation of the proposed assignment or sublease. Tenant agrees to reimburseLandlord for Landlord’s reasonable attorneys’ fees incurred in conjunction with the processing and documentation of any such requested transfer,assignment, subletting, licensing or concession agreement, change of ownership or hypothecation of this Lease or Tenant’s interest in the Leased Premises,such costs and attorneys’ fees not to exceed $1,000. Tenant shall provide Landlord promptly with fully executed copies of all assignments, subleases andrelated instruments. No consent by Landlord to any assignment or sublease by Tenant shall relieve Tenant of any obligation to be performed by Tenant underthis Lease, whether arising before or after the assignment or sublease. The consent by Landlord to any assignment or sublease shall not relieve Tenant of theobligation to obtain Landlord’s express written consent to any other assignment or sublease. 12.2. Consent/Recapture. If Landlord’s consent is requested for an assignment or sublease of all or any portion of the Leased Premises,Landlord shall have the right to terminate 24 the Lease with respect to that portion of the Leased Premises unless Tenant revokes Tenant’s notice of proposed Transfer by notice to Landlord within ten (10)days after acceptance or refusal of Landlord’s notice of termination. Landlord shall have the right at its option to enter into the relationship of landlord andtenant with the proposed assignee or subtenant based upon the rent and other economic consideration agreed to by such proposed assignee or subtenant andotherwise upon the terms and conditions of this Lease insofar as applicable to such portion of the Leased Premises. 12.3 Recapture. [omitted] 12.4. Increase in Minimum Rent. In the event that Landlord is required and Landlord consents to a transfer, the monthly Minimum Rentshall be increased on the effective date of the transfer to an amount equal to the average total monthly Minimum Rent and Percentage Rent payable by Tenantduring the thirty-six (36) months prior thereto (or such shorter period as may have occurred since the Commencement Date). If the Minimum Rent is increasedhereunder, there shall be a proportionate adjustment to the Breakpoint. 12.5 Guarantor of Lease. [omitted] 13. COMMON AREAS AND FACILITIES. 13.1 General. The term “Common Area” refers to all areas within the exterior boundaries of University Village (exclusive of buildings andsites reserved for future buildings) which are now or hereafter made available for general use, convenience and benefit of Landlord and other persons entitled tooccupy space in University Village, which areas shall include, but not be limited to, parking areas, driveways, mall, sidewalks, landscaped and plantedareas. “Common Area” shall also include all on-site and off-site areas and facilities, which may not be accessible to tenants or other persons, which are usedin connection with the operation, management, repair or maintenance of University Village, including janitorial closets, management offices and maintenanceareas, storm and sanitary sewer systems, utility lines, disposal plants, lift stations, and retention ponds or basins, whether located within or outside ofUniversity Village. The Common Areas may, at Landlord’s election, include areas in adjoining properties which are or become available to Landlord, tenants, employeesand invitees of University Village and which are maintained with the Common Area under any reciprocal easement agreement, operating agreement or othersuch agreement now or hereafter in effect. Without limiting the generality of the foregoing, the Common Area may include, as designated by Landlord fromtime to time, any parking areas and structures (whether in tiers or at, above or below grade), mall enclosures and roofs covering University Village buildings,entrances, sidewalks, streets or roadways, passageways, concourses, courts, arcades, service corridors, loading platforms and truck docks, delivery areas,escalators and elevators, ramps, stairs, landscaped and vacant areas, pedestrian bridges, skywalks, skybridges, arrival zones, public bathrooms,information and telephone booths, directory signs and equipment, common lighting facilities, drainage areas, lounges and shelters, package pick-up stations,drinking fountains, public comfort and first aid 25 stations, public meeting rooms, auditoriums, bus stops, taxi stands, and all furniture, decorations, fixtures, improvements, Systems and Equipment, andother facilities, located in or serving any of the foregoing, except to the extent reserved for use by one or more designated tenants. 13.2 Control and Maintenance of Common Area by Landlord. Landlord shall at all times have the exclusive control and management ofthe Common Area. Landlord shall keep or cause to be kept the Common Area in a neat, clean, and orderly condition, properly lighted and landscaped, in afirst class condition consistent with other upscale regional shopping centers, and shall repair any damage thereto. With respect to the Common Area, Landlordshall have the right from time to time to: employ personnel; establish, modify and enforce reasonable rules and regulations governing the use thereof;construct, maintain and operate lighting facilities; patrol the Common Area; change the area, level, location and arrangement of parking areas and otherfacilities; restrict parking by Tenant, its officers, agents and employees to employee parking areas; enforce parking charges (by operation of meters orotherwise), with appropriate provisions for free parking ticket validating by Tenant; close all or any portion of the Common Area to such extent as may, in theopinion of Landlord’s counsel, be legally sufficient to prevent a dedication thereof or the accrual of any interest therein by any person or the public; closetemporarily all or any portion of the parking areas or facilities; discourage non-customer parking; and do and perform such other acts in and to the CommonArea as, in the use of good business judgment, Landlord shall determine to be advisable with a view to the improvement of the convenience and use thereof bytenants of University Village, their employees, invitees and customers. Landlord agrees not to place any permanent or temporary kiosks, carts, automaticteller machines (“ATM”), telephones or any other obstructions within an area extending fifteen (15) feet from each of the side demising lines of the LeasedPremises, except for customer amenities in the pedestrian sidewalk areas including landscape pots, sidewalk lamppost lighting, landscape “hanging pots”,pedestrian moveable signage, customer benches and trash receptacles as are typically found in University Village. If Landlord violates the foregoingprohibition and such violation continues for a period of ten (10) days following written notice from Tenant to Landlord, then Tenant shall be entitled to anabatement of Minimum Rent, Percentage Rent and Other Charges for each day such violation continues. The other provisions notwithstanding, neither Landlord nor its agents shall be responsible for any law enforcement activities within UniversityVillage, and Landlord’s employment of security agencies, personnel, or devices, or any other instrumentalities or agents which are intended to deter criminalactivity within University Village shall not be deemed to create any such responsibilities for Landlord. Tenant shall be responsible for the protection of itsproperty and, to the extent required by law or as it further deems appropriate, the property of its customers, from theft, vandalism and similar acts. 13.3 License. All Common Area which Tenant may be permitted to use and occupy shall be used and occupied under a revocable license. Ifthe amount of such areas or facilities be diminished, such diminution shall not be subject to any liability, nor shall Tenant be entitled to any compensation ordiminution or abatement of rent. 13.4 Additional Land. Subject to Section 4.4(c), should Landlord acquire any interest 26 in land not shown as part of University Village on Exhibit B and make the same available for parking or other Common Area purposes, then the operatingcosts of the Common Area shall also include all of the costs and expenses incurred and paid in connection with such additional land, other than the costs andexpenses of acquiring the same. 13.5 Rules and Regulations. Tenant shall comply with the rules and regulations that Landlord may from time to time promulgate and/ormodify regarding use and operation of the Common Area. The rules and regulations shall be binding upon Tenant upon delivery of a copy thereof to Tenant. Landlord shall not be responsible to Tenant for the nonperformance of such rules and regulations by any other tenants or occupants of space in UniversityVillage. Landlord shall exercise reasonable efforts to enforce the rules of University Village uniformly. 13.6 Employee Parking. It is understood that the employees of Tenant employed at the Leased Premises and the other tenants of Landlordwithin University Village may not park their motor vehicles in the parking areas of the Common Area which may from time to time be designated for patronsof University Village. Landlord may furnish or cause to be furnished, but shall not be obligated to furnish, space for employee automobile parking. Nothingcontained herein shall be deemed to impose liability upon Landlord for personal injury or theft or damage to any motor vehicle or for loss of property fromwithin any motor vehicle, which is suffered by Tenant’s employees, customers, service suppliers or other invitees in connection with their use of any parkingarea. Landlord at all times shall have the right to designate the particular parking areas to be used by any or all of such employees and any such designationmay be changed from time to time. Tenant and its employees shall park their automobiles only in those portions of the Common Area, if any, designated forthat purpose by Landlord. Tenant shall comply with any system or procedure developed by Landlord, including but not limited to the use of identificationstickers, to identify the automobiles of Tenant’s employees. If Tenant or its employees fail to park their automobiles in designated parking areas, thenLandlord may charge Tenant a fee of Ten and No/100 Dollars ($10.00) per day for each day or partial day per vehicle parked in any areas other than thosedesignated; provided, however, for the first violation during any calendar year for each Tenant or employee, Landlord will give Tenant written notice andreasonable time during the day the violation occurs to move the vehicle to a permitted parking area and, if the vehicle is promptly moved to a permitted parkingarea, no fee will be charged. After notice of the first such violation by Tenant or such employee during each calendar year, no notice of any subsequentviolation by the same person shall be required prior to the imposition of any parking fine. All amounts due under the provisions of this Section shall bepayable by Tenant within twenty (20) days after demand therefor. A Tenant or an employee of Tenant who is using the facilities of University Village as acustomer during time periods other than the work shift during which the employee is on-duty may leave on the dashboard of his or her motor vehicle a legiblenotice which indicates that such person is shopping in University Village. If a Tenant receives a violation notice with respect to the Tenant or an employee whowas shopping during a time other than during such employee’s work shift and if the Tenant or the employee placed the notice on the dashboard as providedabove, the fine shall be rescinded if Tenant so notifies Landlord prior to 5:00 p.m. on the next weekday following receipt of the notice of violation. Any vehicleof a Tenant or an employee of Tenant parked in areas of the Common Area not designated for employee parking may be removed by Landlord and the expensethereof charged to the owner of 27 the vehicle. The failure of any employee to park in an appropriate employee parking area shall not be a default by Tenant under this Lease. Tenant shall useits best efforts to cause its employees employed at the Leased Premises to park their personal motor vehicles only in designated employee parking areas. In theevent Landlord provides remote parking for Tenant’s employees, Landlord shall provide all transportation which may be reasonably required by Tenant’semployees with respect to such parking areas. Landlord will cause all employee parking areas (adjacent or remote) to be lit for a period of one (1) hour after theclose of University Village and will provide security for such areas. 14. INSURANCE AND INDEMNITY. 14.1 Indemnification. Landlord shall not be liable for injury to any person, or for the loss of or damage to any property (including property ofTenant) occurring in or about the Leased Premises from any cause whatsoever, except to the extent of Landlord’s gross negligence or willful misconduct or thegross negligence or willful misconduct of Landlord’s employees, agents or contractors. Landlord shall not be responsible or liable to Tenant for any loss ordamage which may be occasioned by the acts or omissions of third parties or persons occupying space adjoining the Leased Premises or any part ofUniversity Village or by theft or by any act or neglect of any tenant or occupant of University Village. Tenant hereby indemnifies and holds Landlordharmless from and against and agrees to defend Landlord against any and all claims, charges, liabilities, obligations, penalties, damages, costs and expenses(including reasonable attorneys’ fees) arising, claimed, charged or incurred against or by Landlord from any matter or thing arising from Tenant’s use of theLeased Premises, the conduct of its business or from any activity, work or other things done, permitted or suffered by the Tenant in or about the LeasedPremises, and Tenant shall further indemnify and hold harmless Landlord from and against any and all claims arising from any breach or default in theperformance of any obligation on Tenant’s part or to be performed under the terms of this Lease, or arising from any act or negligence of the Tenant, or anyofficer, agent, employee, or while within the Leased Premises, guest, or invitee of Tenant, and from all costs, reasonable attorneys’ fees, and liabilitiesincurred in or about the defense of any such claim or any action proceeding brought thereon and in case any action or proceeding be brought against Landlordby reason of such claim. Tenant, upon notice from Landlord, shall defend the same at Tenant’s expense by counsel reasonably satisfactory to Landlord. Inthe event of concurrent negligence of Tenant, its agents, employees, sublessees, invitees while within the Leased Premises, licensees or contractors on the onehand, and that of Landlord, its partners, directors, officers, agents, employees, or contractors on the other hand, which concurrent negligence results in theinjury or damage to persons or property and relates to the construction, alteration, repair, addition to, subtraction from, improvement to or maintenance of theLeased Premises, Common Areas or buildings, Tenant’s obligation to indemnify Landlord as set forth in this Section shall be limited to the extent of Tenant’snegligence, and that of its agents, employees, sublessees, invitees, while within the Leased Premises, licensees or contractors, including Tenant’s proportionalshare of costs, and reasonable attorneys’ fees and expenses incurred in connection with any claim, action or proceeding brought with respect to such injury ordamage. Tenant hereby agrees to waive its immunity under Industrial Insurance with respect to Landlord. Tenant and Landlord further agree that thisindemnification provision was specifically negotiated and agreed to by the parties hereto. None 28 of the events or conditions set forth in this Section shall be deemed a constructive or actual eviction or entitle Tenant to any abatement or reduction of rent. Tenant’s indemnification obligation pursuant to this paragraph shall survive the expiration or termination of this Lease. Landlord shall indemnify and hold Tenant harmless from and against and agrees to defend Tenant against any and all claims, charges, liabilities,obligations, penalties, damages, costs and expenses (including reasonable attorneys’ fees) to the extent arising from any negligence or willful misconduct ofLandlord, its employees, agents or contractors in or about the Leased Premises and the University Village, or to the extent arising from any breach or default inthe performance of any obligation on Landlord’s part to be performed under the terms of this Lease, including all costs, attorneys’ fees, and liabilities incurredin the defense of any such claim, action or proceeding. In addition, except for instances of negligence or willful misconduct of Tenant or its agents, employees,or contractors, Landlord indemnifies and agrees to hold Tenant harmless from and against any and all claims, charges, liabilities, obligations, penalties,damages, costs and expenses (including reasonable attorneys fees) arising, claimed, charged or incurred against or by Tenant from any matter or thingoccurring in or about or relating to the common areas of University Village. Landlord’s indemnification obligation pursuant to this paragraph shall survive theexpiration or termination of this Lease. 14.2 Insurance. During the entire Lease Term, Tenant shall, at its sole cost and expense pay for and keep in full force and effect: (a) anoccurrence form Commercial General Liability policy, to indemnify both Landlord and Tenant against any such claims, demands, losses, damages, liabilitiesand expenses, including insurance against assumed or contractual liability under this Lease, with respect to the Leased Premises and operations of Tenant andany person or entity conducting business in, on or about the Leased Premises for the Tenant or on the Tenant’s behalf, in which the limits with respect toliability and property damage shall not be less than $2,000,000 each occurrence nor less than $4,000,000 annual aggregate on a location basis; (b) productliability coverage, including, without limitation (if this Lease covers premises in which food and/or alcoholic beverages are sold and/or consumed) liquorliability coverage of not less than $1,000,000 per occurrence nor less than $2,000,000 general aggregate on a location basis; (c) special perils form of propertyinsurance, written at replacement cost value in an adequate amount to avoid coinsurance, insuring Tenant’s furniture, fixtures, equipment and inventory,including property of Tenant’s customers located on the Leased Premises, boiler and machinery coverage, if applicable. All policies of insurance required to be carried by Tenant pursuant to this Section 14.2 shall be written by responsible insurance companies with aBest rating of at least A-XI. Any such insurance required of Tenant hereunder may be furnished by Tenant under any blanket policy carried by it or under aseparate policy therefor. A copy of each policy evidencing such insurance or a certificate of the insurer certifying that such policy has been issued, providingthe coverage required by this Section and containing provisions specified herein, shall be delivered to Landlord prior to the commencement of the term of thisLease and, upon renewals, not less than thirty (30) days prior to the expiration of such coverage. Self-insurance shall be permitted for all insurance required ofTenant under this Lease so long as Tenant maintains net worth of at least $75,000,000.00. 29 Each policy evidencing insurance required to be carried by Tenant pursuant to this Section shall contain the following provisions and/or clauses:(a) cross liability, severability or substantially similar clause; (b) a provision that such policy and the coverage evidenced thereby shall be primary andnoncontributing with respect to any policies carried by Landlord, and that any coverage carried by Landlord shall be excess insurance; (c) a provisionincluding Landlord and any other parties in interest designated in writing by Landlord as an additional insured; and (d) a provision that the insurer will notcancel, materially change or fail to renew the coverage provided by such policy without first giving Landlord thirty (30) days prior written notice. If Tenant fails to maintain the insurance required by this Section 14.2, Landlord may obtain and maintain insurance covering such items andinterests. Any premiums paid by Landlord therefor shall be deemed Additional Rent and shall be due immediately upon demand. If, on account of the failureof Tenant to comply with the provisions of this Section, Landlord is deemed a co-insurer by its insurance carrier, then any loss or damage which Landlordshall sustain by reason thereof shall be borne by Tenant and shall be immediately paid by Tenant upon receipt of a bill therefor and evidence of such loss. 14.3 Increase in Insurance Premium. Tenant shall not keep, use, sell or offer for sale in or upon the Leased Premises any article which maybe prohibited by the customary forms of extended coverage direct damage insurance policies typically in effect for properties similar to University Village inthe greater Seattle area. Tenant shall pay any increase in premiums for casualty and fire (including extended coverage) insurance that may be charged duringthe Lease Term on the amount of such insurance which may be carried by Landlord on the Leased Premises or the building of which they are a part, resultingfrom Tenant’s occupancy or from the type of merchandise which Tenant stores or sells on the Leased Premises, whether or not Landlord has consentedthereto. In such event, Tenant shall also pay any additional premium on the insurance policy that Landlord may carry for its protection against rent lossthrough fire or casualty. In determining whether increased premiums are the result of Tenant’s use of the Leased Premises, a schedule, issued by theorganization setting the insurance rate on the Leased Premises, showing the various components of such rate, shall be conclusive evidence of the several itemsand charges which make up the casualty and fire insurance rate on the Leased Premises. Landlord shall deliver bills for such additional premiums to Tenantat such times as Landlord may elect, and Tenant shall immediately reimburse Landlord therefor. 14.4 Waiver of Subrogation. Landlord and Tenant hereby mutually release each other from liability and waive all right of recovery againsteach other for any loss in or about the Leased Premises or University Village, from perils insured against or required to be insured against under all-riskinsurance contracts (whether or not such insurance contracts are in force), including any extended coverage endorsements thereof, whether due to negligence orany other cause (and each party shall attempt to obtain a waiver of subrogation endorsement from its insurance company); provided that this Section shall beinapplicable if it would have the effect, but only to the extent it would have the effect, of invalidating any insurance coverage of Landlord or Tenant. 30 15. EMINENT DOMAIN. 15.1 Total Taking. If all the Leased Premises are taken by the power of eminent domain exercised by any governmental or quasi-governmentalauthority, this Lease shall terminate as of the date Tenant is required to vacate the Leased Premises and all Minimum Rent and other rentals and charges duehereunder shall be allocated as of that date. The term “eminent domain” shall include the taking or damaging of property by, through or under anygovernmental or quasi-governmental authority, and any purchase or acquisition in lieu thereof, whether or not the damaging or taking is by the government orany other person. 15.2 Partial Taking. If more than ten percent (10%) of Tenant’s sales area or twenty percent (20%) of the Leased Premises shall be taken orappropriated, this Lease may, at the option of either party, be terminated by written notice given to the other party not more than thirty (30) days after Landlordor Tenant receive notice of the taking or appropriation, and such termination shall be effective as of the date when Tenant is required to vacate any portion ofthe Leased Premises. In the event that more than twenty percent (20%) of the parking areas or other Common Area of University Village shall be taken orappropriated, then the Landlord may at its option terminate this Lease by written notice given to Tenant within sixty (60) days of the date of such taking. Ifthis Lease is so terminated, all Minimum Rent and other charges due hereunder shall be paid to the date of termination. Whenever any portion of the LeasedPremises or Common Area is taken by eminent domain and this Lease is not terminated, Landlord shall at its expense proceed with all reasonable dispatch torestore, to the extent that it is reasonably prudent to do so, the remainder of the Leased Premises and Common Area to the condition they were in immediatelyprior to such taking, and Tenant shall at its expense proceed with all reasonable dispatch to restore its fixtures, furniture, furnishings, floor covering andequipment to the same condition immediately prior to such taking. From the date Tenant is required to vacate that portion of the Leased Premises taken, theMinimum Rent and Other Charges payable hereunder shall be reduced in the same proportion that the area taken bears to the total area of the Leased Premisesprior to taking. Landlord shall not terminate this Lease as a result of a Taking unless the Leases for all other tenants identified as “similarly situated” onExhibit 15.2 attached hereto which Landlord would be permitted to terminate under the facts and circumstances of the taking and under the terms of saidleases shall also be terminated. 15.3 Damages. Landlord reserves all rights to the entire damage award or payment for any taking by eminent domain, and Tenant shall makeno claim whatsoever against Landlord for damages for termination of its leasehold interest in the Leased Premises or for interference with its business. Tenanthereby grants and assigns to Landlord any right Tenant may now have or hereafter acquire to such damages and agrees to execute and deliver such furtherinstruments of assignment thereof as Landlord may from time to time reasonably request. Tenant shall, however, have the right to claim from the condemningauthority all compensation that may be recoverable by Tenant on account of any loss incurred by Tenant in removing, relocating, and/or loss of Tenant’smerchandise, furniture, trade fixtures and equipment or for damage to Tenant’s business; provided, however, that Tenant may claim such damages only ifthey are awarded separately in the eminent domain proceeding and not as part of Landlord’s damages. 31 16. TENANT’S DEFAULT. 16.1 Default. The occurrence of any one or more of the following events shall constitute a default and breach of this Lease by Tenant. (a) Vacating the Leased Premises. The vacating or abandonment of the Leased Premises by Tenant or the failure of Tenant to beopen for business (except in the event of damage or destruction to the Leased Premises or due to an other event or circumstances affecting Tenant and coveredby Section 30.12 which prevents Tenant from conducting any business thereon) as required by any provision of this Lease where such failure shall continuefor a period of 24 hours after acceptance or refusal of written notice thereof from Landlord. (b) Failure to Pay Rent. The failure by Tenant to make any payment of Minimum Rent, Percentage Rent, Other Charges,Additional Rent, or any other payment required to be made by Tenant hereunder, as and when due, where such failure shall continue for a period of ten (10)days after acceptance or refusal by Tenant of written notice thereof from Landlord. (c) Failure to Perform. The failure by Tenant to observe or perform any of the covenants, conditions or provisions of this Lease tobe observed or performed by Tenant, other than those described in Subsections 16.1(a) and (b) above, where such failure shall continue for a period of thirty(30) days after written notice thereof by Landlord to Tenant; provided, however, that if the nature of Tenant’s default is such that more than thirty (30) daysare reasonably required for its cure, then Tenant shall not be deemed to be in default if Tenant commences such cure within said thirty (30) day period andthereafter diligently prosecutes such cure to completion. (d) Bankruptcy. The making by Tenant of any general assignment or general arrangement for the benefit of creditors; or the filingby or against Tenant of a petition to have Tenant adjudged a bankrupt, or a petition of reorganization or arrangement under any law relating to bankruptcy(unless, in the case of a petition filed against Tenant, the same is dismissed within sixty (60) days of filing); or the appointment of a trustee or a receiver totake possession of substantially all of Tenant’s assets located at the Leased Premises or of Tenant’s interest in this Lease, where such seizure is not dischargedwithin thirty (30) days after appointment of such trustee or receiver, or the filing of the petition for the appointment of the same, whichever shall first occur. (e) Renewed Default. The commission by Tenant of any default described in section (b) above a third time and within nine (9)consecutive months following the time that Tenant has been given two prior notices of such a default and has cured the same within the permitted time. 16.2 Remedies in Default. In the event of any such default or breach by Tenant, Landlord may at any time thereafter, with or without noticeor demand and without limiting Landlord in the exercise of any other right or remedy which Landlord may have by reason of such default or breach: 32 (a) Terminate Lease. Terminate Tenant’s right to possession of the Leased Premises by any lawful means, in which case thisLease shall terminate and Tenant shall immediately surrender possession of the Leased Premises to Landlord. In such event Landlord shall be entitled torecover from Tenant all past due rents, and other necessary expenses of renovation and alteration of the Leased Premises and commissions paid in re-lettingeven if paid to Landlord or any affiliate of Landlord; reasonable attorneys’ fees; the worth at the time of award by the court having jurisdiction thereof of theamount by which the unpaid rent, Additional Rent, and other charges called for herein for the balance of the Lease Term after the time of such award exceedsthe amount of such loss for the same period that Tenant proves could be reasonably avoided; and that portion of any leasing commission paid by Landlordand applicable to the unexpired Lease Term of this Lease. Unpaid installments of rent or other sums shall bear interest from the date due at the Default Rate onthe first day of each month, commencing on the date due through the date of payment; or (b) Continue the Lease. Maintain Tenant’s right to possession, in which case this Lease shall continue in effect whether or notTenant shall have abandoned the Leased Premises. In such event Landlord shall be entitled to enforce all Landlord’s rights and remedies under this Lease,including the right to recover the Minimum Rent and any other charges as may become due hereunder. (c) Reletting. In the event of a default by Tenant, whether or not Landlord elects to terminate or continue the Lease, Landlord mayre-let the Leased Premises in whole or in part to one or more tenants, either in the name of Landlord or as agent for Tenant for a term or terms which may beless or greater than the remainder of the term of the Lease, and may agree to grant concessions, free rent and/or additional improvements in connection with anysuch re-letting. Landlord may receive rent from such re- letting and apply the same first to any expenses incurred in connection with re-entering, ejecting,removing, re-letting, altering, repairing, redecorating, subdividing or otherwise preparing the Leased Premises for re-letting, including brokerage and reasonableattorneys’ fees; secondly, to any indebtedness of Tenant to Landlord other than Minimum Rent or items of Additional Rent payable under the Lease; and third,to the fulfillment of any terms or conditions of the Tenant under the Lease and rent payable hereunder. Tenant shall be liable to Landlord for any deficiency;or (d) Other Remedies. Pursue any other remedy now or hereafter available to Landlord under the laws or judicial decisions of theState of Washington. Landlord shall at all times have the right without prior demand or notice except as required by applicable law to: (i) seek any declaratory,injunctive or other equitable relief, and specifically enforce this Lease or restrain or enjoin a violation of any provision hereof, and Tenant hereby waives anyright to require that Landlord post a bond in connection therewith, and (ii) sue for and collect any unpaid Rent which has accrued. Notwithstanding anythingto the contrary contained in this Lease, to the extent not expressly prohibited by applicable law, in the event of any default by Tenant, Landlord may terminatethis Lease or Tenant’s right to possession and accelerate and declare that all Rent reserved for the remainder of the Term shall be immediately due and payable(in which event, Tenant’s obligations for Percentage Rent, Taxes, Center Expenses, and Marketing Fund Charge 33 herein that would have accrued thereafter shall be projected in the manner described in Section B(1) above; provided the Rent so accelerated shall be reducedby the amount of such loss for the same period that Tenant proves could reasonably have been avoided by Landlord and thereafter discounted in accordancewith accepted financial practice at the rate of four percent (4%) per annum to the then present value. Landlord shall use reasonable efforts to mitigate itsdamages. 16.3 Legal Expenses. If either party is required to bring or maintain any action (including assertion of any counterclaim or cross-claim, orclaim in a proceeding in bankruptcy, receivership or any other proceeding instituted by a party hereto or by others), or otherwise refers this Lease to anattorney for the enforcement of any of the covenants, terms or conditions of this Lease, the prevailing party in such action shall, in addition to all otherpayments required herein, receive from the other party all the costs (including reasonable attorneys’ fees) incurred by the prevailing party in the enforcement ofthe covenants, terms and conditions of this Lease (whether or not an action is instituted) and including any such costs and fees incurred by the prevailingparty on appeal. 16.4 Proceedings. The parties waive trial by jury in any action, proceeding or counterclaim brought by either party against the other withrespect to any matter arising out of or in any way connected with this Lease or University Village. Any action, suit or proceeding relating to, arising out or inconnection with this Lease or University Village brought by either Landlord or Tenant shall be brought in the King County Superior Court, King County,State of Washington. Tenant hereby waives any objection to jurisdiction or venue in any proceeding before such court and agrees that the same shall be theexclusive venue for any such proceeding. 16.5 Remedies Cumulative - Waiver. Landlord’s remedies hereunder are cumulative and the Landlord’s exercise of any right or remedy dueto a default or breach by Tenant shall not be deemed a waiver of, or to alter, affect or prejudice any right or remedy which Landlord may have under this Leaseor by law. Neither the acceptance of rent nor any other acts or omission of Landlord at any time or times after the happening of any event authorizing thecancellation or forfeiture of this Lease, shall operate as a waiver of any past or future violation, breach or failure to keep or perform any covenant, agreement,term or condition hereof or to deprive Landlord of its right to cancel or forfeit this Lease, upon the written notice provided for herein, at any time that cause forcancellation or forfeiture may exist, or be construed so as at any time to stop Landlord from promptly exercising any other option, right or remedy that it mayhave under any term or provision of this Lease, at law or in equity. 16.6 Waiver of Redemption Right. Tenant expressly waives any and all rights of redemption granted by or under any present or future lawsor statutes applicable to the Leased Premises. 17. DEFAULT BY LANDLORD. 17.1 Default by Landlord. Landlord shall not be in default unless Landlord fails to perform obligations required of Landlord within areasonable time, but in no event shall a reasonable time be earlier than thirty (30) days after written notice by Tenant to Landlord (and to 34 the holder of any first mortgage or deed of trust covering the Leased Premises whose name and address shall have theretofore been furnished to Tenant inwriting) specifying wherein Landlord has failed to perform such obligation; provided, however, that if the nature of Landlord’s obligation is such that morethan thirty (30) days are required for performance, then Landlord shall not be in default if Landlord or the holder of any such mortgage or deed of trustcommences performance within such thirty (30) day period and thereafter diligently prosecutes the same to completion. Tenant further agrees not to invoke anyof its remedies under this Lease until such thirty (30) days have elapsed. Tenant’s remedies for Landlord’s default hereunder shall be limited to damagesand/or an injunction to the extent suitable, and the parties agree that Tenant shall not have the right to terminate this Lease except in such cases wheretermination is Tenant’s only suitable remedy. If Landlord shall fail to make a repair Landlord is required to perform under this Lease, and Landlord shall not commence such repair within thirty(30) days after Tenant gives written notice of such failure, or if Landlord fails to diligently pursue such repair once commenced, then Tenant may performsuch repair for the account of and at the expense of Landlord and render a bill to Landlord for such reasonable expense. If Landlord fails to pay the bill withinten (10) days after it is rendered, Tenant may bring suitable legal action to require Landlord to pay the bill. If the final judgment of the action determines thatLandlord was obligated to make the repair and that Tenant, in making the repair, incurred a reasonable expense, then Tenant, in addition to its normalremedies, shall be entitled to deduct such expenses from payments of rent and other charges due or to become due in the future under this Lease. The amountwhich may be deducted shall include interest on the judgment at the statutory interest rate for judgments from the date of the cure to the date of payment. 18. RECONSTRUCTION. 18.1 Reconstruction - Insured Loss. In the event the Leased Premises are damaged by fire or other perils covered by Landlord’s insurance,Landlord agrees to forthwith repair same, and this Lease shall remain in full force and effect, except that Tenant shall be entitled to a proportionate reduction ofthe Minimum Rent and Other Charges from the date of damage and while such repairs are being made until the earlier of (i) the date Tenant reopens forbusiness, or (ii) the time reasonably required to make the repairs required to restore the Leased Premises, such proportionate reduction to be based upon theextent to which the damage and making of such repairs shall reasonably interfere with the business carried on by Tenant in the Leased Premises. If thedamage is due to the fault or neglect of Tenant or its employees, there shall be no abatement of rent except to the extent covered by Landlord’s insurance. Landlord shall not be required to repair any injury or damage to any leasehold improvements, fixtures or personal property of Tenant. No damages,compensation or claims shall be payable by Landlord for inconvenience, loss of business or other damage arising from repair or restoration of any portion ofthe Leased Premises or University Village. If the Leased Premises shall be damaged by fire or casualty and Landlord has the obligation to repair under this Lease, if Landlord fails to repairduring the twelve (12) month period after occurrence of the damage, Tenant may cancel this Lease by giving notice of 35 cancellation within ninety (90) days after the twelve (12) month period expires. 18.2 Uninsured Loss. In the event the Leased Premises are damaged as a result of any cause other than the perils covered by all-risk insurancecoverage maintained by Landlord, then Landlord shall forthwith repair the same, but only if the extent of the damage is less than ten percent (10%) of the thenfull replacement cost of the Leased Premises and of the building of which the Leased Premises are a part. If the damage to the Leased Premises or to thebuilding of which the Leased Premises are a part is greater than ten percent (10%) or more of the then full replacement cost of the Leased Premises or thebuilding, respectively, then Landlord shall have the option: (1) to repair or restore such damage, this Lease continuing in full force and effect, but theMinimum Rent and Other Charges to be proportionately reduced as hereinabove provided in this Section; or (2) give notice to Tenant at any time within sixty(60) days after such damage, terminating this Lease as of the date specified in such notice, which date shall be no more than thirty (30) days after the date ofsuch notice. In the event of giving such notice, this Lease shall expire and all interest of Tenant in the Leased Premises shall end on the date so specified insuch notice and the Minimum Rent and Other Charges, reduced by a proportionate reduction, based upon the extent, if any, to which such damage interferedwith the business carried on by the Tenant in the Leased Premises, shall be paid up to the date of such termination. 18.3 No Obligation. Notwithstanding anything to the contrary contained in this Section 18, Landlord shall not have any obligation whatsoeverto repair, reconstruct or restore the Leased Premises when the damage resulting from any casualty covered under this Section occurs during the last twenty-four(24) months of the Lease Term. If Landlord so elects not to repair or restore during the last 24 months of the Lease, Tenant shall have the right to terminate thisLease within thirty (30) days following notice from Landlord that Landlord does not intend to repair or restore. Landlord shall not have any obligation to makeany repairs or replacements of any leasehold improvements, fixtures, or other personal property. 18.4 Partial Destruction of University Village. If fifty percent (50%) or more of the gross leasable area of University Village is damaged ordestroyed by fire or other cause, notwithstanding that the Leased Premises may be unaffected by such fire or other cause, Landlord may terminate this Leaseand the tenancy hereby created by giving Tenant not less than thirty (30) days prior written notice of Landlord’s election; provided, however, that such noticeshall be given, if at all, within the sixty (60) days following the date of occurrence of such damage or destruction. Minimum Rent and Other Charges shall beprorated as of the date of such termination. Landlord shall not terminate this Lease as a result of partial destruction of University Village unless the leases forall other tenants identified as “similarly situated” on Exhibit 15.2 attached hereto which Landlord would be permitted to terminate under the facts andcircumstances of the partial destruction and under the terms of said leases, shall also be terminated. 19. SUBORDINATION AND ATTORNMENT; MORTGAGEE PROTECTION. 19.1 Subordination - Notice to Mortgagee. Tenant hereby subordinates this Lease to any existing or future mortgages or deeds of trust onUniversity Village or on any leasehold 36 interest held by Landlord and to any extensions, renewals, or replacements thereof. At the request of Landlord, Tenant shall promptly execute and deliver allinstruments which may be appropriate to subordinate this Lease to any existing or future mortgages or deeds of trust on University Village or on the leaseholdinterest held by Landlord, and to any extensions, renewals, or replacements thereof, on forms reasonably satisfactory to the lender under such future mortgageor deed of trust; provided that any such subordination agreements also provide that Tenant’s possession shall not be disturbed following foreclosure so long asTenant is not in default hereunder, subject to applicable notice and cure periods expressly provided herein. Notwithstanding anything to the contrary in thisLease, Landlord shall not be in default under any provision of this Lease unless written notice specifying such default is given to Landlord and to all personswho have an interest in all or part of University Village as mortgagees and/or deed of trust beneficiaries, provided that Tenant has been notified in writing (byway of Notice of Assignment of Rents and Leases, or otherwise) of the addresses of such mortgagees or deed of trust holders, and the provisions ofSection 17.1 have been complied with. Landlord agrees to use reasonable efforts to obtain from its existing lender, following execution of this Lease by allparties, a Non-Disturbance and Attornment Agreement (which agreement shall be on such lender’s standard form and which may also provide additional termsreasonably satisfactory to Tenant regarding subordination of this Lease if required by such lender). 19.2 Tenant’s Certificate. Tenant shall at any time and from time to time upon not less than fifteen (15) days prior written notice fromLandlord execute, acknowledge and deliver to Landlord a statement in writing (a) certifying that this Lease is unmodified and in full force and effect (or, ifmodified, stating the nature of such modification and certifying that this Lease as so modified is in full force and effect), and the date to which the rental andother charges are paid in advance, if any, and (b) acknowledging that there are not, to Tenant’s knowledge, any uncured defaults on the part of Landlordhereunder, or specifying such defaults if any are claimed, (c) setting forth the date of commencement of rents and expiration of the Lease Term hereof; and(d) setting forth such other information with respect to this Lease as Landlord may reasonably request. Any such statement may be relied upon by anyprospective purchaser or encumbrancer of all or any portion of University Village. If Tenant fails to respond to a request hereunder in a timely fashion (but inno event longer than thirty (30) days), Tenant shall be deemed to have admitted the accuracy of any information provided by Landlord to the prospectivepurchaser or lender and to have certified that this Lease is in full force and effect with no uncured defaults on the part of Landlord; that the security deposit isas stated in the Lease; and that no more than one month’s rent has been paid in advance. 19.3 Mortgagee Protection Clause. Tenant agrees to give any mortgagees and/or deed of trust holders, by registered mail, a copy of any noticeof default served upon the Landlord, provided that prior to such notice Tenant has been notified in writing (by way of Notice of Assignment of Rents andLeases, or otherwise) of the addresses of such mortgagees or deed of trust holders. Tenant further agrees that if Landlord shall have failed to cure such defaultwithin the time provided for in this Lease, then the mortgagees or deed of trust holders shall have an additional thirty (30) days within which to cure suchdefault or if such default cannot be cured within that time, then such additional time as may be necessary if within such thirty (30) days any mortgagee ordeed of trust holder has commenced and is diligently pursuing the remedies 37 necessary to cure such default (including but not limited to commencement of foreclosure proceedings if necessary to effect such cure), in which event thisLease shall not be terminated if such remedies are being so diligently pursued. 19.4 Ground Lease. [omitted] 20. ACCESS BY LANDLORD. 20.1 Right of Entry. Landlord or Landlord’s employees, agents, and contractors shall have the right (upon reasonable notice depending uponthe circumstances) to enter the Leased Premises at any reasonable time to examine the same, and to show them to prospective purchasers or during the last six(6) months of the Lease Term tenants of the building, and to make such repairs, alterations, improvements or additions as Landlord may deem necessary ordesirable to the Leased Premises or to University Village. If Tenant is not personally present to permit entry and an entry is necessary, Landlord may in caseof emergency forcibly enter the same, without rendering Landlord liable therefor. Nothing contained herein shall be construed to impose upon Landlord anyduty of repair of the Leased Premises or building of which the Leased Premises are a part except as otherwise specifically provided for herein. Landlord shallexercise its best reasonable efforts to make repairs and alterations to the Leased Premises only during reasonable hours except in the event of an emergency. Inconnection with the exercise of any of these rights, Landlord agrees that to the extent practicable, Landlord will not interfere with the operation of Tenant’sbusiness and will attempt to complete repairs during non-business hours. 20.2 Excavation. If an excavation is made upon property adjacent to the Leased Premises, Tenant shall afford to the person causing orauthorized to cause such excavation, license to enter upon the Leased Premises for the purpose of doing such work as Landlord shall deem necessary topreserve the wall of the building of which the Leased Premises is a part from injury or damage and to support the same by proper foundations, without anyclaim for damages or indemnification against Landlord or diminution or abatement of rent. 20.3 Reserved Areas. Landlord reserves all rights to use (or grant other parties the right to use) and Tenant shall have no right, title or interestin: (i) the roof of any structures, (ii) exterior non-storefront portions of the Leased Premises (including, without limitation, demising walls and outer walls ofthe area of the building in which the Leased Premises are located), (iii) air rights above the Leased Premises and rights to the land and improvements below thefloor level of the Leased Premises, and (iv) areas within the Leased Premises necessary for utilities, services, safety and operation of University Village thatwill not materially interfere with Tenant’s use of the Leased Premises, including any systems and equipment, fire stairways, and space between the suspendedceiling of the Leased Premises and the slab of the floor or roof thereabove. If the Leased Premises does not contain a suspended ceiling, the Leased Premisesshall extend vertically to the height where, in Landlord’s reasonable opinion, a suspended ceiling would otherwise exist, and Landlord reserves the right toinstall a suspended ceiling and use the area thereabove. Tenant utilizes a “Frame Relay” service in its operations in connection with its telecommunicationssystem. Landlord shall permit Tenant to install the equipment and facilities necessary to utilize such Frame Relay service for the Leased Premises, includingconnections 38 from Landlord’s local exchange carrier’s telecommunications facilities at University Village to the Leased Premises, exclusively in connection with Tenant’sbusiness, provided that (a) Tenant shall be continuously complying with all governmental laws, ordinances and regulations; (b) upon expiration of the term ofthis Lease, Tenant shall remove such equipment and facilities and repair all damage caused by installation and removal; (c) Tenant shall indemnify and holdharmless Landlord from any damages, expenses, costs, reasonable attorney’s fees, and other costs and expenses arising in connection with the installation,operation, removal and repair of such equipment and facilities; (d) Tenant shall give Landlord at least thirty (30) days prior written notice of its intention toinstall such equipment and facilities; (e) Tenant shall comply with all requirements of Landlord’s local exchange carrier in connection with the installation ofsuch equipment and facilities; (f) Tenant shall comply with Landlord’s construction requirements and criteria as set forth in this Lease, and (g) Tenant shalluse its best efforts to minimize interference with the operations of Landlord and other tenants in University Village. In the event of any future changes ormodifications in Tenant’s telecommunications requirements, Landlord shall not unreasonably withhold its approval of Tenant’s installations, includingwithout limitation installations required to connect the Leased Premises to University Village’s telecommunications access facilities. Except as to conduits inplace as of the date that Tenant takes possession of the Leased Premises, any utility conduits (electrical, HVAC, water, etc.) installed for the benefit of othertenants and running through the Leased Premises shall be installed above Tenant’s lowered ceiling, and as close to the back wall of the Leased Premises aspossible. 20.4 Remeasurement. Landlord shall remeasure the Leased Premises prior to the date Tenant takes possession of the Leased Premises. Allmeasurements shall be made from the outside of exterior walls, shaft walls or corridors or the center of any common walls, without deduction for columns,stairs or other interior construction or equipment. If such remeasurement determines that the Leased Premises contain a different number of square feet than setforth in Article 1, the Minimum Rent, Breakpoint and Other Charges shall be adjusted retroactively and prospectively on a pro rata basis to reflect the numberof square feet determined by such remeasurement; provided, however, that if such measurement reveals that the floor area of the Leased Premises is more thanthree percent (3%) above the figure therefore set forth in Section 1.4, then such charges hereunder shall nevertheless be increased as aforesaid but only by threepercent (3%). Upon either party’s request, the revised square footage shall be confirmed in an amendment to this Lease signed by both parties. Landlord shallgive Tenant 48 hours prior notice before such remeasurement and Tenant may elect to have a representative of Tenant present during such remeasurement. 20.5 Access to University Village. Landlord may prevent or restrict access to University Village or designated portions thereof by suchsecurity procedures as Landlord may from time to time impose on days and hours when University Village is, or portions thereof are, closed for business tothe public. Landlord reserves the right to control, prevent access by and remove, any person whose presence in the judgment of Landlord shall be prejudicialto the safety, character, reputation and interests of University Village, or who in the judgment of Landlord, is intoxicated or under the influence of liquor ordrugs. 20.6 Emergency Closings. Landlord shall have the right (but not the obligation) to 39 limit or prevent access to all or any portion of University Village, shut down elevator and escalator service, activate emergency controls or procedures, orotherwise take such action or preventive measures deemed necessary by Landlord for the safety of tenants or other occupants of University Village or theprotection of University Village or other property located thereon or therein, in case of fire or other casualty, riot or other civil disorder, strike or labor unrest,public excitement or other dangerous condition, or threat thereof. 20.7 Other Tenants. Landlord reserves the right to lease any portion of University Village to such other tenants as Landlord, in Landlord’ssole discretion, deems appropriate, whether or not engaged in the same or similar business for which Tenant is permitted to use the Leased Premises under thisLease. Except as specifically provided herein, Tenant acknowledges that Landlord has made no representations as to the presence of any specific tenant ornumber or types of tenants at University Village as of or after the Commencement Date, hours or days that such other tenants shall or may be open forbusiness, or gross sales which may be achieved by Tenant or any other tenants at University Village. Except as specifically provided herein, a vacation orabandonment of its premises or cessation of business in University Village by any other tenant or occupant shall not release or excuse Tenant from Tenant’sobligations under any provision of this Lease. 21. SURRENDER OR ABANDONMENT OF LEASED PREMISES. 21.1 Surrender of Possession. Tenant shall promptly yield and deliver to Landlord possession of the Leased Premises at the expiration orprior termination of this Lease. 21.2 Holding Over. Any holding over by Tenant after the expiration of the Lease Term hereof, with Landlord’s written consent, shall beconstrued to be a tenancy from month to month at the rents and on all of the terms and conditions set forth herein, to the extent not inconsistent with a month-to-month tenancy; provided, however, monthly Minimum Rent shall be one hundred fifty percent (150%) of the monthly minimum Rent in effect during thecalendar month prior to the expiration of the Lease. Notwithstanding the foregoing, Tenant shall not be required to pay the increased Minimum Rent ifLandlord and Tenant are engaged in good faith negotiations to extend this Lease and enter into an agreement providing for the same within 45 days afterexpiration of this Lease. 21.3 Abandonment. Should Tenant vacate or abandon the Leased Premises or be dispossessed by process of law or otherwise, suchabandonment, vacation or dispossession shall be deemed a breach of this Lease, and, in addition to any other rights which Landlord may have, Landlordmay remove any personal property belonging to Tenant which remains on the Leased Premises and store the same, the cost of such removal and storage to becharged to the account of Tenant. 21.4 Voluntary or other Surrender. The voluntary or other surrender of this Lease by Tenant, or a mutual cancellation thereof, shall notwork a merger, but shall, at the option of Landlord, terminate all or any existing subleases or subtenancies, or operate as an assignment to it of any or all suchsubleases or subtenancies. 40 22. QUIET ENJOYMENT. Upon fully complying with and promptly performing all of the terms, covenants and conditions of this Lease on its partto be performed, and upon the prompt and timely payment of all sums due hereunder, Tenant shall have and quietly enjoy the Leased Premises for the LeaseTerm set forth herein. 23. TENANT’S REPRESENTATIONS. 23.1 Corporate Authority. Tenant represents and warrants that the individual(s) executing this Lease on Tenant’s behalf is/are dulyauthorized to execute and deliver this Lease on behalf of said entity, in accordance with a duly adopted resolution of the board of directors or other governingbody of such entity, that such action and execution are in accordance with the bylaws or other governing documents of such entity, and that this Lease isbinding upon such entity in accordance with its terms. 23.2 Financial Matters. Tenant represents and warrants that there are no proceedings pending, or to the best of Tenant’s knowledge,threatened, which would adversely affect the financial condition of Tenant or the ability of Tenant to enter into this Lease, or the validity and enforceability ofthis Lease; no provision of any mortgage, contract or agreement binding on Tenant which would conflict with or prevent the performance of this Lease byTenant; that the financial statements of Tenant provided to Landlord are true and correct and prepared in accordance with generally accepted accountingprinciples consistently applied; and that there have been no material, adverse changes in financial condition of Tenant since the date of such financialstatements. 23.3 No Reliance. Tenant acknowledges and agrees that neither Landlord nor any agent or representative of Landlord, including any leasingagent, has made, and Tenant has not relied upon, any representations or assurances as to Tenant’s projected or likely sales volume, customer traffic orprofitability in the Leased Premises or University Village. Tenant acknowledges that to the extent any projections, materials, discussions, reports or otherinformation relating to sales volume, customer traffic or profitability have been provided to Tenant by Landlord, that the same are not to be construed as apromise, guarantee or representation that Tenant will realize any sales volume, customer traffic or profitability. 24. SIGNS. Tenant shall not place or suffer to be placed on the exterior walls of the Leased Premises or upon the roof or any exterior door or wall or onthe exterior or interior of any window thereof any sign, awning, canopy, marquee, advertising matter, decoration, letter or other thing of any kind (exclusive ofthe signs, if any, which may be provided for in the original construction or improvement plans and specifications approved by the Landlord and Tenanthereunder, and interior signs in accordance with Tenant’s national sign program) without the prior written consent of Landlord. Landlord hereby reserves theexclusive right to the use for any purpose whatsoever of the roof and exterior of the walls of the Leased Premises and the building of which the Leased Premisesare a part. Notwithstanding anything to the contrary herein, Tenant shall have the right to place reasonably sized, professionally prepared signs and decalsconsistent with J. Crew’s national signage program in Tenant’s store windows. 41 25. DISPLAYS. Tenant may not display or sell merchandise or allow grocery carts or other similar devices within the control of Tenant to be stored orto remain outside the defined exterior walls and permanent doorways of the Leased Premises. Tenant further agrees not to install or use any exterior lighting,amplifiers or similar devices in or about the Leased Premises, such as flashing lights, searchlights, loudspeakers, phonographs or radio broadcasts. Ifmusic or any other audio transmission emanating from within the Leased Premises is objectionable or offensive (in the reasonable judgment of Landlord),Landlord may require Tenant to decrease the volume of such sounds to a reasonable level, as determined by Landlord, and Tenant shall comply immediately. 26. AUCTIONS AND SALES. 26.1 General. Tenant shall not conduct or permit to be conducted any sale by auction upon or from the Leased Premises, whether the auctionbe voluntary, involuntary, pursuant to any assignment for the payment of creditors, or pursuant to any bankruptcy or other insolvency proceeding. 26.2 No Distress Sales. No auction, fire, bankruptcy, “going out of business” or other distress sales of any nature may be conducted on theLeased Premises without the prior written consent of Landlord. 27. MERCHANTS’ ASSOCIATION. 27.1 General. Tenant shall become a member of, participate fully in, pay dues to, and remain in good standing in the Merchants’ Associationfor University Village. Tenant will further abide by the bylaws, regulations and rules of the Merchants’ Association. The sole objectives of the Associationshall be (i) to promote and advertise University Village as an entity through cooperative advertising efforts, relying on assistance from the Landlord’srepresentative in promoting University Village, (ii) to encourage its members to deal fairly and courteously with their customers, and (iii) to encourage ethicalbusiness practices. The Merchants’ Association shall not act or attempt to function as a collective body for the purpose of engaging in discussions or adviceconcerning management, leasing, or other administrative functions of University Village nor shall it exercise any control over the Common Area or sponsor orhold any activities in or on behalf of University Village other than through the Landlord and with the Landlord’s prior approval. 27.2 Board of Directors. The Merchants’ Association is governed by a Board of Directors elected by the members of the Merchants’Association with the number of such board members being determined from time to time in accordance with its bylaws. Landlord, the major department storetenant, the major drug store tenant, the major hardware store tenant and the major supermarket tenant may not be denied membership on the Board ofDirectors. 27.3 Dues. Tenant shall pay an annual Promotional Assessment in the amount of $0.50 per square foot of the ground level portion of the Areaof Leased Premises. 42 27.4 Method of Payment; Annual Adjustment. The Tenant shall pay its Promotional Assessment in monthly installments, payable inadvance on the first day of each month during the calendar year. Tenant’s assessment shall be adjusted bi-annually on the first day of every second calendaryear after 2004 (“Adjustment Date”) during the term of this Lease by adjusting the amount per square foot set forth in Section 27.3 above for any increase inthe cost of living index for December 2004 as compared to the index for the December immediately preceding each Adjustment Date. Adjustments shall bebased upon the U.S. city Average Consumer Price Index for Urban Wage Earners and Clerical Workers for All Items (1982-84 = 100) published by the bureauof Labor of the U.S. Department of Labor as published for December 2004 and as published for the month of December immediately preceding the AdjustmentDate. If the index ceases to be published or is modified, such increase shall be based on the replacement index and/or such adjustment factors as provided bythe bureau, or otherwise upon a reasonably comparable cost of living index. Notwithstanding the foregoing, in no event shall the Promotional Assessmentincrease by more than six percent (6%) every two years on a non-cumulative basis. 27.5 Landlord’s Contribution. Landlord shall be a member of the Merchants’ Association and shall pay, on a noncumulative basis, acontribution equal to twenty-five percent (25%) of all contributions collected by the Merchants’ Association; provided, however, that the Landlord’scontribution shall not exceed the sum of Fifty Thousand and No/100 Dollars ($50,000) in any one (1) fiscal year. Landlord may elect to contribute part or allof the services of a marketing director in lieu of all or a portion of its cash contribution. In the event Landlord makes the above election, the marketing directorshall be under the exclusive control and supervision of Landlord. 27.6 Use of Tenant’s Name. Landlord covenants that it will not advertise the Tenant’s business or its merchandise in any media without firstobtaining Tenant’s consent, which consent may be withheld in Tenant’s sole discretion. 27.7 Conversion to Marketing Fund. At any time during the Term of this Lease, Landlord shall have the right to disband the Merchants’Association by written notice to each member thereof. In lieu of the Merchants’ Association, Landlord shall establish a Marketing Fund to furnish andmaintain advertising and sale promotions, which, in Landlord’s sole opinion, will benefit University Village. The Marketing Director, staff and anyconsultants shall be hired by the Landlord to direct and perform the activities of the Marketing Fund and shall be under the exclusive control and supervisionof Landlord. Tenant’s advertising requirements under the Marketing Fund shall be the same as those under the Merchants’ Association as provided above. Landlord shall appoint a committee comprised of a representative from each of four tenants occupying premises in University Village to review the advertisingand other promotional activities provided by the Marketing Fund. During each Lease Year, Tenant shall pay to Landlord in equal monthly installments, as itsshare of the cost of the Marketing Fund, an amount herein equal to the then current Merchants’ Association dues payable by Tenant in accordance with thisSection 27. Tenant’s obligations to participate in the Marketing Fund and pay its share of the costs are subject to the same conditions and caps as Tenant’sobligations to participate in 43 and pay its share of funding the Merchant’s Association. 28. MAJOR RENOVATION. 28.1 Cooperation of Tenant. [omitted] 28.2 Construction Coordination. If Landlord shall undertake an expansion and/or reconfiguration of University Village, in whole or in part,such construction and reconfiguration may result in noise, dust, debris and other disruption which could adversely impact Tenant’s business in the LeasedPremises. Landlord shall use reasonable efforts to mitigate the adverse impact on Tenant, including any adverse affect on access to or visibility of Tenant’sstorefront and the Leased Premises, but Tenant understands and accepts that such impacts may not be capable of mitigation without unreasonable expense. Such adverse impacts shall not constitute a default under this Lease by Landlord or a constructive eviction of Tenant. In connection with such a project,Landlord may find it necessary or desirable, as determined by Landlord, to enter into the Leased Premises to inspect the same or perform work in or aroundthe Leased Premises, including, without limitation, the installation of temporary and/or permanent supports and other structures and facilities, provided theinstallation of same shall not materially adversely affect Tenant’s ability to operate its business in the Leased Premises for the Permitted Use, no suchinstallations shall be made in the sales area of the Leased Premises unless no other reasonable alternative is available and Landlord shall use reasonable effortsto perform any such work in the Leased Premises during non-business hours. If, as a result of no other reasonable alternative being available, Landlordnotifies Tenant of its intention to install a column or columns in the sales area of the Leased Premises in connection with such a project, Tenant shall have theright, upon one hundred twenty (120) days notice to Landlord delivered within twenty (20) days of receipt of such notice from Landlord, to terminate thisLease, unless within sixty (60) days following Landlord’s receipt of Tenant’s notice of termination, Landlord delivers notice to Tenant advising Tenant of itsdecision to not proceed with the installation of any columns within the Leased Premises. Tenant consents to such actions by Landlord and Landlord’s agentsand contractors. 29. HAZARDOUS AND TOXIC SUBSTANCES. 29.1 Tenant’s Representation and Warranty. Tenant represents, warrants and covenants that throughout the term of this Lease, nochemical, substance, material or waste or component thereof which is now or hereafter listed, defined or regulated as a hazardous or toxic chemical, substance,material or waste or component thereof by any federal, state or local governing or regulatory body having jurisdiction, or which would trigger any employee orcommunity “right-to-know” requirements adopted by any such body (“Hazardous Substances”) will be improperly generated, treated, released, stored ordisposed of, or otherwise deposited in or on the Leased Premises by Tenant, its employees, agents, contractors, subtenants, licensees or invitees, includingwithout limitation the surface waters and subsurface waters thereof, no underground tanks will be located on the Leased Premises, and there will be noHazardous Substances or hazardous conditions in or on the Leased Premises which may support a claim or cause of action under any federal, state or localenvironmental statutes regulations, ordinances or 44 regulatory requirements. Tenant may store in the Leased Premises household quantities of cleaning supplies provided Tenant uses care in storing them andotherwise complies with all applicable laws. 29.2 Tenant’s Notice to Landlord. Tenant shall promptly notify Landlord of: (i) any enforcement, cleanup or other regulatory action taken orthreatened by any governmental or regulatory authority with respect to the presence of any Hazardous Substances on the Leased Premises or the migrationthereof from or to other property, (ii) any demands or claims made or threatened by any party relating to any loss or injury resulting from any HazardousSubstances on the Leased Premises, (iii) any release, discharge or nonroutine, improper or unlawful disposal or transportation of any Hazardous Substanceson or from the Leased Premises or in violation of this Section 29, and (iv) any matters where Tenant is required by law to give a notice to any governmental orregulatory authority respecting any Hazardous Substances on the Leased Premises. Landlord shall have the right (but not the obligation) to join andparticipate, as a party, in any legal proceedings or actions affecting the Leased Premises initiated in connection with any environmental, health or safety law. 29.3 Remediation of Contamination. If any Hazardous Substances are released, discharged or disposed of by Tenant, or their employees,agents or contractors, on or about University Village in violation of the foregoing provisions, Tenant shall immediately, properly and in compliance withapplicable laws clean up and remove the Hazardous Substances from University Village and any other affected property and clean or replace any affectedpersonal property, at Tenant’s expense. Such clean up and removal work shall be subject to Landlord’s prior written approval (except in emergencies), andshall include, without limitation, any testing, investigation, and the preparation and implementation of any remedial action plan required by any court orgovernmental body having jurisdiction or reasonably required by Landlord. If Landlord or any lender to Landlord or any governmental body arranges for anytests or studies showing that this Section has been violated, Tenant shall pay for the costs of such tests. 29.4 Indemnity of Landlord. Tenant shall defend, indemnify, and hold Landlord harmless from all claims, liabilities, damages, costs,expenses fees fines and penalties (both civil and criminal) (including, but not limited to, reasonable attorneys’ fees) resulting from any personal injury,property damage, water pollution, air pollution, hazardous waste combination, Hazardous Substances contamination, damage to fish or wildlife, damage tonatural resources, or environmental harm due to the release, discharge or disposal of Hazardous Substances by Tenant or Tenant’s employees, agents orcontractors on or about University Village. Without limiting the generality of the foregoing, Tenant’s obligations under this subsection shall extend to liabilityarising under common law or under any federal, state, local, or other governmental requirement. This indemnity shall apply to the fullest extent permitted byapplicable law. Tenant’s indemnification obligation pursuant to this paragraph shall survive the expiration or termination of this Lease. 29.5 Acceptance of Leased Premises. Tenant accepts the Leased Premises “AS IS” subject only to completion of Landlord’s Work. 45 29.6 Soil Contamination. In the event that any preexisting contamination in the soils beneath the building in which the Leased Premises arelocated and affecting the construction or use of the Leased Premises is discovered following the date of this Lease, and if the same requires remediationpursuant to any applicable law, rule, regulation or order of any governmental agency having jurisdiction over the same, or otherwise in the judgment ofLandlord, then, Landlord shall promptly remediate the same at Landlord’s sole cost and expense and, if Landlord is required to enter into the Leased Premisesor if such remediation measures require the disruption of Tenant’s use of the Leased Premises, the parties agree that to the extent that Tenant is unable to use theLeased Premises for Permitted Uses under this Lease, the Minimum Rent and Other Charges payable by Tenant hereunder shall equitably abate in proportionto the extent of the Leased Premises so affected for the period of any such interruption. 29.7 Indemnity of Tenant. To the best of Landlord’s knowledge, there are no Hazardous Substances, including, without limitation, anyasbestos containing materials, located within or under the Leased Premises. Landlord shall defend, indemnify, and hold Tenant harmless from all claims,liabilities, damages, costs, expenses, fees, fines and penalties (both civil and criminal) (including, but not limited to, reasonable attorneys’ fees) resultingfrom any personal injury, property damage, water pollution, air pollution, hazardous waste contamination, Hazardous Substances contamination, damage tofish or wildlife, damage to natural resources, or environmental harm due to preexisting contamination of the Leased Premises by Hazardous Substances (exceptto the extent such Hazardous Substances are within the Leased Premises due to acts by Tenant or Tenant’s employees, agents or contractors on or aboutUniversity Village). Landlord’s indemnification obligation pursuant to this paragraph shall survive the expiration or termination of this Lease. 30. MISCELLANEOUS. 30.1 Successors or Assigns. All the terms, conditions, covenants and agreements of this Lease shall extend to and be binding upon Landlord,Tenant and their respective heirs, administrators, executors, successors and assigns, and upon any person or persons coming into ownership or possession ofany interest in the Leased Premises by operation of law or otherwise, and shall be construed as covenants running with the land. 30.2 Tenant Defined. The word “Tenant” as used herein shall mean each and every person, partnership or corporation who is mentioned asTenant herein or who executes this Lease as Tenant. 30.3 Broker’s Commission. Landlord and Tenant represent and warrant that it has incurred no liabilities or claims for brokeragecommissions or finder’s fees in connection with the execution of this Lease and that it has not dealt with or has any knowledge of any real estate broker, agentor salesperson in connection with this Lease. Each party agrees to indemnify and hold the other harmless from all such liabilities or claims (including,without limitation, attorneys’ fees). 46 30.4 Partial Invalidity. If any term, covenant, or condition of this Lease or the application thereof to any person or circumstance is, to anyextent, invalid or unenforceable, the remainder of this Lease, or the application of such term, covenant or condition to persons or circumstances other thanthose as to which it is held invalid or unenforceable, shall not be affected thereby and each term, covenant or condition of this Lease shall be valid and beenforced to the fullest extent permitted by law. Titles of sections and paragraphs herein are for convenience only and shall not affect the meaning orinterpretation of any provision of this Lease. 30.5 Recording. Tenant shall not record this Lease without the prior written consent of Landlord. However, upon the request of Landlord, bothparties shall execute a memorandum or “short form” of this Lease for the purposes of recordation in a form customarily used for such purposes. Saidmemorandum or short form of this Lease shall describe the parties, the Leased Premises and the Lease Term and shall incorporate this Lease by reference. 30.6 Notices. Any notices required in accordance with any of the provisions herein shall be in writing and, if to Landlord, shall be delivered ormailed by registered or certified mail or reputable air courier such as Federal Express to the address of Landlord as set forth at the beginning of this Lease or atsuch other place as Landlord may in writing from time to time direct to Tenant, and if to Tenant, shall be delivered or mailed by registered or certified mail orreputable air courier such as Federal Express to Tenant at 770 Broadway, New York, NY 10003, Attn: General Counsel. If there is more than one Tenant,any notice required or permitted hereunder may be given by or to any one thereof and shall have the same force and effect as if given by or to all thereof. Notice shall be deemed delivered upon acceptance or refusal of the same. 30.7 Waiver. The waiver by Landlord or Tenant of any term, covenant or condition herein contained shall not be deemed to be a waiver ofsuch term, covenant or condition or any subsequent breach of the same or any other term, covenant or condition herein contained. The subsequent acceptanceof Minimum Rent or Percentage Rent or any other charges or sum hereunder by Landlord shall not be deemed to be a waiver of any preceding default byTenant of any term, covenant or condition of this Lease, other than the failure of Tenant to pay the particular sum so accepted, regardless of Landlord’sknowledge of such preceding default at the time of the acceptance of such sum. 30.8 Joint Obligation. If there be more than one Tenant, the obligations hereunder imposed shall be joint and several. 30.9 Time. Time is of the essence of this Lease and each and all of its provisions in which performance is a factor. 30.10 Late Charges. If Tenant fails to pay, when the same is due and payable, any Minimum Rent or Percentage Rent or Additional Rent, or theOther Charges described herein, such unpaid amounts shall bear interest at Default Rate on the first day of each month, commencing on the date due to thedate of payment. In addition to such interest, Tenant 47 acknowledges that either the late reporting of gross sales or late payment by Tenant of any monthly installment of Minimum Rent, Percentage Rent or OtherCharges will cause Landlord to incur certain costs and expenses not contemplated under this Lease, the exact amount of such costs being extremely difficult orimpractical to fix. Such costs and expenses will include, without limitation, administrative and collection costs, and processing and accounting expenses. Therefore, if any gross sales or any installment of Minimum Rent, Percentage Rent or Other Charges is not received by Landlord from Tenant within ten (10)days after Landlord has given written notice of such delinquency to Tenant, Tenant shall immediately pay to Landlord a late charge of Two Hundred andNo/100 Dollars ($200.00) for each delinquency. Landlord and Tenant agree that this late charge represents a reasonable estimate of such costs and expensesand is fair compensation to Landlord for its loss suffered by such nonpayment by Tenant. Acceptance of this late charge shall not constitute a waiver ofTenant’s default with respect to such nonpayment by Tenant nor prevent Landlord from exercising all other rights and remedies available to Landlord underthis Lease. Landlord shall apply payments made by Tenant first to accrued charges, interest and rent in the following order: Late Charges, interest,Minimum Rent, Percentage Rent, Other Charges and Additional Rent; and any balance remaining to current Minimum Rent, Percentage Rent, Other Chargesand Additional Rent. 30.11 Prior Agreements. This Lease contains all of the agreements of the parties hereto with respect to any matter covered or mentioned in thisLease, and no prior agreements or understanding pertaining to any such matters shall be effective for any purpose. No provisions of this Lease may beamended or added to except by an agreement in writing signed by the parties hereto or their respective successors in interest. This Lease shall not be effectiveor binding on any party until fully executed by both parties hereto. 30.12 Inability to Perform. Except for the obligation of the Tenant to pay Rent, which shall not be excused by force majeure, this Lease and theobligations of the parties hereunder shall be excused for the period of a delay in performing its obligations hereunder, if such inability or delay is caused byreason of strike, labor troubles, acts of God, or any other cause beyond the reasonable control of the obligated party. 30.13 Choice of Law. This Lease shall be governed by the laws of the State of Washington. 30.14 Landlord’s Consent. Except as otherwise specifically provided herein, whenever Landlord’s consent or approval is required, the samemay be withheld in Landlord’s sole discretion. 30.15 Negotiations. This Lease, and any Riders and Exhibits hereto, have been mutually negotiated by Landlord and Tenant, and anyambiguities shall not be interpreted in favor of either party. Any printed provisions that have been deleted shall not be used to interpret the remainingprovisions. 30.16 Landlord’s Liability. Anything in this Lease to the contrary notwithstanding, the covenants, undertakings and agreements herein madeon the part of Landlord are made and 48 intended not as personal covenants, undertakings and agreements for the purpose of binding Landlord personally or the assets of Landlord, but are made andintended for the purpose of binding only Landlord’s interest in the Leased Premises and University Village, as the same may from time to time beencumbered. In consideration of the benefits accruing hereunder, Tenant and all successors and assigns, covenant and agree that in the event of any actual oralleged failure, breach or default hereunder by Landlord, the sole and exclusive remedy of Tenant hereunder shall be against the Landlord’s interest in theLeased Premises and University Village, and no general or limited partner of Landlord, or any director, officer, agent or employee of any corporation which isthe Landlord or a general or limited partner of Landlord, shall be sued or named as a party in any such suit or action and no judgment shall be taken againstany such general or limited partner of Landlord. In case Landlord or any successor owner of University Village shall convey or otherwise dispose of anyportion thereof in which the Leased Premises are located to another party (and nothing herein shall be construed to restrict or prevent such conveyance ordisposition), such other party shall thereupon be and become landlord hereunder and shall be deemed to have fully assumed and be liable for all obligations ofthis Lease to be performed by Landlord, including the return of any Security Deposit. Tenant shall attorn to such other party, and Landlord or suchsuccessor owner shall, from and after the date of conveyance, be free of all liabilities and obligations hereunder. 30.17 Conflict. In the event there is a conflict between the terms of this Lease and Exhibits and the plans for Tenant’s work approved in writingby Landlord, the approved plans shall prevail. 49 IN WITNESS WHEREOF, the parties hereto have executed this instrument the day and year first above set forth. LANDLORD:UNIVERSITY VILLAGE LIMITED PARTNERSHIP,a Washington limited partnership By:UV, INC.,a Washington corporation,Its General Partner By:/s/ Matt GriffinMatt GriffinV P. TENANT:GRACE HOLMES, INC.,a Delaware corporation By:/s/ Scott Gilbertson Printed Name:Scott GilbertsonTitle:Chief Operating Officer 50 LANDLORD ACKNOWLEDGMENT STATE OF WASHINGTON)) ss.COUNTY OF KING) On this day of , 2003, before me, the undersigned, a notary public in and for the state of Washington, duly commissionedand sworn personally appeared Stuart M. Sloan, to me known to be the President of UV, Inc., the general partner of UNIVERSITY VILLAGE LIMITEDPARTNERSHIP, the partnership that executed the foregoing instrument, and acknowledged the said instrument to be the free and voluntary act and deed ofsaid partnership, for the uses and purposes therein mentioned and on oath stated that he is authorized to execute the said instrument. WITNESS my hand and official seal hereto affixed the day and year in this certificate abovewritten. Printed Name:Notary Public for the State of Washington,residing at My appointment expires: CORPORATE ACKNOWLEDGMENT STATE OF)) ss.COUNTY OF) On this day of , 2003, before me, the undersigned, a Notary Public in and for said State, personally appeared and , known or identified to me to be the and of , the corporation that executed the within instrument, or the persons who executed the instrumenton behalf of said corporation, and acknowledged to me that such corporation executed the same. IN WITNESS WHEREOF, I have hereto set my hand and affixed my official seal the day and year in this certificate first above written. Printed Name:Notary Public for the state ofresiding at My appointment expires: 51 INDIVIDUAL ACKNOWLEDGMENT STATE OF)) ss.COUNTY OF) On this day of , 20 , before me, the undersigned, a Notary Public in and for said State, personally appeared , who acknowledged that authorized to sign the foregoing instrument, and that the same is free act and deed. IN WITNESS WHEREOF, I have hereto set my hand and affixed my official seal the day and year in this certificate first above written. Printed Name:Notary Public for the state ofresiding at My appointment expires: PARTNERSHIP ACKNOWLEDGMENT STATE OF)) ss.COUNTY OF) On this day of , 20 before me, the undersigned, a Notary Public in and for the state of duly commissioned and sworn personally appeared to me known to be the of the partnership that executed the foregoing instrument,and acknowledged the said instrument to be the free and voluntary act and deed of said partnership, for the uses and purposes therein mentioned and on oathstated that he/she is authorized to execute the said instrument. WITNESS my hand and official seal hereto-affixed the day and year in this certificate above written. Printed Name:Notary Public for the state ofresiding at My appointment expires: 52 LIMITED LIABILITY COMPANY ACKNOWLEDGMENT STATE OF)) ss.COUNTY OF) On this day of , 20 before me, the undersigned, a Notary Public in and for the state of duly commissioned and sworn personally appeared to me known to be the of the limited liability company thatexecuted the foregoing instrument, and acknowledged the said instrument to be the free and voluntary act and deed of said limited liability company, for theuses and purposes therein mentioned and on oath stated that he/she is authorized to execute the said instrument. WITNESS my hand and official seal hereto-affixed the day and year in this certificate above written. Printed Name:Notary Public for the state ofresiding at My appointment expires: 53 GUARANTY OF LEASE THIS GUARANTY OF LEASE is made as of the 7th day of November, 2003 by J. CREW GROUP, INC., a New York corporation, with officesat 770 Broadway, New York, NY 10003 (“Guarantor”). UNIVERSITY VILLAGE LIMITED PARTNERSHIIP, a Washington limited partnership (“Landlord”), and GRACE HOLMES, INC., a Delawarecorporation (“Tenant”), are entering into a certain Shopping Center Lease as of the date hereof (the “Lease”), with respect to certain premises containingapproximately 7,400 square feet (the “Premises) within the shopping center located in Seattle, Washington, known as University Village. In order to induce Landlord to lease the Premises to Tenant, Guarantor agreed to guarantee the performance of all of the terms, conditions, covenants,obligations, liabilities and agreements contained in the Lease which are required to be fulfilled or performed by Tenant, subject to the terms and provisionshereof. 1. (a) Guarantor unconditionally guarantees to Landlord and the successors and assigns of Landlord the full and punctual performance andobservance by Tenant of all the terms, covenants and conditions in the Lease contained on Tenant’s part to be kept, performed or observed. (b) If at any time default shall be made by Tenant in the performance or observance of any of the terms, covenants or conditions in theLease contained on Tenant’s part to be kept, performed or observed, Guarantor will keep, perform and observe the same, as the case may be, in place andstead of Tenant. 2. Any act of Landlord, or the successors or assigns of Landlord, consisting of a waiver of any of the terms or conditions of the Lease, orthe giving of any consent to any manner or thing relating to the Lease, or the granting of any indulgences or extensions of time to Tenant, may be done withoutnotice to Guarantor and without releasing the obligations of Guarantor hereunder. Landlord agrees to give to Guarantor notice of any Tenant default under theLease at the address of Guarantor set forth below (or any subsequent address of which Guarantor gives Landlord written notice) in the same manner as noticeto Tenant as provided under the Lease and shall afford Guarantor the period of time to cure such default as provided Tenant under the Lease with respect tosuch default. Failure to give any such notice by Landlord hereunder shall not discharge Guarantor of any obligation or liability under this Guaranty exceptthat Landlord must give such notice and opportunity to cure to Guarantor prior to enforcement of any rights, remedies, liabilities or obligations under thisGuaranty. 3. The obligations of Guarantor hereunder shall not be released by Landlord’s receipt, application or release of security given for theperformance and observance of covenants and conditions in the Lease contained on Tenant’s part to be performed or observed; nor by any modification of theLease, but in case of any such modification the liability of Guarantor shall be 54 deemed modified in accordance with the terms of any such modification of the Lease. 4. The liability of Guarantor hereunder shall in no way be affected by (a) the release or discharge of Tenant in any creditors’, receivership,bankruptcy or other proceedings; (b) the impairment, limitation or modification of the liability of the Tenant or the estate of the Tenant in bankruptcy, or ofany remedy for the enforcement of Tenant’s liability under the Lease resulting from the operation of any present or future provision of the NationalBankruptcy Act or other statute or from the decision in any court; (c) the rejection or disaffirmance of the Lease in any such proceedings; (d) the assignmentor transfer of the Lease by Tenant or the sublease of all or any part of the premises described therein; or (e) any disability of Tenant. Guarantor further agreesthat this Guaranty shall continue to be effective or be reinstated as the case may be if at any time payment, or any part thereof, of any amount pursuant to theLease is rescinded or must otherwise be restored by Landlord as a result of the bankruptcy or reorganization of Tenant. 5. The liability of Guarantor under this Guaranty shall be continuing and shall remain in full force and effect as long as Tenant is or may beobligated to Landlord on account of any obligation covered by this Guaranty. The obligations of Guarantor to Landlord hereunder are independent of Tenant’sobligations and a separate action or actions may be brought and prosecuted by Landlord against Guarantor whether or not such action or actions are alsobrought against Tenant. This Guaranty constitutes a guarantee of payment when due and not of collection. Guarantor waives and agrees not to assert orotherwise take advantage of any right which it may have (a) to require Landlord to proceed against Tenant or any other person, firm or corporation or toproceed against or exhaust any security held by it at any time or to pursue any other remedy; or (b) any defense which it may have by reason of incapacity,lack of authority or other approvals relating either to Tenant or Guarantor, or based upon any statute of limitations or an election of remedies by Landlord. 6. This Guaranty shall be construed and performed in accordance with the laws of the State of Washington. Guarantor hereby irrevocablysubmit to the jurisdiction of King County Superior Court in Seattle, King County, Washington in any action or proceeding brought to enforce or otherwisearising out of or relating to this Guaranty and waive to the fullest extent permitted by law any objection which it may have now or hereafter to such venue orany claim that such forum is an inconvenient forum. 7. This guarantee shall apply to the Lease, any extension or renewal thereof pursuant to the exercise by Tenant of any option to extendcontained in the Lease or otherwise consented to by Guarantor, and to any holdover term following the term granted by the Lease or any extension or renewalthereof. 8. This instrument may not be changed, modified, discharged or terminated orally or in any manner other than by an agreement in writingsigned by Guarantor and the Landlord. If there is more than one Guarantor, the obligations of the undersigned shall be joint and several. This Guarantee shallbe binding upon Guarantor and its/their successors and assigns. 9. Notwithstanding anything herein to the contrary, the obligations of Guarantor 55 hereunder shall not include any increased obligations of Tenant evidenced by any amendment or modification of the Lease entered into by Landlord and anysuccessor to Tenant who is not affiliated with Guarantor. DATED as of the day and year first above written. GUARANTOR:J. CREW GROUP, INC. By:/s/ Nicholas LambertiName:Nicholas LambertiTitle:VP Controller 56 Exhibit 23.1 The Board of DirectorsJ. Crew Group, Inc.: We consent to the incorporation by reference in the previously filed registration statement No. 333-60658 on Form S-8 of J. Crew Group, Inc. 1997 StockOption Plan of our report dated April 4, 2005, with respect to the consolidated balance sheets of J. Crew Group, Inc. and subsidiaries as of January 29, 2005and January 31, 2004, and the related consolidated statements of operations, cash flows, and changes in stockholders’ deficit for each of the years in the three-year period ended January 29, 2005, and the related financial statement schedule, which report appears in the January 29, 2005 annual report on Form 10-Kof J. Crew Group, Inc. Our report refers to the adoption of Statement of Financial Accounting Standard No. 150, “Accounting for Certain Financial Instruments with Characteristicsof both Liabilities and Equity” in the third quarter of fiscal 2003. Our report also indicates that J. Crew Group, Inc. and subsidiaries have restated the consolidated statements of cash flows for each of the years in the two-yearperiod ended January 31, 2004, to reclassify the proceeds from construction allowances from cash flows from investing activities to cash flows from operatingactivities. New York, New YorkApril 29, 2005 QuickLinks -- Click here to rapidly navigate through this documentEXHIBIT 31.1 CERTIFICATION PURSUANT TO SECTION 302OF THE SARBANES-OXLEY ACT OF 2002 I, 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 report does not contain any untrue statement of a material fact or omit to state a material factnecessary to make the statements made, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by this report; 3.Based on my knowledge, the financial statements and other financial information included in this report fairly present in allmaterial respects the financial condition, results of operations and cash flows of each registrant as of, and for, the periodspresented in this report; 4.Each registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for such registrant and have: a)Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designedunder our supervision, to ensure that material information relating to such registrant, including its consolidatedsubsidiaries, is made known to us by others within those entities, particularly during the period in which this report isbeing prepared; b)Evaluated the effectiveness of such registrant's disclosure controls and procedures and presented in this report ourconclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by thisreport based on such evaluation; and c)Disclosed in this report any change in such registrant's internal control over financial reporting that occurred during theregistrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that hasmaterially affected, or is reasonably likely to materially affect, such registrant's internal control over financial reporting;and 5.Each registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control overfinancial reporting, to such registrant's auditors and the audit committee of such registrant's board of directors (or personsperforming the equivalent functions): a)All significant deficiencies and material weaknesses in the design or operation of internal control over financial reportingwhich are reasonably likely to adversely affect such registrant's ability to record, process, summarize and reportfinancial information; and b)Any fraud, whether or not material, that involves management or other employees who have a significant role in suchregistrant's internal control over financial reporting.Dated: April 29, 2005 /s/ MILLARD S. DREXLER Millard S. DrexlerChief Executive Officer QuickLinksEXHIBIT 31.1CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002QuickLinks -- Click here to rapidly navigate through this documentEXHIBIT 31.2 CERTIFICATION PURSUANT TO SECTION 302OF THE SARBANES-OXLEY ACT OF 2002 I, Amanda J. Bokman, 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 report does not contain any untrue statement of a material fact or omit to state a material factnecessary to make the statements made, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by this report; 3.Based on my knowledge, the financial statements and other financial information included in this report fairly present in allmaterial respects the financial condition, results of operations and cash flows of each registrant as of, and for, the periodspresented in this report; 4.Each registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for such registrant and have: a)Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designedunder our supervision, to ensure that material information relating to such registrant, including its consolidatedsubsidiaries, is made known to us by others within those entities, particularly during the period in which this report isbeing prepared; b)Evaluated the effectiveness of such registrant's disclosure controls and procedures and presented in this report ourconclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by thisreport based on such evaluation; and c)Disclosed in this report any change in such registrant's internal control over financial reporting that occurred during theregistrant's most recent fiscal quarter (the registrant's fourth fiscal year in the case of an annual report) that hasmaterially affected, or is reasonably likely to materially affect, such registrant's internal control over financial reporting;and 5.Each registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control overfinancial reporting, to such registrant's auditors and the audit committee of such registrant's board of directors (or personsperforming the equivalent functions): a)All significant deficiencies and material weaknesses in the design or operation of internal control over financial reportingwhich are reasonably likely to adversely affect such registrant's ability to record, process, summarize and reportfinancial information; and b)Any fraud, whether or not material, that involves management or other employees who have a significant role in suchregistrant's internal control over financial reporting.Dated: April 29, 2005 /s/ AMANDA J. BOKMAN Amanda J. BokmanExecutive Vice-President andChief Financial Officer QuickLinksEXHIBIT 31.2CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002QuickLinks -- Click here to rapidly navigate through this documentEXHIBIT 32.1 CERTIFICATION PURSUANT TO SECTION 906OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of J.Crew Group, Inc. and J.Crew Operating Corp. (collectively, the "Company") on Form 10-K forthe period ended January 29, 2005 (the "Report") as filed with the Securities and Exchange Commission, Millard S. Drexler, ChiefExecutive Officer of the Company, and Amanda J. Bokman, Executive Vice-President and Chief Financial Officer of the Company, certify,pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of theirknowledge: 1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations ofthe Company.Dated: April 29, 2005 /s/ MILLARD S. DREXLER Millard S. DrexlerChief Executive Officer /s/ AMANDA J. BOKMAN Amanda J. BokmanExecutive Vice-President andChief Financial Officer The foregoing certification is being furnished solely pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350)and is not being filed as part of the Report or as a separate disclosure document. A signed original of this written statement required by Section 906 has been provided to the Company and will be retained bythe Company and furnished to the Securities and Exchange Commission or its staff upon request.QuickLinksEXHIBIT 32.1CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

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