jcg-10q_20190504.htm

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended May 4, 2019

Or

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission

File Number

 

Registrant, State of Incorporation

Address and Telephone Number

 

I.R.S. Employer

Identification No.

333-175075

 

 

 

22-2894486

 

J.CREW GROUP, INC.

(Incorporated in Delaware)

 

225 Liberty Street

New York, New York 10281

Telephone: (212) 209-2500

 

Securities registered pursuant to Section 12(b) of the Act:

Title of each class

 

Trading Symbol(s)

 

Name of each exchange on which registered

None

 

N/A

 

N/A

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange 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   

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).      Yes        No   

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large Accelerated Filer

 

  

Accelerated Filer

 

 

 

 

 

Non-Accelerated Filer

 

 

Smaller Reporting Company

 

 

 

 

 

 

 

 

  

Emerging growth company

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.        

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes        No   

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Common Stock

 

Outstanding at May 24, 2019

Common Stock, $.01 par value per share

 

1,000 shares

*

The Registrant has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934, but is not required to file such reports under such sections.

 

 

 

 


 

J.CREW GROUP, INC.

TABLE OF CONTENTS – FORM 10-Q

 

 

 

Page
Number

 

 

 

PART I. FINANCIAL INFORMATION

 

 

 

 

Item 1.

Condensed Consolidated Financial Statements (unaudited):

3

 

 

 

 

Condensed Consolidated Balance Sheets at May 4, 2019 and February 2, 2019

3

 

 

 

 

Condensed Consolidated Statements of Operations and Comprehensive Loss for the thirteen weeks ended May 4, 2019 and May 5, 2018

4

 

 

 

 

Condensed Consolidated Statements of Changes in Stockholders’ Deficit for the thirteen weeks ended May 4, 2019 and May 5, 2018

5

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the thirteen weeks ended May 4, 2019 and May 5, 2018

6

 

 

 

 

Notes to Unaudited Condensed Consolidated Financial Statements

7

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

21

 

 

 

Item 3.

Quantitative and Qualitative Disclosure About Market Risk

31

 

 

 

Item 4.

Controls and Procedures

32

 

 

 

PART II. OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

33

 

 

 

Item 1A.

Risk Factors

33

 

 

 

Item 6.

Exhibits

34

 

 

 

2


 

PART I – FINANCIAL INFORMATION

 

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

J.CREW GROUP, INC.

Condensed Consolidated Balance Sheets

(unaudited)

(in thousands, except share data)

 

 

 

May 4,

2019

 

 

February 2,

2019

 

ASSETS

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

30,236

 

 

$

25,738

 

Restricted cash

 

 

5,258

 

 

 

13,747

 

Accounts receivable, net

 

 

56,444

 

 

 

40,342

 

Merchandise inventories, net

 

 

418,009

 

 

 

390,470

 

Prepaid expenses and other current assets

 

 

68,739

 

 

 

84,942

 

Refundable income taxes

 

 

5,772

 

 

 

7,331

 

Total current assets

 

 

584,458

 

 

 

562,570

 

Property and equipment, net

 

 

239,478

 

 

 

243,620

 

Right-of-use lease assets

 

 

513,037

 

 

 

 

Intangible assets, net

 

 

300,117

 

 

 

301,397

 

Goodwill

 

 

107,900

 

 

 

107,900

 

Other assets

 

 

7,642

 

 

 

6,164

 

Total assets

 

$

1,752,632

 

 

$

1,221,651

 

LIABILITIES AND STOCKHOLDERS’ DEFICIT

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

Accounts payable

 

$

224,700

 

 

$

259,705

 

Borrowings under the ABL Facility

 

 

215,800

 

 

 

70,800

 

Other current liabilities

 

 

203,903

 

 

 

244,864

 

Current portion of right-of-use lease liabilities

 

 

114,052

 

 

 

 

Due to Parent

 

 

35,004

 

 

 

37,462

 

Interest payable

 

 

8,848

 

 

 

23,866

 

Current portion of long-term debt

 

 

32,070

 

 

 

32,070

 

Total current liabilities

 

 

834,377

 

 

 

668,767

 

Long-term debt, net

 

 

1,672,166

 

 

 

1,673,282

 

Long-term right-of-use lease liabilities

 

 

487,765

 

 

 

 

Lease-related deferred credits, net

 

 

 

 

 

105,877

 

Deferred income taxes, net

 

 

16,545

 

 

 

16,872

 

Other liabilities

 

 

31,199

 

 

 

29,096

 

Total liabilities

 

 

3,042,052

 

 

 

2,493,894

 

Stockholders’ deficit:

 

 

 

 

 

 

 

 

Common stock $0.01 par value; 1,000 shares authorized, issued and outstanding

 

 

 

 

 

 

Additional paid-in capital

 

 

733,233

 

 

 

733,229

 

Accumulated other comprehensive loss

 

 

(2,918

)

 

 

(1,967

)

Accumulated deficit

 

 

(2,019,735

)

 

 

(2,003,505

)

Total stockholders’ deficit

 

 

(1,289,420

)

 

 

(1,272,243

)

Total liabilities and stockholders’ deficit

 

$

1,752,632

 

 

$

1,221,651

 

 

 

 

 

 

 

See notes to unaudited condensed consolidated financial statements.

 

3


 

J.CREW GROUP, INC.

Condensed Consolidated Statements of Operations and Comprehensive Loss

(unaudited)

(in thousands)

 

 

 

For the

Thirteen

Weeks Ended

May 4, 2019

 

 

For the

Thirteen

Weeks Ended

May 5, 2018

 

Revenues:

 

 

 

 

 

 

 

 

Net sales

 

$

508,976

 

 

$

507,706

 

Other

 

 

69,530

 

 

 

32,744

 

Total revenues

 

 

578,506

 

 

 

540,450

 

Cost of goods sold, including buying and occupancy costs

 

 

364,729

 

 

 

333,642

 

Gross profit

 

 

213,777

 

 

 

206,808

 

Selling, general and administrative expenses

 

 

189,750

 

 

 

200,836

 

Impairment losses

 

 

1,918

 

 

 

6,866

 

Income (loss) from operations

 

 

22,109

 

 

 

(894

)

Interest expense, net

 

 

36,918

 

 

 

32,982

 

Loss before income taxes

 

 

(14,809

)

 

 

(33,876

)

Provision for income taxes

 

 

1,421

 

 

 

49

 

Net loss

 

$

(16,230

)

 

$

(33,925

)

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

Reclassification of losses (gains) on cash flow hedges, net of tax, to earnings

 

 

(333

)

 

 

996

 

Unrealized gain (loss) on cash flow hedges, net of tax

 

 

(666

)

 

 

2,418

 

Foreign currency translation adjustments

 

 

48

 

 

 

(331

)

Comprehensive loss

 

$

(17,181

)

 

$

(30,842

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

See notes to unaudited condensed consolidated financial statements.

4


 

J.CREW GROUP, INC.

Condensed Consolidated Statements of Changes in Stockholders’ Deficit

(unaudited)

(in thousands, except shares)

 

 

 

Common stock

 

 

Additional

paid-in

 

 

Accumulated

 

 

Accumulated

other

comprehensive

 

 

Total

stockholders’

 

 

 

Shares

 

 

Amount

 

 

capital

 

 

deficit

 

 

loss

 

 

deficit

 

Balance at February 3, 2018

 

 

1,000

 

 

$

 

 

$

733,071

 

 

$

(1,883,426

)

 

$

(2,603

)

 

$

(1,152,958

)

Net loss

 

 

 

 

 

 

 

 

 

 

 

(33,925

)

 

 

 

 

 

(33,925

)

Share-based compensation

 

 

 

 

 

 

 

 

46

 

 

 

 

 

 

 

 

 

46

 

Reclassification of realized losses on cash flow

   hedges, net of tax, to earnings

 

 

 

 

 

 

 

 

 

 

 

 

 

 

996

 

 

 

996

 

Unrealized gain on cash flow hedges

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2,418

 

 

 

2,418

 

Foreign currency translation adjustments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(331

)

 

 

(331

)

Balance at May 5, 2018

 

 

1,000

 

 

$

 

 

$

733,117

 

 

$

(1,917,351

)

 

$

480

 

 

$

(1,183,754

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at February 2, 2019

 

 

1,000

 

 

$

 

 

$

733,229

 

 

$

(2,003,505

)

 

$

(1,967

)

 

$

(1,272,243

)

Net loss

 

 

 

 

 

 

 

 

 

 

 

(16,230

)

 

 

 

 

 

(16,230

)

Share-based compensation

 

 

 

 

 

 

 

 

4

 

 

 

 

 

 

 

 

 

4

 

Reclassification of realized gains on cash flow

   hedges, net of tax, to earnings

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(333

)

 

 

(333

)

Unrealized loss on cash flow hedges

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(666

)

 

 

(666

)

Foreign currency translation adjustments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

48

 

 

 

48

 

Balance at May 4, 2019

 

 

1,000

 

 

$

 

 

$

733,233

 

 

$

(2,019,735

)

 

$

(2,918

)

 

$

(1,289,420

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

See notes to unaudited condensed consolidated financial statements.

5


 

J.CREW GROUP, INC.

Condensed Consolidated Statements of Cash Flows

(unaudited)

(in thousands)

 

 

 

For the

Thirteen

Weeks Ended

May 4, 2019

 

 

For the

Thirteen

Weeks Ended

May 5, 2018

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

 

 

 

Net loss

 

$

(16,230

)

 

$

(33,925

)

Adjustments to reconcile to cash flows from operating activities:

 

 

 

 

 

 

 

 

Depreciation of property and equipment

 

 

20,282

 

 

 

21,505

 

Impairment losses

 

 

1,918

 

 

 

6,866

 

Amortization of deferred financing costs and debt discount

 

 

1,796

 

 

 

1,790

 

Amortization of intangible assets

 

 

1,285

 

 

 

1,803

 

Foreign currency transaction losses

 

 

20

 

 

 

30

 

Share-based compensation

 

 

4

 

 

 

46

 

Deferred income taxes

 

 

(327

)

 

 

(991

)

Reclassification of hedging losses (gains) to earnings

 

 

(333

)

 

 

1,355

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

Accounts receivable, net

 

 

(16,102

)

 

 

(9,164

)

Merchandise inventories, net

 

 

(27,584

)

 

 

(53,005

)

Prepaid expenses and other current assets

 

 

16,157

 

 

 

7,686

 

Other assets

 

 

(1,620

)

 

 

(1,668

)

Accounts payable and other

 

 

(109,887

)

 

 

(43,913

)

Federal and state income taxes

 

 

2,624

 

 

 

563

 

Net cash used in operating activities

 

 

(127,997

)

 

 

(101,022

)

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

 

 

 

Capital expenditures

 

 

(17,997

)

 

 

(7,179

)

Net cash used in investing activities

 

 

(17,997

)

 

 

(7,179

)

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

 

 

 

Net borrowings under the ABL Facility

 

 

145,000

 

 

 

41,561

 

Proceeds from Notes

 

 

1,003

 

 

 

 

Quarterly principal repayments of Term Loan Facility

 

 

(3,917

)

 

 

(3,918

)

Net cash provided by financing activities

 

 

142,086

 

 

 

37,643

 

Effect of changes in foreign exchange rates on cash, cash equivalents and restricted cash

 

 

(83

)

 

 

(470

)

Decrease in cash, cash equivalents and restricted cash

 

 

(3,991

)

 

 

(71,028

)

Beginning balance

 

 

39,485

 

 

 

107,066

 

Ending balance

 

$

35,494

 

 

$

36,038

 

Supplemental cash flow information:

 

 

 

 

 

 

 

 

Income taxes paid

 

$

7

 

 

$

9

 

Interest paid

 

$

50,301

 

 

$

42,131

 

 

 

 

 

See notes to unaudited condensed consolidated financial statements.


6


 

J.CREW GROUP, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the thirteen weeks ended May 4, 2019 and May 5, 2018

(Dollars in thousands, unless otherwise indicated)

 

1. Basis of Presentation  

J.Crew Group, Inc. and its wholly owned subsidiaries (the “Company” or “Group”) were acquired (the “Acquisition”) on March 7, 2011 through a merger with a subsidiary of Chinos Holdings, Inc. (the “Parent”). The Parent was formed by investment funds affiliated with TPG Capital, L.P. (“TPG”) and Leonard Green & Partners, L.P. (“LGP” and together with TPG, the “Sponsors”). Subsequent to the Acquisition, Group became an indirect, wholly owned subsidiary of Parent, which is owned by affiliates of the Sponsors, investors and members of management. Prior to March 7, 2011, the Company operated as a public company with its common stock traded on the New York Stock Exchange.

The accompanying unaudited condensed consolidated financial statements were prepared in accordance with generally accepted accounting principles (“GAAP”) for interim financial information. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted. Therefore, these financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the fiscal year ended February 2, 2019.

The Company’s fiscal year ends on the Saturday closest to January 31. All references to “fiscal 2019” represent the 52-week fiscal year that will end on February 1, 2020 and to “fiscal 2018” represent the 52-week fiscal year that ended February 2, 2019.

In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments, consisting of normal recurring adjustments, necessary to present fairly in all material respects the Company’s financial position, results of operations and cash flows for the applicable interim periods. Certain prior year amounts have been reclassified to conform to current period presentation. The results of operations for these periods are not necessarily comparable to, or indicative of, results of any other interim period or for the fiscal year as a whole.

Management is required to make estimates and assumptions about future events in preparing financial statements in conformity with generally accepted accounting principles. These estimates and assumptions affect the amounts of assets, liabilities, revenues and expenses at the date of the unaudited condensed consolidated financial statements. While management believes that past estimates and assumptions have been materially accurate, current estimates are subject to change if different assumptions as to the outcome of future events are made. Management evaluates estimates and judgments on an ongoing basis and predicates those estimates and judgments on historical experience and on reasonable factors. Since future events and their effects cannot be determined with absolute certainty, actual results may differ from the estimates used in preparing the accompanying unaudited condensed consolidated financial statements.

 

2. Revenue Recognition

Overview

The Company generates revenue from three sources: (i) customers who shop in its brick-and-mortar stores, (ii) customers who shop on its websites and (iii) wholesale customers who buy and resell its merchandise. The Company recognizes revenue at (i) the point-of-sale in brick-and-mortar stores, (ii) the date of receipt by a customer in the e-commerce business and (iii) the time ownership is transferred in the wholesale business.

7


 

Disaggregation of Revenue  

A summary of disaggregated revenue is as follows:

 

 

For the

Thirteen

Weeks Ended

 

 

 

May 4, 2019

 

 

May 5, 2018

 

J.Crew

 

$

376,082

 

 

$

391,864

 

Madewell

 

 

132,894

 

 

 

115,842

 

Other revenues:

 

 

 

 

 

 

 

 

Wholesale

 

 

59,301

 

 

 

23,247

 

Shipping and handling fees

 

 

7,618

 

 

 

7,321

 

Other

 

 

2,611

 

 

 

2,176

 

Total revenues

 

$

578,506

 

 

$

540,450

 

 

Accounts Receivable

A summary of accounts receivable with respect to the Company’s wholesale customers is as follows:

 

 

May 4, 2019

 

 

February 2, 2019

 

Accounts receivable

 

$

56,550

 

 

$

40,439

 

Less allowance for doubtful accounts

 

 

(106

)

 

 

(97

)

Accounts receivable, net

 

$

56,444

 

 

$

40,342

 

Contract Liabilities

The Company recognizes a contract liability when it has received consideration from a customer and has a future performance obligation to transfer merchandise to the customer. The Company’s contract liabilities include (i) unredeemed gift cards and (ii) unredeemed loyalty program rewards.  

With respect to unredeemed gift cards, the Company is obligated to transfer merchandise in the future when a holder uses a gift card to make a purchase. The contract liability for gift cards is increased when customers purchase cards, and decreased when (i) a customer redeems the card or (ii) the Company estimates the gift card will go unredeemed (referred to as “breakage”). All of the Company’s gift cards do not have an expiration date, and are classified as a current liability.  

With respect to unearned loyalty program rewards, the Company is obligated to transfer merchandise to the customer upon accumulating points to certain thresholds. The contract liability for unearned loyalty program rewards is increased as certain customers make qualifying purchases, and decreased when (i) a customer achieves a threshold and a rewards card is issued or merchandise is transferred or (ii) the expiration of accumulated points that did not reach a threshold.

Rollforwards of the liabilities for gift cards and loyalty program awards are as follows:              

 

 

 

Unredeemed Gift Cards

 

 

 

For the

Thirteen

Weeks Ended

 

 

 

May 4, 2019

 

 

May 5, 2018

 

Balance at beginning of period

 

$

36,167

 

 

$

32,665

 

Issuance of cards

 

 

12,231

 

 

 

13,220

 

Redemption of cards

 

 

(14,701

)

 

 

(15,963

)

Recognition of estimated breakage

 

 

(810

)

 

 

(921

)

Other

 

 

75

 

 

 

(119

)

Balance at end of period

 

$

32,962

 

 

$

28,882

 

 

8


 

 

 

Unredeemed Loyalty Program Rewards

 

 

 

For the

Thirteen

Weeks Ended

 

 

 

May 4, 2019

 

 

May 5, 2018

 

Balance at beginning of period

 

$

13,830

 

 

$

8,422

 

Earning of loyalty program points

 

 

9,272

 

 

 

3,537

 

Redemption of cards

 

 

(5,433

)

 

 

(7,463

)

Recognition of estimated breakage

 

 

(2,269

)

 

 

(766

)

Other

 

 

(8

)

 

 

184

 

Balance at end of period

 

$

15,392

 

 

$

3,914

 

 

3. Leases

Overview

The Company is party to various long-term operating lease agreements in connection with the leasing of its brick-and-mortar stores and its corporate offices. These operating leases expire on varying dates through 2034, with a portion of these leases containing options to renew for periods of up to 5 years. Generally, these leases contain standard provisions concerning the payment of rent, events of default and the rights and obligations of each party. Rent due under the leases is typically comprised of annual base rent plus a contingent rent payment based on the store’s sales in excess of a specified threshold. Some of the leases also contain early termination options, which can be exercised by the Company or the landlord under certain conditions. The leases ordinarily require the Company to pay real estate taxes, insurance, certain utilities and common area costs.

Accounting for Leases

Historically, these operating leases were accounted for by expensing rent payments on a straight-line basis after consideration of rent holidays, step rent provisions and escalation clauses. Differences between rental expense, which was recognized from the date of possession, and actual rental payments were recorded as deferred rent and included in deferred credits. No liabilities were recognized on the balance sheet for long-term obligations pursuant to these lease agreements.

During the first quarter of fiscal 2019, however, the Company adopted pronouncements that were issued with respect to the accounting for leases. The pronouncements require lessees to recognize right-of-use lease assets (“ROU assets”) and right-of-use lease liabilities (“ROU liabilities”) for leases with terms of more than one year. The ROU liabilities are measured as the present value of the lease obligations. The ROU assets reflect the amount of the ROU liabilities less lease-related deferred credits. The Company used the effective date method whereby initial application occurred on the date of adoption with comparative periods unchanged. 

Upon adoption of the new standard, the Company recorded a significant gross-up to the balance sheet, including ROU assets of $533.5 million and ROU liabilities of $624.6 million. The Company utilized the package of practical expedients permitted by the transition guidance, which allowed for a carryforward of its identification of leases, historical lease classification and initial direct costs for existing leases. The Company elected to use hindsight in determining lease term.

The new pronouncement requires a company to discount its ROU liabilities using implicit rates of return in the underlying leases. To the extent these rates of return cannot be readily determined, a company is permitted to use its incremental borrowing rate, which is required to be a collateralized rate for a period of time that corresponds to the remaining lease term.  

A summary of the components of lease expense included in statement of operations is as follows:

 

 

For the

Thirteen

Weeks Ended

May 4, 2019

 

Operating lease cost

 

$

39,410

 

Variable lease cost

 

 

28,745

 

Total lease cost

 

$

68,155

 

As of May 4, 2019, the weighted-average remaining lease term was 7.7 years and the weighted-average discount rate was 8.93%. The Company paid $39.0 million in the first quarter of fiscal 2019 for amounts included in the measurement of the ROU liabilities.

9


 

A reconciliation of undiscounted cash flows to the ROU liabilities is as follows:

Fiscal year

 

Amount

 

Remainder of 2019

 

$

98,801

 

2020

 

 

138,057

 

2021

 

 

125,758

 

2022

 

 

112,467

 

2023

 

 

84,260

 

Thereafter

 

 

325,514

 

Total lease payments

 

$

884,857

 

Less: interest

 

 

(283,040

)

Present value of ROU liabilities

 

$

601,817

 

 

 

 

May 4, 2019

 

Current portion of ROU liabilities

 

$

114,052

 

Long-term ROU liabilities

 

 

487,765

 

Total ROU liabilities

 

$

601,817

 

A summary of aggregate minimum rent at February 2, 2019 is as follows:

Fiscal year

 

Amount

 

2019

 

$

146,282

 

2020

 

 

132,209

 

2021

 

 

121,330

 

2022

 

 

107,245

 

2023

 

 

78,925

 

Thereafter

 

 

313,800

 

Total

 

$

899,791

 

 

4. Debt Exchange and Refinancing

Transaction Overview

In the second quarter of fiscal 2017, the Parent and certain of its subsidiaries completed the following interrelated liability management transactions:

 

a private exchange offer (the “Exchange Offer”) pursuant to which $565.7 million aggregate principal amount of the outstanding 7.75%/8.50% Senior PIK Toggle Notes due 2019 (the “PIK Notes”) issued by Chinos Intermediate Holdings A, Inc., a direct wholly-owned subsidiary of the Parent (the “PIK Notes Issuer”), were exchanged for aggregate consideration consisting of:

 

o

$249,596,000 aggregate principal amount of 13% Senior Secured Notes due 2021 issued by J.Crew Brand, LLC and J.Crew Brand Corp. (the “Exchange Notes”), which are secured primarily by the U.S. intellectual property assets held by J.Crew Domestic Brand, LLC (“IPCo”);

 

o

189,688 shares of Parent’s 7% non-convertible perpetual series A preferred stock, no par value per share, with an aggregate initial liquidation preference of $189,688,000 (the “Series A Preferred Stock”) (which aggregate liquidation preference was $196,108,732 as of May 4, 2019); and

 

o

15% of Parent’s common equity, or 17,362,719 shares of Parent’s class A common stock, $0.00001 par value per share (the “Class A Common Stock”);

 

certain amendments to the indenture governing the PIK Notes;

 

an amendment to the Company’s Amended and Restated Credit Agreement, dated as of March 5, 2014 (the “Term Loan Facility”) to, among other things, facilitate the following related transactions:

 

o

the repayment of $150.5 million principal amount of term loans then outstanding under the Term Loan Facility;

10


 

 

o

the transfer of the remaining undivided 27.96% ownership interest in the U.S. intellectual property rights of the J.Crew brand (the “Additional Transferred IP”) to IPCo, which, together with the undivided 72.04% ownership interest transferred in December 2016 (the “Initial Transferred IP”) represent 100% of the U.S. intellectual property rights of the J.Crew brand (the “Transferred IP”), and the execution of related license agreements;

 

o

the issuance of $97.0 million aggregate principal amount of an additional series of 13% Senior Secured Notes due 2021 by J.Crew Brand, LLC and J.Crew Brand Corp. (the “New Money Notes” and, together with the Exchange Notes, the “Notes”), subject to the same terms and conditions as the Exchange Notes, for cash at a 3% discount, subject to the terms of the note purchase agreement, dated June 12, 2017, the proceeds of which were loaned on a subordinated basis to the Company and were applied, in part, to finance the repayment of the $150.5 million principal amount of term loans referenced above; and

 

o

the raising of additional borrowings under the Term Loan Facility of $30.0 million (at a 2% discount) provided by the Company’s Sponsors (the “New Term Loan Borrowings”), the net proceeds of which were also applied, in part, to finance the repayment of the $150.5 million principal amount of term loans referenced above.

 

5. Management Services Agreement

Pursuant to a management services agreement (as amended and restated, the “Management Services Agreement”) entered into by the Parent, the Sponsors and the Company in connection with the Acquisition, and amended in the second quarter of fiscal 2017 in connection with the debt exchange and refinancing, the Parent provides the Company with certain ongoing consulting and management advisory services (the “Services”) and the Parent receives an aggregate annual monitoring fee prepaid quarterly in an amount equal to the greater of (i)  40 basis points of consolidated annual revenues or (ii) $8 million (in either case, the “Advisory Fee”). The Parent also receives reimbursement for out-of-pocket expenses incurred in connection with services provided pursuant to the Management Services Agreement.

In addition to the amendment to the Management Services Agreement, in the second quarter of fiscal 2017 the Parent and Sponsors entered into a new management services agreement (the “New Management Services Agreement”), pursuant to which the Sponsors provide the Services to the Parent for an amount equal to the Advisory Fee less the accrued cash dividend in an amount equal to 5% of the liquidation preference on the outstanding Series A Preferred Stock of the Parent. The New Management Services Agreement also provides for reimbursement for out-of-pocket expenses incurred by the Sponsors or their designees.

The Company recorded an expense of $2.5 million in the first quarter of both fiscal 2019 and fiscal 2018 for monitoring fees and out-of-pocket expenses, included in selling, general and administrative expenses in the statements of operations and comprehensive loss.

6. Goodwill and Intangible Assets

A summary of the components of intangible assets is as follows:

 

 

 

Favorable Lease

Commitments

 

 

Madewell

Trade Name

 

 

Key Money

 

 

J.Crew

Trade Name

 

 

Total

 

Balance at February 2, 2019

 

$

908

 

 

$

49,542

 

 

$

752

 

 

$

250,195

 

 

$

301,397

 

Amortization expense

 

 

(227

)

 

 

(1,025

)

 

 

(33

)

 

 

 

 

 

(1,285

)

Effect of changes in foreign exchange rates

 

 

 

 

 

 

 

 

5

 

 

 

 

 

 

5

 

Balance at May 4, 2019

 

$

681

 

 

$

48,517

 

 

$

724

 

 

$

250,195

 

 

$

300,117

 

Total accumulated amortization or impairment losses at May 4, 2019

 

$

(60,329

)

 

$

(33,483

)

 

$

(4,093

)

 

$

(635,105

)

 

$

(733,010

)

 

The impairment losses were the result of the write-down of the following assets:

 

 

 

For the

Thirteen

Weeks Ended

 

 

 

 

May 4, 2019

 

 

May 5, 2018

 

 

Intangible asset related to the J.Crew trade name

 

$

 

 

$

 

 

Long-lived assets (see note 10)

 

 

1,918

 

 

 

6,866

 

 

Impairment losses

 

$

1,918

 

 

$

6,866

 

 

11


 

The carrying value of goodwill of $107.9 million relates to the Madewell reporting unit. There is no remaining goodwill attributable to the J.Crew reporting unit. The carrying value of the J.Crew and Madewell trade names is $250.2 million and $48.5 million, respectively, at May 4, 2019. If revenues or operating results decline below the Company’s current expectations, additional impairment charges may be recorded in the future.


7. Share-Based Compensation

Chinos Holdings, Inc. 2011 Equity Incentive Plan

The Parent adopted the Chinos Holdings, Inc. 2011 Equity Incentive Plan (the “2011 Plan”) in connection with the Acquisition. In the second quarter of fiscal 2017, in connection with a debt exchange and refinancing, the Parent completed a recapitalization of its outstanding equity. The recapitalization resulted in, among other things, a reverse stock split of the shares of common stock underlying the share-based awards issued by the Company. The reverse stock split of 10,000-to-1 resulted in (i) a substantial decrease in number of authorized awards from 91,740,627 shares to 9,174 shares and (ii) a substantial increase in the exercise price of $0.10 to $1,000 per share. 

The recapitalization included (i) the issuance of preferred stock of the Parent, including an authorization for equity awards to be granted up to 20,000 shares and (ii) the issuance of additional shares of common stock of the Parent, including an authorization for equity awards to be granted up to 13,003,295 shares. Additionally, on October 3, 2017, the Company authorized additional awards of 5,209,823 shares to be granted to its then-Chief Executive Officer in accordance with an employment agreement. The following disclosures are presented with respect to the newly authorized share-based awards only.  

A summary of share-based compensation recorded in the statements of operations and comprehensive loss is as follows:

 

 

For the

Thirteen

Weeks Ended

 

 

 

May 4, 2019

 

 

May 5, 2018

 

Share-based compensation

 

$

4

 

 

$

46

 

A summary of shares available for grant as stock options or other share-based awards, as adjusted for the reverse stock split, is as follows:

 

 

Common Stock Awards

 

 

Preferred Stock Awards

 

Available for grant at February 2, 2019

 

 

5,344,394

 

 

 

20,000

 

Authorized

 

 

 

 

 

 

Granted

 

 

(168,050

)

 

 

 

Forfeited and available for reissuance

 

 

1,588,796

 

 

 

 

Available for grant at May 4, 2019

 

 

6,765,140

 

 

 

20,000

 

 

8. Long-Term Debt and Credit Agreements  

A summary of the components of long-term debt is as follows:

 

 

May 4, 2019

 

 

February 2, 2019

 

Term Loan Facility

 

$

1,369,792

 

 

$

1,373,554

 

Notes

 

 

347,599

 

 

 

346,596

 

Less: current portion

 

 

(32,070

)

 

 

(32,070

)

Less: deferred financing costs

 

 

(9,141

)

 

 

(10,288

)

Less: discount

 

 

(4,014

)

 

 

(4,510

)

Long-term debt, net

 

$

1,672,166

 

 

$

1,673,282

 

Borrowings under the ABL Facility

 

$

215,800

 

 

$

70,800

 

12


 

 

ABL Facility

The Company has an ABL Facility, which is governed by an asset-based credit agreement with Bank of America, N.A., as administrative agent, and the other agents and lenders party thereto, that, following the Sixth Amendment described below, provides for a $375 million senior secured asset-based revolving line of credit (which may be increased by up to $75 million in certain circumstances), subject to a borrowing base limitation. The Company cannot borrow in excess of $375 million under the ABL Facility without the consent of holders of at least a majority of the loans outstanding under the Term Loan Facility. The ABL Facility includes borrowing capacity in the form of letters of credit up to $200 million, and up to $25 million in U.S. dollars for loans on same-day notice, referred to as swingline loans, and is available in U.S. dollars, Canadian dollars and Euros. Any amounts outstanding under the ABL Facility are due and payable in full on the maturity date of November 17, 2021.

On September 19, 2018, the Company entered into a Sixth Amendment to Credit Agreement (Incremental Amendment) (the “Sixth Amendment”), which amended the ABL Facility to increase the revolving credit commitment from $350 million to $375 million, with the additional $25 million provided by MUFG Union Bank, N.A., which joined the ABL Facility as an additional lender.

On May 4, 2019, standby letters of credit were $64.5 million, outstanding borrowings were $215.8 million, and excess availability, as defined, was $94.7 million. The weighted average interest rate on the borrowings outstanding under the ABL Facility was 4.62% on May 4, 2019. Average short-term borrowings under the ABL Facility were $196.4 million and $30.5 million in the first quarter of fiscal 2019 and fiscal 2018, respectively.

Demand Letter of Credit Facility

The Company has an unsecured demand letter of credit facility with HSBC which provides for the issuance of up to $20 million of documentary letters of credit on a no fee basis. On May 4, 2019, outstanding documentary letters of credit were $1.6 million and availability under this facility was $18.4 million.

Term Loan Facility

2017 Amendment.  In the second quarter of fiscal 2017, concurrently with the settlement of the Exchange Offer, the Company amended its Term Loan Facility to, among other things, (i) increase the interest rate applicable to the loans held by consenting lenders, which represented 88% of lenders, (the “Consenting Lenders”; and the loans held by the Consenting Lenders, the “Amended Loans”) by 22 basis points, (ii) increase the amount of amortization payable to Consenting Lenders, (iii) provide for the New Term Loan Borrowings of $30.0 million, (iv) amend certain covenants and events of default and (v) direct Wilmington Savings Fund Society, FSB, as administrative agent under the Term Loan Facility, to dismiss, with prejudice, certain litigation regarding the Initial Transferred IP (and the related actions). Additionally, the Company repaid $150.5 million of principal amount of term loans outstanding under the Term Loan Facility, which was financed with (i) the net proceeds from the New Money Notes of $94.1 million, (ii) the net proceeds from the New Term Loan Borrowings of $29.4 million and (iii) cash on hand of $27.0 million.

Interest Rate.  Initial borrowings under the Term Loan Facility bear interest at a rate per annum equal to an applicable margin (which, in the case of the Amended Loans, was increased by 22 basis points) plus, at Group’s option, either (a) a LIBOR determined by reference to the costs of funds for U.S. dollar deposits for the relevant interest period adjusted for certain additional costs (subject to a floor) or (b) a base rate determined by reference to the highest of (1) the prime rate of Bank of America, N.A., (2) the federal funds effective rate plus 0.50% and (3) a LIBOR determined by reference to the costs of funds for U.S. dollar deposits for an interest period of one month, plus 1.00%. New Term Loan Borrowings bear interest at 9% per annum payable in cash plus 3% per annum payable in kind.

The weighted average interest rate on the borrowings outstanding under the Term Loan Facility was 5.93% on May 4, 2019. The applicable margin (i) in effect for base rate borrowings was, (x) in the case of term loans, other than the New Term Loan Borrowings and the Amended Loans, 2.00%, (y) in the case of the Amended Loans, 2.22% and (z) in the case of the New Term Loan Borrowings, 12.00% (of which 3.00% is payable in kind) and (ii) with respect to LIBOR borrowings was, (x) in the case of term loans, other than the New Term Loan Borrowings and the Amended Loans, 3.00% and the LIBOR Floor, (y) in the case of the Amended Loans, 3.22% and the LIBOR Floor and (z) in the case of the New Term Loan Borrowings, 12.00% (of which 3.00% is payable in kind), respectively, at May 4, 2019.

13


 

Principal Repayments.  The Company is required to make principal repayments equal to 0.25% of the original principal amount of the Term Loan Facility (excluding the New Term Loan Borrowings), or $3.9 million, on the last business day of January, April, July, and October. The Company is also required (i) to repay the term loan based on an annual calculation of excess cash flow, as defined in the agreement, (ii) in the second quarter of fiscal 2019, to make a principal repayment of $11.9 million which is equal to 1.00% of the aggregate principal amount of Amended Loans outstanding on July 13, 2017 and (iii) beginning on July 31, 2019, on the last business day of January, April, July and October, to make additional principal repayments of $1.5 million equal to 0.125% of the aggregate principal amount of Amended Loans outstanding on July 13, 2017. The maturity date of the Term Loan Facility is March 5, 2021.

Notes

General.  In the second quarter of fiscal 2017, in connection with settlement of the Exchange Offer and the issuance of the Notes, J.Crew Brand, LLC and J.Crew Brand Corp. (together, the “Notes Co-Issuers”) and the Guarantors (as defined below) entered into (i) an indenture with U.S. Bank National Association, as Trustee and collateral agent, governing the terms of the Exchange Notes (the “Exchange Notes Indenture”) and (ii) an indenture with the Trustee and U.S. Bank, as collateral agent, governing the terms of the New Money Notes (the “New Money Notes Indenture”), which is in substantially the same form as the Exchange Notes Indenture.

Interest Rate.  The Notes bear interest at a rate of 13% per annum, and interest is payable semi-annually on March 15 and September 15 of each year. The Notes mature on September 15, 2021.

Notes Guarantee.  The Notes are guaranteed by J.Crew Brand Intermediate, LLC, IPCo and J.Crew International Brand, LLC, each of which is a Delaware limited liability company and a wholly-owned indirect subsidiary of the Company (collectively, the “Guarantors,” and each, a “Guarantor”). The PIK Notes Issuer also unconditionally guarantees the payment obligations of the Notes Co-Issuers and the Guarantors.

Exchange Notes Collateral.  The Exchange Notes and the guarantees thereof are general senior secured obligations of the  Notes Co-Issuers and the Guarantors, secured on a first priority lien basis by the Initial Transferred IP and certain other assets of the Notes Co-Issuers and Guarantors, and on a second priority lien basis by the Additional Transferred IP, subject, in each case, to permitted liens under the Exchange Notes Indenture and that certain intercreditor agreement, entered into between the collateral agents on July 13, 2017.

New Money Notes Collateral.  The New Money Notes and the guarantees thereof are general senior secured obligations of the Notes Co-Issuers and the Guarantors, secured on a first priority lien basis by the Additional Transferred IP and certain other assets, and on a second priority lien basis by the Initial Transferred IP, subject, in each case, to permitted liens under the New Money Notes Indenture and the intercreditor agreement.

Redemption.  The Notes are redeemable at the option of the Notes Co-Issuers, in whole or in part, at any time, at a price equal to one hundred percent (100%) of the principal amount of the Notes to be redeemed, plus accrued and unpaid interest, if any, to, but not including, the redemption date, plus a “make whole” premium. The Notes are not subject to any mandatory redemption obligation, and there is no sinking fund provided for the Notes.

Change in Control.  Upon the occurrence of a Change of Control (as defined in each of the indentures, as applicable), the Notes Co-Issuers will be required to offer to repay all of the Notes at 100% of the aggregate principal amount repaid plus accrued and unpaid interest, if any, to, but not including, the date of purchase.

Covenants.  Each of the indentures contains covenants covering (i) the payment of principal and interest, (ii) maintenance of an office or agency for the payment of the Notes, (iii) reports to the applicable Trustee and holders of the Notes, (iv) stay, extension and usury laws, (v) payment of taxes, (vi) existence, (vii) maintenance of properties and (viii) maintenance of insurance. Each of the indentures relating to the Notes also includes covenants that (i) limit the ability to transfer the collateral and (ii) limit liens that may be imposed on the assets of the Guarantors, which covenants are, in each case, subject to certain exceptions set forth in each of the indentures.

14


 

Interest Expense

A summary of the components of interest expense is as follows:

 

 

 

For the

Thirteen

Weeks Ended

 

 

 

 

May 4, 2019

 

 

May 5, 2018

 

 

Term Loan Facility

 

$

21,130

 

 

$

18,383

 

 

Notes

 

 

11,250

 

 

 

11,264

 

 

ABL Facility

 

 

2,361

 

 

 

355

 

 

Amortization of deferred financing costs and debt discount

 

 

1,796

 

 

 

1,790

 

 

Realized hedging losses (gains)

 

 

(333

)

 

 

1,355

 

 

Other interest, net of interest income

 

 

714

 

 

 

(165

)

 

Interest expense, net

 

$

36,918

 

 

$

32,982

 

 

 

9. Derivative Financial Instruments

October 2018 Interest Rate Swap

In October 2018, the Company entered into a floating-to-fixed interest rate swap agreement effective in March 2019 for a notional amount of $750 million. This instrument limits exposure to interest rate increases on a portion of the Company’s floating rate indebtedness through the expiration of the agreement in March 2020. Under the terms of this agreement, the Company’s effective fixed interest rate on the notional amount of indebtedness is 3.03% plus the applicable margin.

August 2014 Interest Rate Swaps

In August 2014, the Company entered into interest rate swap agreements that limited exposure to interest rate increases on a portion of the Company’s floating rate indebtedness. The interest rate swap agreements covered an aggregate notional amount of $800 million from March 2016 to March 2019 and carried a fixed rate of 2.56% plus the applicable margin.

The Company designated the interest rate swap agreements as cash flow hedges. As cash flow hedges, unrealized gains are recognized as assets while unrealized losses are recognized as liabilities. The effective portion of such gains or losses is recorded as a component of accumulated other comprehensive loss, while the ineffective portion of such gains or losses is recorded as a component of interest expense. Realized gains and losses in connection with each required interest payment are reclassified from accumulated other comprehensive loss to interest expense.

The fair values of the interest rate swap agreements are estimated using industry standard valuation models using market-based observable inputs, including interest rate curves (level 2 inputs). A summary of the recorded assets (liabilities) included in the condensed consolidated balance sheet is as follows:

 

 

May 4, 2019

 

 

February 2, 2019

 

 

Interest rate swaps (included in other assets)

 

$

 

 

$

480

 

 

Interest rate swaps (included in other liabilities)

 

$

(3,973

)

 

$

(3,663

)

 

 

10. Fair Value Measurements

The Company uses a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. This hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows:

 

Level 1 – Quoted prices in active markets for identical assets or liabilities.

 

Level 2 – Observable inputs, other than quoted prices included in Level 1, such as quoted prices for markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

 

Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.

15


 

Financial assets and liabilities

The fair value of the Company’s long-term debt was estimated to be $1,559 million and $1,401 million at May 4, 2019 and February 2, 2019, respectively, based on quoted market prices of the debt (level 1 inputs).

The Company’s interest rate swap agreements are measured in the financial statements at fair value on a recurring basis. See note 9 for more information regarding the fair value of this financial liability.

The carrying amounts reported in the condensed consolidated balance sheets for cash and cash equivalents, accounts payable and other current liabilities approximate fair value because of their short-term nature.

Non-financial assets and liabilities

Certain non-financial assets, including goodwill, the intangible asset for the J.Crew trade name, and certain long-lived assets, have been written down and measured in the financial statements at fair value. The Company does not have any other non-financial assets or liabilities as of May 4, 2019 or February 2, 2019 that are measured on a recurring basis in the financial statements at fair value.

The Company assesses the recoverability of goodwill and intangibles whenever there are indicators of impairment, or at least annually in the fourth quarter. If the recorded carrying value of an intangible asset exceeds its fair value, the Company records a charge to write-down the intangible asset to its fair value. Impairment charges of goodwill are based on fair value measurements derived using a combination of an income approach, specifically the discounted cash flow, a market approach, and a transaction approach. Impairment charges of intangible assets are based on fair value measurements derived using an income approach, specifically the relief from royalty method, which is a revenue and royalty rate approach. The valuation methodologies incorporate unobservable inputs reflecting significant estimates and assumptions made by management (level 3 inputs). For more information related to goodwill and intangible asset impairment charges, see note 6.

The Company performs impairment tests of certain long-lived assets whenever there are indicators of impairment. These tests typically contemplate assets at a store level (for example, leasehold improvements) or at the corporate level (for example, software). The Company recognizes an impairment loss when the carrying value of a long-lived asset is not recoverable in light of the undiscounted future cash flows and measures an impairment loss as the difference between the carrying amount and fair value of the asset based on discounted future cash flows. The Company has determined that the future cash flow approach (level 3 inputs) provides the most relevant and reliable means by which to determine fair value in this circumstance.

A summary of the impact of the impairment of certain long-lived assets on financial condition and results of operations is as follows:
 

 

 

For the

Thirteen

Weeks Ended

 

 

 

 

May 4, 2019

 

 

May 5, 2018

 

 

Carrying value of long-term assets written down to fair value

 

$

1,918

 

 

$

6,866

 

 

Impairment charge

 

$

1,918

 

 

$

6,866

 

 

 

 

11. Income Taxes

The Parent files a consolidated federal income tax return and state combined income tax returns, which include Group and all of its wholly owned subsidiaries. The income tax provision is calculated as if Group were a stand-alone taxpayer.

In the first quarter of fiscal 2019, the Company recorded a provision for income taxes of $1.4 million on a pre-tax loss of $14.8 million. The provision for income taxes reflects a charge for current federal and state tax liabilities and a discrete item of $0.3 million related to state tax law changes. The Company’s effective tax rate of (9.6)% differs from the U.S. federal statutory rate of 21% primarily related to current year pre-tax losses for which limited tax benefit was provided as the Company could not conclude that all of its deferred tax assets were realizable on a more-likely-than not basis. Other items impacting the provision for income taxes include the U.S. taxation of foreign earnings under the Global Intangible Low Tax Income (“GILTI”) regime, the recognition of valuation allowances with respect to the carryforward of unutilized interest deductions, the recognition of international valuation allowances and lower rates in foreign tax jurisdictions.        

16


 

In the first quarter of fiscal 2018, the Company recorded a provision for income taxes of $49, which reflects a charge for the valuation allowance with respect to the deferred tax asset related to the carryforward of unutilized interest deductions. Other items impacting the provision for income taxes include the recognition of international valuation allowances, lower rates in foreign tax jurisdictions, and reserves for uncertain tax positions.

The Company regularly assesses the need for a valuation allowance related to its deferred tax assets. In making that assessment, the Company considers both positive and negative evidence related to the likelihood of realization of the deferred tax assets to determine, based on a weighing process of available evidence, whether it is more-likely-than-not that its deferred tax assets will not be realized. As of May 4, 2019, the Company maintained a full valuation allowance against its deferred tax assets.

The federal tax returns for the periods ended January 2013 through January 2016 are currently under examination. Various state and local jurisdiction tax authorities are in the process of examining income tax returns for certain tax years ranging from 2014 to 2016. The results of these audits and appeals are not expected to have a significant effect on the results of operations or financial position.


12. Legal Proceedings

The Company is subject to various legal proceedings and claims arising in the ordinary course of business. Management does not expect that the results of any of these legal proceedings, either individually or in the aggregate, would have a material effect on the Company’s financial position, results of operations or cash flows. As of May 4, 2019, the Company has recorded a reserve for certain legal contingencies in connection with ongoing claims and litigation. The reserve is not material to its results of operations. In addition, there are certain other claims and legal proceedings pending against the Company for which accruals have not been established.

Eaton Vance Management, et al. v. Wilmington Savings Fund Society, FSB, as Administrative Agent and Collateral Agent, et al., Index No. 654397/2017, (Sup. Ct. N.Y. C’ty.).

On June 22, 2017, Eaton Vance Management and certain affiliated funds as well as Highland Capital Management and certain affiliated funds (collectively, the “Plaintiffs”), filed a complaint in the New York State Supreme Court, Commercial Division, against the Company and WSFS, seeking, among other things, declarations that the July 13, 2017 Amendment to the Term Loan Facility was ineffective absent unanimous consent of all lenders under the facility, that certain of the Company’s actions with respect to certain of its intellectual property assets were taken in violation of the terms of the Term Loan Facility, and that those actions also constituted fraudulent conveyances.

On August 7, 2017, WSFS and the Company filed separate motions to dismiss certain of Plaintiffs’ claims for failure to state a claim and lack of standing, among other reasons. On September 7, 2017, Plaintiffs filed an amended complaint in the New York State Supreme Court, Commercial Division, against the Company and WSFS. The amended complaint continued to assert claims for breach of the terms of the Term Loan Facility, and for fraudulent conveyance and added an additional claim for fraudulent inducement against the Company.

In response to the amended complaint, WSFS and the Company withdrew their prior motions to dismiss and, on October 20, 2017, filed renewed motions seeking dismissal in whole or part. Among other things, the Company sought dismissal of the amended complaint for failure to state a claim, lack of standing, and because its fraud claims are duplicative of Plaintiffs’ claims under the documents governing the Term Loan Facility. Plaintiffs filed an omnibus brief on December 1, 2017 opposing the motions to dismiss. The Company and WSFS each filed reply briefs on December 22, 2017 reiterating that the majority of Plaintiffs’ claims should be dismissed as a matter of law.

Oral argument on the motions to dismiss occurred on March 8, 2018. On April 25, 2018, the judge issued a Memorandum Decision and Order, which granted the Company’s partial motion to dismiss in its entirety and dismissed as a matter of law the majority of Plaintiffs’ claims with prejudice. Plaintiffs’ sole remaining claim is for breach of contract based on the theory that the July 13, 2017 Amendment to the Term Loan Facility required unanimous consent of all lenders under the facility.

On October 25, 2018, Highland Capital Management and certain affiliated funds were dismissed from the action with prejudice.

17


 

On November 21, 2018, the remaining Plaintiffs filed a limited appeal of the judge’s April 25, 2018 Memorandum Decision and Order with the First Department of the New York Appellate Division in an attempt to resuscitate their fraudulent conveyance claim. The Company filed an opposition brief on February 14, 2019, arguing that the trial court properly dismissed the fraudulent conveyance claim. On March 8, 2019, the remaining Plaintiffs filed a reply brief in support of their appeal. Oral argument on the appeal occurred on April 2, 2019. On April 25, 2019, the First Department unanimously affirmed the trial court’s decision to dismiss the fraudulent conveyance claim with prejudice.

Discovery in the action is ongoing. The Company believes that the remaining claim is wholly without merit, and intends to vigorously oppose the claim.

13. Workforce Reductions

A rollforward of the reserve for severance and related costs is as follows:

 

 

For the

Thirteen

Weeks Ended

 

 

 

May 4, 2019

 

 

May 5, 2018

 

Balance at beginning of period

 

$

7,965

 

 

$

3,543

 

  Provisions charged to expense

 

 

2,543

 

 

 

3,288

 

  Reversals

 

 

(107

)

 

 

 

  Payments

 

 

(4,116

)

 

 

(4,700

)

Balance at end of period

 

$

6,285

 

 

$

2,131

 

The Company expects the unpaid severance at May 4, 2019 to be paid through the third quarter of fiscal 2020.

14. Corporate Headquarters Relocation

In the second quarter of fiscal 2018, the Company entered into a lease amendment and surrender agreement (the “Surrender Agreement”) with Vornado Office Management, LLC (“Vornado”). The terms of the Surrender Agreement provide for, among other things, the early termination and surrender of the space currently occupied by the Company at 770 Broadway in New York City. In exchange for the surrender, Vornado agreed to pay the Company a termination payment of $35 million. The Company plans to be fully vacated from its former corporate headquarters by June 30, 2019, and expects to collect the termination payment in installments through such date. The Company records the benefit of $35 million, as a reduction of selling, general and administrative expense, over the period starting May 10, 2018 until June 30, 2019.   

Additionally, concurrent with the entry into the Surrender Agreement, the Company entered into a sublease of new corporate office space at 225 Liberty Street in New York City. The sublease provides for, among other things, a 16-year occupancy of 325,000 square feet of office space in lower Manhattan with aggregate base rent of $277 million, net of free rent. The Company began relocating to the new corporate office space in August 2018 and the Company expects to reinvest a significant portion of the termination payment of $35 million into the new corporate office space. 

15. Related Party Transactions

Intellectual property license agreements

In December 2016, J.Crew International, Inc. (“JCI”) transferred an undivided 72.04% ownership interest in the U.S. intellectual property rights of the J.Crew brand to IPCo, and entered into a related intellectual property license agreement with IPCo. In July 2017, JCI transferred the remaining undivided 27.96% ownership interest in the U.S. intellectual property rights of the J.Crew brand to IPCo, which, together with the initial intellectual property contributed in December 2016, represent 100% of the U.S. intellectual property rights of the J.Crew brand, entered into a license agreement amending and restating the December 2016 license agreement with IPCo and entered into an additional intellectual property license agreement with IPCo (collectively, the “IP License Agreements”).

Under the IP License Agreements, J.Crew Operating Corp. (“OpCo”), a direct wholly-owned subsidiary of the Company, pays a fixed license fee of $59 million per annum to IPCo, which owns the U.S. intellectual property rights of the J.Crew brand. The license fees are payable on March 1 and September 1 of each fiscal year. These royalty payments have no impact on the Company’s condensed consolidated results of operations and are not subject to the covenants under the Company’s credit facilities or the PIK Notes. 

18


 

The proceeds from the license fees to IPCo are used by IPCo and J.Crew Brand, LLC, wholly-owned subsidiaries of the Company (collectively, “J.Crew BrandCo”), to meet debt service requirements on the Notes. Any license fees in excess of the debt service requirements are loaned back to OpCo on a subordinated basis. As of May 4, 2019, J.Crew BrandCo had total assets of $396.2 million, consisting of intangible assets of $250.2 million, receivable due from OpCo of $136.0 million, license fee receivable of $9.8 million and cash and cash equivalents of $0.2 million, and total liabilities of $348.4 million related to the Notes. For the thirteen weeks ended May 4, 2019, IPCo earned royalty revenue of $14.8 million. The Notes are guaranteed by the intangible assets of J.Crew BrandCo.

Chinos Intermediate Holdings A, Inc. Senior PIK Toggle Note

In the fourth quarter of fiscal 2013, the PIK Notes Issuer, which is an indirect parent holding company of Group, issued $500 million of PIK Notes. As part of the debt exchange and refinancing in July 2017, $565.7 million in aggregate principal amount of the PIK Notes were exchanged for $249.6 million of Exchange Notes and shares of preferred and common stock of the Parent. As of February 2, 2019, there were $1.0 million in aggregate principal amount of PIK Notes outstanding, and in the first quarter of fiscal 2019 the Parent redeemed all remaining outstanding PIK Notes. The PIK Notes were: (i) senior unsecured obligations of the PIK Notes Issuer, (ii) structurally subordinated to all of the liabilities of the PIK Notes Issuers’ subsidiaries, and (iii) not guaranteed by any of the PIK Notes Issuers’ subsidiaries, and therefore are not recorded in the Company’s financial statements.

The PIK Notes were not guaranteed by any of the PIK Notes Issuer’s subsidiaries, and therefore were not recorded in the Company’s financial statements. The Exchange Notes, however, are guaranteed by the Company’s subsidiaries, and therefore are recorded in its financial statements. In connection with recognizing the Exchange Notes, the Company recorded a non-cash contribution to its Parent as a reduction of additional paid-in capital. For more information on the long-term debt of the Company, see note 8.       

Due to Sponsors

As part of the debt exchange and refinancing, the Sponsors purchased $30.0 million principal amount of new term loans under the Term Loan Facility. As of May 4, 2019, the principal amount outstanding was $31.6 million. For more information on the New Term Loan Borrowings, see note 8.

Due to Parent

Certain transactions, primarily related to income taxes, between Group and its Parent give rise to intercompany receivables and payables. A summary of the components of Due to Parent is as follows:

 

 

May 4, 2019

 

 

February 2, 2019

 

Income taxes payable to Parent

 

$

(48,648

)

 

$

(48,648

)

Monitoring fees payable

 

 

(483

)

 

 

(1,938

)

Transaction-related payments on behalf of Parent