UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-K/A

(Amendment No. 1)

 

 

 

Securities Registered Pursuant to Section 12(b) of the Act: None

 

Securities 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 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 ý  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 be contained, to the best of each registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý

 

Indicate by a check mark whether any of the registrants is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes o  No ý

 

The common stock of each registrant is not publicly traded. Therefore, the aggregate market value is not readily determinable.

 

As of April 15, 2004, there were 12,197,978 shares of common stock, par value $.01 per share, of J. Crew Group, Inc. outstanding and 100 shares of common stock, par value $.01 per share, of J. Crew Operating Corp. outstanding (all of which are owned beneficially and of record by J. Crew Intermediate LLC). J. Crew Group, Inc. is the sole member of J. Crew Intermediate LLC.

 

Documents incorporated by reference:    None

 

J. Crew Operating Corp. and J.Crew Intermediate LLC meet the conditions set forth in General Instruction (I)(1)(a) and (b) of the Form 10-K and are therefore filing this Form 10-K/A with the reduced disclosure format.

EXPLANATORY NOTE

J. Crew Group, Inc., J. Crew Intermediate LLC, and J. Crew Operating Corp. (the "Registrants") are filing this Amendment No. 1 to their Annual Report on Form 10-K for the year ended January 31, 2004 (this "Form 10-K/A") to reflect the write-off of certain prepaid sample costs that should have been expensed as incurred. As a result of this revision, the Registrants are restating their consolidated financial statements for the fiscal year ended January 31, 2004. For a detailed description of the effect of the restatement, see Note 2 to the consolidated financial statements accompanying this Amendment.

In accordance with the rules of the Commission, the affected items of the Form 10-K as originally filed, Items 6, 7, 8 and 9A of Part II and Item 15 of Part IV, are being amended and restated in their entirety. This Form 10-K/A does not reflect events occurring after January 31, 2004 or substantively modify or update the disclosure contained in the Form 10-K as originally filed in any way other than as required to reflect the amendments discussed above and reflected herein.

FILING FORMAT

This Annual Report on Form 10-K/A is a combined report being filed by three different registrants: J. Crew Group, Inc. (“Group”), J. Crew Intermediate LLC, a wholly owned subsidiary of Group (“Intermediate”), and J. Crew Operating Corp., a wholly-owned subsidiary of Intermediate (“Operating Corp.”). Except where the content clearly indicates otherwise, any references in this report to the “Company,” “J. Crew” or “Group” include all subsidiaries of Group, including Intermediate and Operating Corp. Neither Intermediate nor Operating Corp. make any representation as to the information contained in this report in relation to Group and its subsidiaries other than Intermediate and Operating Corp., as the case may be.

References herein to fiscal years are to the fiscal years of J. Crew Group, Inc., J. Crew Intermediate LLC and J. Crew Operating Corp., which end on the Saturday closest to January 31 in the following calendar year for fiscal years 1999, 2000, 2001, 2002 and 2003. Accordingly, fiscal years 1999, 2000, 2001, 2002 and 2003 ended on January 29, 2000, February 3, 2001, February 2, 2002, February 1, 2003 and January 31, 2004. All fiscal years for which financial information is included had 52 weeks, except fiscal year 2000 which had 53 weeks.

PART I

BUSINESS

In this section, “we,” “us” and “our” refer to Group and our wholly owned subsidiaries, including Operating Corp. and Intermediate.

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 the circulation of catalogs that use magazine-quality photography to portray a classic American perspective and aspirational lifestyle and the operation of our stores and internet website. We believe that the “J. Crew” brand name is widely recognized for its timeless styles at price points that represent exceptional product value. We offer a full line of men’s and women’s clothing, including basic durables (casual weekend), workwear (casual weekday), swimwear, sport, accessories and shoes to meet our customers lifestyle needs. Many of the original items introduced by us in the early 1980s (such as the rollneck sweater, weathered chino, barn jacket and pocket tee) were instrumental in establishing the J. Crew brand and continue to be our core product offerings.

J. Crew products are distributed exclusively through our retail and factory stores, our catalog and our internet website located at www.jcrew.com. As of January 31, 2004, we operated 154 retail stores and 42 factory outlet stores in the United States. We believe that our customer base consists primarily of college-educated, professional and upscale customers who in our experience have demonstrated strong brand loyalty and a tendency to make repeated purchases. In addition, J. Crew products are distributed through 45 freestanding and shop-in-shop stores in Japan under a licensing agreement with Itochu Corporation.

We have three major operating divisions: J. Crew Retail, J. Crew Direct, and J. Crew Factory, each of which operate under the J. Crew brand name. In fiscal 2003, products sold under the J. Crew brand contributed $660.6 million in revenues, comprised of:

•              $408.1 million from J. Crew Retail;

•              $173.5 million from J. Crew Direct; and

•              $79.0 million from J. Crew Factory.

In addition, in fiscal 2003, we generated licensing revenues of $2.5 million and shipping and handling revenues of $25.2 million.

Merchandising and Design

Over time, the J. Crew merchandising strategy has evolved from providing unisex products to creating full lines of men’s and women’s clothing, shoes and accessories. This strategy had the effect of increasing overall J. Crew brand sales volume and significantly increasing revenues from sales of women’s apparel to 75% of J. Crew brand sales in fiscal 2003.

All of our products are designed by an in-house design staff to reflect a classic, clean aesthetic that is consistent with our American lifestyle brand image. Design teams are formed around J. Crew product lines and categories to develop concepts, themes and products for each of our J. Crew businesses. Our technical design teams develop construction and fit specifications for every product to ensure quality workmanship and consistency across product lines. These teams work in close collaboration with the merchandising, production and quality assurance 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 23 countries. We do not own or operate any manufacturing facilities and instead contract with third-party vendors for production of our merchandise. In fiscal 2003, approximately 80% of our merchandise was sourced in Asia, 5% was sourced in the United States and 15% was sourced in Europe and other regions. Any event causing a sudden disruption of manufacturing or imports from China, including the imposition of additional import restrictions, could have a

 

2

 

material adverse impact on our operations. In addition, one vendor supplies approximately 20% of our merchandise, but we believe that the loss of this vendor would not have a material adverse impact on our ability to source our products. Substantially all of our foreign purchases are negotiated and paid 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 be subject to additional trade restrictions imposed by the United States and other foreign governments, nor can we predict the likelihood, type or effect of any such restrictions. Trade restrictions, including increased tariffs or quotas, against apparel and other items sold by us could increase the cost or reduce the supply of merchandise available to us and adversely affect our business, financial condition and results of operations. Our sourcing operations may also be adversely affected by political and financial instability in any country in which our goods are produced or by acts of war or terrorism in the United States or worldwide to the extent these acts impact the production, shipment or receipt of merchandise. Sourcing operations may also be adversely affected by significant fluctuation in the value of the U.S. dollar against foreign currencies or restrictions on the transfer of funds.

 

Distribution

 

We operate two major customer contact and distribution facilities for our operations. Order fulfillment for J. Crew Direct takes place primarily at a 406,500 square foot facility located in Lynchburg, Virginia. The Lynchburg facility processes catalog and internet website orders and serves as the distribution center for our factory store operations. This facility employs approximately 500 full and part-time employees during our non-peak season and additional employees during our peak season. The main distribution center for our retail store operations is located in a 192,500 square foot facility in Asheville, North Carolina. This facility employs approximately 150 full- and part-time employees during our non-peak season and additional employees during our peak season. Orders for merchandise may be received by telephone, facsimile, mail and through our internet website. Each customer contact associate is trained to assist customers in determining the customer’s correct size and describing merchandise fabric, texture and function. We believe that our fulfillment and distribution operations are designed to process and ship customer orders in a customer-friendly, quick, and cost-effective manner.

 

We ship merchandise via the United States Postal Service and FedEx. To enhance efficiency, each facility is fully equipped with an advanced telephone system, automated warehouse locator system and inventory bar coding system. In addition, our Lynchburg facility has automated packing and shipping sorters.

 

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 have point-of-sale registers in our retail and factory outlet stores that enable us to track inventory from store receipt to final sale on a real-time basis. We believe our merchandising and financial systems, coupled with our point-of-sale registers and software programs, allow for rapid stock replenishment, concise merchandise planning and real-time inventory accounting practices. Our telephone and telemarketing systems, warehouse package sorting systems, automated warehouse locator and inventory bar coding systems utilize advanced technology. These systems have provided us with a number of benefits in the form of enhanced customer service, improved operational efficiency and increased management control and reporting. In addition, our real-time inventory systems provide inventory management on a stock keeping unit basis and allow for an efficient fulfillment process.

 

We have installed a SAP enterprise resource planning system for our information technology requirements. This system was implemented in fiscal years 2000 and 2001. In fiscal 2000, our accounting systems were implemented. A corporate-wide purchasing system, a retail sales and inventory system (including new point-of-sale registers) and a human resource and payroll system were completed in fiscal 2001. In November 2000, we outsourced our data center, desktop, network and telecommunication services management and operations support. In February 2001, we outsourced the hosting and support of our internet website to a third-party vendor.

 

Trademarks and Licensing

 

The “J. Crew” trademark and variations thereon, and certain other trademarks, are registered or are subject to pending trademark applications with the United States Patent and Trademark Office and with the registries of many foreign countries.

 

In addition, we license our “J. Crew” trademark to Itochu Corporation in Japan for which we receive percentage royalty fees. Under the license agreement, we retain a high degree of control over the manufacture, design, marketing and sale of merchandise by Itochu Corporation under the J. Crew trademark. This agreement expires in January 2007. In fiscal 2003, licensing revenues totaled $2.5 million.

 

Employees

 

As of January 31, 2004, we had approximately 5,500 associates, of whom approximately 1,700 were full-time associates and 3,800 were part-time associates. In addition, approximately 1,900 associates are hired on a seasonal basis to meet demand during the peak season. None of our associates are represented by a union. We believe that our relationship with our associates is good.

 

Competition

 

All aspects of our business are highly competitive. We compete primarily with specialty brand retailers,

 

3

 

other catalog and internet operations, department stores and mass merchandisers that offer similar merchandise. We believe that the principal bases upon which we compete are quality, design, efficient service, selection and price. Many of our competitors are substantially larger, have a more established retail store presence and experience and have greater financial, marketing and other resources than us. There is no assurance that we will be able to successfully compete with our competitors in the future. In addition, our business is sensitive to a number of factors that could affect the level of consumer spending, including the following:

 

•              adverse economic conditions;

 

•              the levels of disposable consumer income;

 

•              consumer confidence; and

 

•              interest rates.

 

Our Business

 

J. Crew Retail

 

As of January 31, 2004, we operated 154 retail stores throughout the United States, of which 4 stores were opened during fiscal 2003. These stores are located in upscale regional malls, lifestyle centers, shopping centers and street locations. During fiscal 2003, J. Crew Retail generated revenues of $408.1 million, representing 59.3% of our total revenues.

 

An important aspect of our business strategy has been an expansion program designed to reach new and existing customers through the opening of J. Crew Retail stores. As a result of the slowdown in the overall economic environment and our declining comparable store sales trends for the last three years, we have decided to curtail the number of new store openings. We opened 4 stores in fiscal 2003 and plan to open 5 stores in fiscal 2004. In addition to generating sales of J. Crew products, J. Crew Retail stores help set and reinforce the J. Crew brand image. The stores are designed in-house and fixtured to create a distinctive J. Crew environment and store associates are trained to maintain high standards of visual presentation and customer service. Store locations are determined based on several factors, including the following:

 

•              geographic location;

 

•              demographic information;

 

•              anchor tenants in mall locations; and

 

•              proximity to other specialty retail stores in mall and street locations.

 

J. Crew Retail stores that were open during all of fiscal 2003 averaged $2.7 million per store in sales and produced sales per gross square foot of $345. J. Crew Retail stores have an average size of 7,680 total square feet.

 

The table below highlights certain information regarding J. Crew Retail stores opened through fiscal 2003.

 

Fiscal Year		Stores Open At Beginning of Fiscal Year		Stores Opened During Fiscal Year		Stores Closed During Fiscal Year		Stores Open at End of Fiscal Year		Total Square Footage (in thousands)		Average Store Square Footage
1999		65		16		—		81		668		8,243
2000		81		24		—		105		833		7,933
2001		105		34		3		136		1,054		7,752
2002		136		16		—		152		1,172		7,712
2003		152		4		2		154		1,183		7,680

 

J. Crew Direct

 

J. Crew Direct consists of our catalog and internet website operations. During fiscal 2003, J. Crew Direct generated $173.5 million in revenues, including $61.9 million from the catalog and $111.6 million from the internet website, representing 25.2% of our total J. Crew revenues.

 

We believe we have distinguished ourselves from other catalog retailers by our award-winning catalog which utilizes magazine-quality, “real moment” pictures to depict an aspirational lifestyle image. In fiscal 2003, we distributed 28 catalog editions with a total circulation of approximately 53 million and pages circulated of approximately 5.8 billion. This represented a decrease from fiscal 2002 in which we had total circulation of approximately 66 million and pages circulated of approximately 7.8 billion.

 

J. Crew Direct’s circulation strategy focuses on continually improving the segmentation of customer files and the acquisition of additional customer names. In fiscal 2003, approximately 65% of J. Crew Direct revenues

 

4

 

were from customers who had made a purchase from any J. Crew catalog or on the internet in the prior 12 months. We segment our customer file and tailor our catalog offerings to address the different product needs of our customer segments. To increase core catalog productivity and improve the effectiveness of marginal and prospecting circulation, each customer segment is offered appropriate catalog editions. We also acquire new names from various sources, including the following:

 

•              our retail stores;

 

•              our internet website;

 

•              list rentals; and

 

•              exchanges with other catalog companies.

 

We have installed telephones in all of our J. Crew Retail stores with direct access to the J. Crew Direct telemarketing center to allow customers in the 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 the J. Crew brand image. Photography is executed both on location and in studios, and creative design and copy writing are executed on a desktop publishing system. Digital images are transmitted directly to outside printers, thereby reducing lead times and improving reproduction quality. We believe that appropriate page presentation of our merchandise stimulates demand, and therefore we place great emphasis on page layout.

 

J. Crew Direct does not have long-term contracts with paper mills. Projected paper requirements are communicated on an annual basis to paper mills to ensure the availability of an adequate supply. Management believes that our long-standing relationships with a number of the largest coated paper mills 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 the internet. In fiscal 2003, the website logged over 38 million unique visitors and represents 65% of the J. Crew Direct business. We design and operate our website using an in-house technical staff and our website emphasizes simplicity and ease of customer use while integrating the J. Crew brand’s aspirational lifestyle imagery used in the catalog.

 

J. Crew Factory

 

As of January 31, 2004, we operated 42 factory stores in the United States. The factory stores target value-oriented customers and also serve to liquidate excess, irregular and out-of-season J. Crew merchandise. In the 2003 Fall season, our Factory division began creating and selling its own merchandise. During fiscal 2003, J. Crew Factory generated revenues of $79.0 million, representing 11.5% of our total revenues.

 

J. Crew Factory stores have an average size of 6,500 total square feet and are generally located in major regional outlet centers in 24 states across the United States. We believe that the factory stores, which are designed in-house, maintain fixturing, visual presentation and service standards comparable to those typically associated with outlet stores.

 

Forward Looking Statements

 

Certain statements in this Annual Report on Form 10-K/A under the captions “Business,” “Selected Financial Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Financial Statements and Supplementary Data” and elsewhere constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. We may also make 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. Such forward-looking statements involve known and unknown risks, uncertainties and other important factors that could cause the actual results, performance or achievements of the Company, or industry results, to differ materially from historical results, any future results, performance or achievements 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 the Company’s products, overall economic conditions, governmental regulations and trade restrictions, acts of war or terrorism in the United States or worldwide, political or financial instability in the countries where the Company’s goods are manufactured, postal rate increases, paper and printing costs, availability of suitable store locations at appropriate terms, the level of the Company’s indebtedness and exposure to interest rate fluctuations, and other risks and uncertainties described in this report and the Company’s 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 you should not place undue reliance on them. Forward looking statements speak only as of the date they are made and we undertake no obligation to update publicly any of them in light of new information or future events.

 

Available Information

 

We are subject to the informational requirements of the Securities Exchange Act of 1934 (Exchange Act). We therefore file periodic reports and other information with the Securities and Exchange Commission (SEC). Such reports may be obtained by visiting the Public Reference Room of the SEC at 450 Fifth Street NW, Washington,

 

5

 

D.C. 20549, or by calling the SEC at (800) SEC-0330. In addition, the SEC maintains an internet site (www.sec.gov) that contains reports, proxy information statements and other information regarding issuers 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 are available as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. The reference to the Company’s website address does not constitute incorporation by reference of the information contained on the website, and the information contained on the website is not part of this document.

 

ITEM 2.          PROPERTIES

 

We are headquartered in New York City. The New York City headquarter offices are leased under a lease agreement expiring in 2012, with an option to renew thereafter. We own two customer contact and distribution facilities: a 406,500-square-foot customer contact and distribution center for J. Crew Direct operations in Lynchburg, Virginia and a 192,500-square-foot distribution center in Asheville, North Carolina servicing the J. Crew Retail operations.

 

As of January 31, 2004, we operated 154 J. Crew retail stores and 42 factory stores in 38 states and the District of Columbia. All of the retail and factory stores are leased from third parties, and the leases in most cases have terms of 10 to 12 years, with options to renew for periods typically ranging from five to ten years. As a general matter, the 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 generally 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 us or in some cases the landlord under certain conditions. The leases also generally require us 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 31, 2004.

 

		Retail Stores		Factory Stores		Total Number Of Stores
Alabama		2		1		3
Arizona		4		—		4
California		20		3		23
Colorado		4		2		6
Connecticut		5		1		6
Delaware		1		1		2
Florida		4		3		7
Georgia		4		2		6
Illinois		9		—		9
Indiana		2		2		4
Kansas		1		—		1
Kentucky		2		—		2
Louisiana		1		—		1
Maine		—		2		2
Maryland		3		1		4
Massachusetts		6		2		8
Michigan		6		1		7
Minnesota		3		—		3
Missouri		2		1		3
Nevada		1		—		1
New Hampshire		1		2		3
New Jersey		9		1		10
New Mexico		1		—		1
New York		15		4		19
North Carolina		4		—		4
Ohio		7		—		7
Oklahoma		2		—		2
Oregon		2		—		2
Pennsylvania		8		3		11
Rhode Island		1		—		1
South Carolina		2		2		4
Tennessee		3		1		4
Texas		6		2		8
Utah		2		—		2
Vermont		1		1		2
Virginia		5		2		7
Washington		2		1		3
Wisconsin		1		1		2
District of Columbia		2		—		2
Total		154		42		196

 

6

 

ITEM 3.          LEGAL PROCEEDINGS

 

Charles E. Hill & Associates, Inc., or Hill, filed a lawsuit on August 16, 2002 in the U. S. District Court for the Eastern District of Texas against us and seventeen other defendants, primarily large retailers, alleging infringement of three patents registered to Hill relating to electronic catalog systems and methods for processing data at a remote location and updating and displaying that data. The suit seeks an injunction 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 the outcome of these other claims cannot be predicted with certainty, management does not believe that the ultimate resolution of these matters will 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 31, 2004.

 

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 Corp. common stock or for Intermediate’s equity. As of April 15, 2004, there were 44 shareholders of record of the Group common stock. See “Item 12. Security Ownership of Certain Beneficial Owners and Management” for a discussion of the ownership of Group. Group is the sole member of Intermediate, and Intermediate owns 100% of the common stock of Operating Corp.

 

Group has not paid cash dividends on its common stock and does not anticipate paying any such dividends in the foreseeable future. Operating Corp. may from time to time pay cash dividends on its common stock to permit Group to make required payments relating to its 13 ¹¤₈% senior discount debentures.

 

Our credit facility with Wachovia Bank, N.A., as arranger, Congress Financial Corporation, as administrative and collateral agent, and a syndicate of lenders (the “Congress Credit Facility”) and the Indenture relating to the 13 ¹¤₈% senior discount debentures of Group (the “Group Indenture”) prohibit the payment of dividends by Group on shares of common stock (other than dividends payable solely in shares of capital stock of Group). Additionally, because Group is a holding company, its ability to pay dividends is dependent upon the receipt of dividends from its direct and indirect subsidiaries. Each of the Congress Credit Facility, the Group Indenture and the Indenture relating to the 10 ³¤₈% senior subordinated notes of Operating Corp., contains covenants which impose substantial restrictions on Operating Corp.’s ability to pay dividends 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 the J. Crew Group, Inc. 2003 Equity Incentive Plan (the “2003 Plan”), as of January 31, 2004. Our shareholders have approved both of these plans.

 

		(a)		(b)			(c)
Plan Category		Number of Securities to be Issued Upon Exercise of Outstanding Options Warrants and Rights		Weighted Average Exercise Price of Outstanding Options, Warrants and Rights			Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans (Excluding Securities Reflected in Column (a))
Equity Compensation Plans Approved by Shareholders		2,410,606		$	8.37		2,840,830
Equity Compensation Plans Not Approved by Shareholders		0		N/A			0
TOTAL		2,410,606		$	8.37		2,840,830

 

In addition to options, the 2003 Plan authorizes the issuance of restricted stock of Group. The 2003 Plan contains a sub-limit of 1,450,724 shares on the aggregate number of shares of restricted Group common stock which may be issued, of which 1,144,979 shares are outstanding and 305,745 shares are available.

 

7

 

ITEM 6.          SELECTED FINANCIAL DATA

 

The following table sets forth selected consolidated historical financial, operating, balance sheet and other data of the Company. The selected income statement and balance sheet data for each of the five fiscal years ended January 31, 2004 are derived from the Consolidated Financial Statements of the Company, which have been audited by KPMG LLP, independent auditors. The data presented below should be read in conjunction with the Consolidated Financial Statements, including the related Notes thereto, included herein, the other financial information included herein, and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

		Fiscal Year Ended
		January 29, 2000			February 3, 2001(a)			February 2, 2002				February 1, 2003				January 31, 2004 (as restated)
		(dollars in thousands, except per square foot data)
Income Statement Data:
Revenues		$	750,696		$	825,975		$	777,940			$	766,382			$	688,289
Cost of goods sold(b)(c)(g)		426,464			458,205			454,491				470,300				438,600
Selling, general and administrative expenses(c)		284,031			307,569			303,448				301,718				280,464
Other charges		7,018			—			—				—				—
Charges incurred in connection with discontinuance of Clifford & Wills		4,000			4,130			—				—				—
Income/(loss) from operations(g)		29,183			56,071			20,001				(5,636		)		(30,775		)
Interest expense-net		(38,861		)	(36,642		)	(36,512		)		(40,954		)		(63,844		)
Gain on exchange of debt		—			—			—				—				41,085
Insurance proceeds		—			—			—				1,800				3,850
Gain on sale of Popular Club Plan		1,000			—			—				—				—
(Provision) benefit for income taxes		2,050			(7,500		)	5,500				4,200				(500		)
Net income (loss)(g)		$	(6,628	)	$	11,929		$	(11,011	)		$	(40,590	)		(50,184		)
Balance Sheet Data (at period end):
Cash and cash equivalents		$	38,693		$	32,930		$	16,201			$	18,895			49,650
Working capital(g)		75,929			49,482			39,164				38,015				46,217
Total assets(g)		373,604			389,861			401,320				348,878				297,611
Total long term debt and preferred stock		458,218			464,310			510,147				556,038				609,440
Stockholders’ deficit(g)		$	(264,593	)	$	(278,347	)	$	(319,043	)		$	(391,663	)		(468,066		)
Operating Data:
Revenues:
J. Crew retail		$	333,575		$	406,784		$	397,998			$	408,028			$	408,119
J. Crew direct
Catalog		213,308			177,535			135,353				108,531				61,883
Internet		65,249			107,225			122,844				139,456				111,653
		278,557			284,760			258,197				247,987				173,536
J. Crew factory		101,987			96,114			85,085				76,264				78,973
J. Crew licensing		2,505			3,020			2,560				2,280				2,456
J. Crew shipping & handling fees		34,072			35,297			34,100				31,823				25,205
Total		750,696			825,975			777,940				766,382				688,289
J. Crew Direct:
Number of catalogs circulated (in thousands)		75,479			72,522			71,000				66,000				53,000
Number of pages circulated (in millions)		9,319			8,677			8,300				7,800				5,800
J. Crew Retail:
Sales per gross square foot(d)		$	571		$	567		$	439			$	365			$	345
Number of stores open at end of period		81			105			136				152				154
Comparable store sales change(e)		1.8		%	1.7		%	(15.5		)%		(10.4		)%		(3.4		)%
Depreciation and amortization(c)		$	23,970		$	28,670		$	39,963			$	43,197			43,075
Net capital expenditures(f)
New store openings		$	13,300		$	16,700		$	17,572			$	11,400			$	3,500
Other		27,953			25,475			25,003				9,018				4,386
Total net capital expenditures		$	41,253		$	42,175		$	42,575			$	20,418			$	7,886

 

8

 

 

(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 increased fiscal 2000 sales by $10.8 million.

 

(b)           Includes buying and occupancy costs.

 

(c)           Amounts reported in prior periods for amortization of deferred landlord contributions have been reclassified from depreciation and amortization to rent expense to conform to current presentation.

 

(d)           Includes stores that have been opened for a full twelve month period.

 

(e)           Comparable store sales excludes the sales of stores that were not open during the same period in the prior year.

 

(f)            Capital expenditures are net of proceeds from construction allowances.

 

(g)           Amounts previously reported for fiscal year ended January 31, 2004 have been restated. (See Note 2 to the consolidated financial statements for a description of the restatement).

 

9

 

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 during the three-year period ended January 31, 2004. You should read the following discussion and analysis in conjunction with our audited consolidated financial statements for the three-year period ended January 31, 2004 and the related notes thereto included herein.

 

Management’s discussion and analysis of the results of operations are provided solely with respect to J.Crew Operating Corp. and its subsidiaries since substantially all of the Company’s operations are conducted by J.Crew Operating Corp. However, J.Crew Intermediate LLC and J.Crew Group, Inc. have outstanding additional debt securities. Accordingly, information with respect to interest income and expense of each of those entities is also provided herein. The discussion of liquidity and capital resources pertains to J.Crew Group, Inc. and its consolidated subsidiaries, including J.Crew Intermediate LLC and J.Crew Operating Corp.

 

Management Overview

 

The fashion and apparel industry is highly competitive. We compete primarily with specialty brand retailers, department stores, mass merchandisers, other catalog operations, 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. We believe 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 is sensitive to a number of factors that influence the levels of consumer spending including economic conditions and the level of disposable consumer income, consumer debt, interest rates and consumer confidence. The recent economic environment had a negative impact on our sales and contributed to a higher level of promotional sales activities which adversely affected our profitability. We believe our comparable store sales results in fiscal 2001 and 2002 also resulted from customer dissatisfaction with our product offerings. When our new management took over in January 2003, they initiated a program to upgrade the quality and style of our merchandise assortments. These changes were not implemented until our Fall and Holiday 2003 product offerings.

 

As part of our growth strategy, we intend to expand our base of J.Crew retail stores. This expansion has been curtailed recently as the number of new stores opened decreased to four in fiscal 2003 and the anticipated openings in fiscal 2004 is five. We have decided to concentrate our efforts on increasing the sales productivity (as measured by sales per square foot) of our current stores before we resume our store opening program.

 

Restatement

 

We have restated our consolidated financial statements for the fiscal year ended January 31, 2004 to reflect the write-off of certain prepaid sample costs that should have been expensed as incurred. (See Note 2 to the consolidated financial statements for a description of the restatement).

 

Results of Operations

 

Our consolidated statements of operations presented as a percentage of revenues are as follows:

 

		Fiscal Year Ended
		January 31, 2004 (as restated)		February 1, 2003		February 2, 2002
Revenues(1)		100.0	%	100.0	%	100.0	%
Cost of goods sold, including buying and occupancy costs(2)(3)(4)		63.7		61.4		58.4
Selling, general and administrative expenses(2)(3)		40.7		39.3		39.0
Income/(loss) from operations(4)		(4.5	)	(0.7	)	2.6
Interest expense, net		(9.3	)	(5.3	)	(4.7	)
Gain on exchange of debt		6.0		—		—
Insurance proceeds		.6		.2		—
Loss before income taxes(4)		(7.2	)	(5.8	)	(2.1	)
Income taxes		(.1	)	0.5		0.7
Net loss(4)		(7.3	)%	(5.3	)%	(1.4	)%

 

(1)           Includes licensing, shipping and handling fees.

 

(2)           Our gross margins may not be comparable to others as some companies include all of the costs related to their distribution network in the cost of goods sold while others, like us, exclude all or a portion of them from gross margins and, instead, include them in selling, general and administrative expenses.

 

(3)           Amounts reported in prior periods for amortization of deferred landlord contributions have been reclassified from depreciation and amortization to rent expense to conform to current year presentation.

 

(4)           Amounts previously reported for the fiscal year ended January 31, 2004 have been restated. (See Note 2 to the consolidated financial statements for a description of the restatement).

 

10

 

Revenues

 

Consolidated revenues for fiscal years 2003, 2002 and 2001 by channel of distribution were, as follows:

 

		2003			2002			2001
		(in millions)
Retail		$	408.1		$	408.0		$	398.0
Direct		173.5			248.0			258.2
Factory		79.0			76.3			85.0
Other		27.7			34.1			36.7
		$	688.3		$	766.4		$	777.9

 

Revenues of J. Crew Retail for fiscal years 2003, 2002 and 2001 were, as follows:

 

		2003			2002			2001
		($ in millions)
Comparable store sales		$	390.5		$	352.0		$	331.0
Noncomparable store sales		17.6			56.0			67.0
		$	408.1		$	408.0		$	398.0
Number of stores open		154			152			136
Sales per gross square foot		$	345		$	365		$	439
Comparable stores sales change		(3.4		)%	(10.4		)%	(15.5		)%

 

Net sales in 2003 were $408.1 million flat with fiscal 2002. A decline of 3.4% in comparable store sales was offset by sales from four stores opened in fiscal 2003 and 16 stores opened in 2002 that were open for a full year in fiscal 2003. The improvement in comparable store sales results in 2003 is the result of an improving economy and an upgrade in the quality and style of our merchandise assortments in the second half of the year. The increase in net sales of 2.5% in fiscal 2002 compared to fiscal 2001 was derived from the sales of 16 new stores opened during 2002 and the 34 stores opened in 2001 that were open for a full year in fiscal 2002, which offset a decline of 10.4% in comparable store sales. We believe this decrease in comparable store sales was attributable to the effect of the continuing slow economy on consumer spending and customer dissatisfaction with our product offerings.

 

Revenues of J. Crew Direct for fiscal years 2003, 2002 and 2001 were, as follows:

 

		2003			2002			2001
		(in millions)
Internet		$	111.7		$	139.4		$	122.9
Catalog		61.8			108.6			135.3
		$	173.5		$	248.0		$	258.2

 

Net sales in the Direct business decreased from $248.0 million in 2002 to $173.5 million in 2003, a decrease of 30%. This decrease resulted from (a) a 25% decrease in catalog circulation from 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 second half of the year (b) a decrease in density (items per page) resulting from a 30% reduction in style counts and (c) the reduction in promotional practices, including promotional e-mails.

 

The decrease in net sales of 4% from $258.2 million in 2001 to $248.0 million in 2002 resulted from a decrease in catalog sales not offset by the increase in Internet sales. Pages circulated decreased by 6% from 8.3 billion pages in 2001 to 7.8 billion pages in 2002 while internet sales increased from the efforts to migrate customers to the Internet through promotional e-mails and other activities.

 

Revenues of J. Crew Factory for fiscal years 2003, 2002 and 2001 were, as follows:

 

11

 

		2003			2002			2001
		($ in millions)
Comparable store sales		$	77.7		$	72.3		$	85.0
Noncomparable store sales		1.3			4.0			—
		$	79.0		$	76.3		$	85.0
Number of stores open		42			42			41
Comparable stores sales change		2.9		%	(14.1		)%	(10.5		)%

 

The increase in factory store sales in 2003 resulted from the increase in comparable store sales. We strengthened our factory business in fiscal 2003 by moving away from deep discounting of prior season’s merchandise carried over from our Retail and Direct channels to having our factory channel create and sell its own merchandise. This change was effective in the 2003 Fall season and contributed to a 9% increase in comparable store sales in the Fall season. The decline in factory store sales in 2002 from 2001 resulted from higher markdowns to clear excess prior season inventories.

 

Other revenues for fiscal years 2003, 2002 and 2001 were, as follows:

 

		2003			2002			2001
		($in millions)
Royalties		$	2.5		$	2.3		$	2.6
Shipping and handling fees		25.2			31.8			34.1
		$	27.7		$	34.1		$	36.7

 

The decline in other revenues during the three year period resulted from a decrease in shipping and handling fees which is directly attributable to the downward trend in net sales of the Direct business.

 

Cost of sales, including buying and occupancy costs

 

		2003 (as restated)		2002		2001
Cost of sales, including buying and occupancy costs		63.7	%	61.4	%	58.4	%
Gross margin		36.3	%	38.6	%	41.6	%

 

The decrease in gross margin from 2002 to 2003 resulted primarily from the 180 basis point increase in buying and occupancy costs (including the writeoff of certain prepaid sample costs which increased buying and occupancy costs by 40 basis points) as a percentage of revenues because of the decrease in revenues not offset by a decrease in buying and occupancy costs which are primarily fixed expenses and a decrease of 50 basis points in merchandise margins primarily from the liquidation of prior season’s inventories in the first half of 2003.

 

The decrease in gross margin from 2002 to 2001 was caused by an increase of 120 basis points in buying and occupancy costs as a percentage of revenues because of the decrease in revenues not offset by a decrease in buying and occupancy costs which are primarily fixed expenses and a 180 basis point decrease in merchandise margins from the markdowns taken to clear inventories in the fourth quarter of 2002. The fourth quarter of 2002 also included a $9 million charge as result of the decision to modify our disposition strategy to accelerate inventory clearing at the end of each selling season.

 

Selling, general and administrative expenses

 

		2003			2002			2001
		($in millions)
Selling		$	40.0		$	53.2		$	60.8
General and administrative		240.4			248.5			242.6
		$	280.4		$	301.7		$	303.4
% of revenues		40.7		%	39.3		%	39.0		%

 

12

 

Selling expenses consist of catalog production and mailing costs. Pages circulated were 5.8 billion, 7.8 billion and 8.3 billion in fiscal 2003, 2002 and 2001. The decreases in selling expenses during the period were related primarily to the reduction in pages circulated and the elimination of women’s only editions and clearance catalogs in the second half of 2003. A decrease in the cost of paper also contributed to the decrease from 2001 to 2002.

 

The decrease in general and administrative expenses in 2003 compared to 2002 resulted primarily from a decrease in severance and other one time employment related charges of $10 million partially offset by store expenses from additional stores in operation in 2003.

 

The increase in general and administrative expenses in 2002 compared to 2001 resulted from (a) severance and other one time employment related charges of $13.7 million and (b) store expenses related to the additional stores in operation in 2002 partially offset by the cost reduction initiatives instituted in the first quarter of 2002.

 

Interest Expense

 

		2003			2002			2001
		($ in millions)
Operating Corp.:
Working capital credit facility		$	2.4		$	3.4		$	3.8
5% notes payable		1.0			—			—
10 3¤8% senior subordinated notes		15.6			15.6			15.6
Amortization of deferred financing costs		1.7			4.2			1.8
Interest income		(.2		)	—			(.3		)
Total Operating Corp.		20.5			23.2			20.9
Intermediate:
16% senior discount contingent principal notes		16.0			—			—
Amortization of debt issuance discount		5.4			—			—
Amortization of deferred financing costs		.4			—			—
Total Intermediate		42.3
Group:
13 1¤8% senior discount debentures		7.2			17.6			15.4
Dividends on redeemable preferred stock		14.2			—			—
Amortization of deferred financing costs		.1			.2			.2
Total Group		$	63.8		$	41.0		$	36.5
A significant amount of interest expense during the three year period was non-cash interest as indicated below:
Cash interest		$	20.5		$	24.3		$	19.1
Non cash interest		43.3			16.7			17.4
		$	63.8		$	41.0		$	36.5

 

The change in interest expense for Operating Corp. during the three year period related primarily to the increase in amortization of deferred financing costs in fiscal 2002, which resulted primarily from a write off of $1.8 million related to the refinancing of our working capital credit facility.

 

Intermediate was formed in March 2003 in connection with an offer to exchange 16% senior discount contingent principal notes of Intermediate for the outstanding 13 ¹¤₈% senior discount debentures of Group, which was completed on May 6, 2003. The interest expense for Intermediate for fiscal 2003 relates to interest expense and amortization of debt issuance costs for the 16% senior discount notes issued by Intermediate in exchange for the 13 ¹¤₈% senior discount debentures of Group.

 

The interest expense for Group in 2001 and 2002 relates to the amount of 13 ¹¤₈% senior discount debentures outstanding during the periods while the amount of interest expense in 2003 includes interest on $142.0 million of the outstanding 13 ¹¤₈% senior discount debentures prior to the exchange offer and on $21.6 million subsequent to the exchange offer. Group interest expense also includes dividends related to mandatorily redeemable preferred stock for the third and fourth quarters of fiscal 2003.

 

Gain on exchange of debt

 

The net consolidated gain on exchange of debt of $41.1 million reflects the difference between the fair value of the 16% senior discount notes at date of issuance and the carrying value of the 13 ¹¤₈% senior discount

 

13

 

debentures of $44.1 million recorded by Intermediate less Group related expenses which consist of (a) the additional expense of 2 ⁷¤₈% from October 15, 2002 to May 6, 2003 paid to the note holders who accepted the exchange offer $(1.9 million) and (b) the write off of unamortized deferred financing costs related to the debentures exchanged ($1.1 million).

 

Income Taxes

 

Group files a consolidated federal tax return which includes all of its wholly owned subsidiaries. Accordingly, the following discussion pertains to Group.

 

The effective tax rate was a benefit of 9.4% in fiscal 2002 compared to a benefit of 33.3% in fiscal 2001. The lower effective rate in 2002 resulted from the establishment of a valuation allowance of $21.0 million to reduce the net deferred tax assets to estimated recoverable amount at February 1, 2003, offset by a benefit of $9.0 million from the reversal of prior years’ tax accruals. The valuation allowance was recorded in fiscal 2002 as a result of the significance of our net loss in fiscal 2002 and management’s projection of taxable income/loss in the near future. Management had previously concluded that considering all factors, including available tax planning strategies 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 fact that our operating results for fiscal 2002 were significantly worse than originally forecasted and the downward revision of the outlook for fiscal year 2003 and forward, we reassessed the need for a valuation allowance. We believed in fiscal 2002 that the “positive evidence” no longer outweighed the “negative evidence” and a valuation allowance was, therefore, necessary. The tax accruals were reversed in 2002 based on a proposed IRS settlement of open years and results of state audits at amounts less than the accrued amounts. We do not expect to recognize any tax benefits in future results of operations until an appropriate level of profitability is sustained.

 

In fiscal 2003 there was a tax provision of $500,000 for state and foreign taxes. We established an additional valuation allowance of $5.0 million to fully reserve the net deferred tax assets at January 31, 2004. This increase was offset by additional tax refunds and a reduction in prior year tax accruals as a result of the finalization of certain tax audits.

 

Insurance Proceeds

 

Insurance proceeds in fiscal 2002 and 2003 represent recoveries for claims related to the destruction of our World Trade Center store on September 11, 2001. The recovery in fiscal 2003 is the final settlement of this claim.

 

Liquidity and Capital Resources

 

Our sources of liquidity are primarily cash flows from operations and borrowings under our working capital credit facility. Our primary cash needs are for capital expenditures incurred primarily for opening new stores and system enhancements, debt service requirements and working capital.

 

On December 23, 2002, Operating Corp. entered into a Loan and Security Agreement with Wachovia Bank, N.A., as arranger, Congress Financial Corporation, as administrative and collateral agent, and a syndicate of lenders which provides for maximum credit availability of up to $180.0 million. The Congress Credit Facility provides for revolving loans of up to $160.0 million; supplemental loans of up to $20.0 million each year during the period from April 15 to September 15; and letter of credit accommodations. The Congress Credit Facility expires in December 2005. The total amount of availability is limited to the sum of 85% of eligible receivables, 90% of the net recovery percentage of inventories (as determined by inventory appraisal) for the period of August 1 through November 30, 85% of the net recovery percentage of inventories for the period December 1 through July 31 and the real estate availability of $5.8 million.

 

The Congress Credit Facility includes restrictions, including the incurrence of additional indebtedness, the payment of dividends and other distributions, the making of investments, the granting of loans and the making of capital expenditures. We are required to maintain minimum levels of earnings before interest, taxes, depreciation, amortization and certain non-cash items (“EBITDA”) if excess availability is less than $15.0 million for any 30 consecutive day period. We have at all times been in compliance with all financial covenants under the Congress Credit Facility.

 

The Congress Credit Facility permits restricted payments (by way of dividends or other distributions) with respect to, among other things, our capital stock payable solely in additional shares of our capital stock, our tax sharing agreement, the Series A Preferred Stock of Group, the Series B Preferred Stock of Group and the 13 ¹¤₈% senior discount debentures due 2008 of Group. Our ability to declare dividends on our 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 the event 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. Under the Congress Credit Facility, the assets of Intermediate and its subsidiaries are restricted.

 

Cash provided by operating activities was $16.2 million in fiscal 2003, $25.3 million in fiscal 2002 and $25.8 million in fiscal 2001. The increases in net losses in 2003 and 2002 were offset by improvements in working capital, primarily reductions in inventories of $41.3 million in 2003 and $31.6 million in 2002.

 

Capital expenditures, net of construction allowances were $7.9 million in fiscal 2003, $20.4 million in fiscal 2002 and $42.6 million in 2001. Capital expenditures related to new stores were $3.5 million, $11.4 million and $17.6 million during the three years. Furthermore, fiscal 2001 included software development costs of

 

14

 

$8.5 million. Anticipated capital expenditures in fiscal 2004 are approximately $9 million, which includes 5 new stores.

 

There were no borrowings under the Congress Credit Facility at January 31, 2004 and February 1, 2003. Average borrowings under the Congress Credit Facility were $1.0 million for fiscal 2003, $40.4 million for fiscal 2002 and $43.1 million for fiscal 2001. Long-term indebtedness increased by $25.8 million in fiscal 2003 consisting of $20.0 million of TPG-MD Investment notes payable due in 2008 and $5.8 million under the Congress Credit Facility repayable over a period of 60 months, commencing June 1, 2003. As of January 31, 2004, there was $18.9 million in availability under the Congress Credit Facility.

 

On May 6, 2003, we (through our wholly-owned subsidiary, Intermediate) completed an offer to exchange 16% senior discount contingent principal notes for the outstanding 13 ¹¤₈% senior discount debentures of Group. Approximately 85% of the outstanding senior discount debentures of Group were tendered for exchange. Effective October 15, 2002, the interest payments accruing on the senior discount debentures of Group became payable in cash on April 15 and October 15 of each year subsequent thereto. We did not pay the accrued and unpaid interest on the senior discount debentures of Group on the scheduled interest payment date of April 15, 2003. Rather, we paid such interest on May 6, 2003, the settlement date of the exchange offer, together with interest thereon at a rate of 13 ¹¤₈% per annum from April 15, 2003 to May 5, 2003, to the holders of the senior discount debentures of Group who did not tender their debentures for the initial notes in the exchange offer. Interest on the 16% notes becomes payable in cash commencing on November 15, 2005 and is payable on each May 15 and November 15 thereafter through May 15, 2008.

 

Management believes that invested cash, cash flow from operations and availability under the Congress Credit Facility will provide adequate funds for our foreseeable working capital needs, planned capital expenditures and debt service obligations. Our ability to fund our operations and make planned capital expenditures, to make scheduled debt payments, to refinance indebtedness and to remain 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 our control.

 

15

 

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 certain obligations.

 

		Within 1 year			2-3 years			4-5 years			After 5 years			Total
		(dollars in millions)
Letters of Credit
Standby		$	.7		$	—		$	—		$	2.8		$	3.5
Import		36.0			—			—			—			36.0
		$	36.7		$	—		$	—		$	2.8		$	39.5

 

Contractual Obligations

 

The following summarizes our contractual obligations as of January 31, 2004 and the effect such obligations are expected to have on our liquidity and cash flows in future periods.

 

		Within 1 year			2-3 years			4-5 years			After 5 years			Total
		(dollars in millions)
Long term debt obligations(1)		$	1.2		$	2.4		$	341.2		$	—		$	344.8
Redeemable preferred stock		—			—			—			211.7			211.7
Operating lease obligations(2)		52.4			96.4			84.3			116.2			349.3
Purchase obligations
Inventory commitments		144.0			—			—			—			144.0
Other		4.8			9.1			8.1			—			22.0
Employment agreements		1.5			1.5			1.5			1.5			6.0
		150.3			10.6			9.6			1.5			172.0
		$	203.9		$	109.4		$	435.1		$	329.4		$	1,077.8

 

 

(1)           Excludes unamortized debt issuance discount.

 

(2)           Operating lease obligations represent obligations under various long-term operating leases entered in the normal course of business for retail and factory stores, warehouses, office space and equipment requiring minimum annual rentals. Operating lease expense is a significant component of our operating expenses. The lease terms range for various periods of time in various rental markets and are entered into at different times, which mitigates exposure to market changes which could have a material effect on the company’s results 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 the impact of inflation due to the imprecise nature of the estimates required, we believe that the effects of inflation, if any, on our results of operations and financial condition have been minor. However, there can be no assurance that during a period of significant inflation, our results of operations would not be adversely affected.

 

Seasonality

 

We experience two distinct selling seasons, spring and fall. The spring season is comprised of the first and second quarters and the fall season is comprised of the third and fourth quarters. Net sales are usually substantially higher in the fall season and selling, general and administrative expenses as a percentage of net sales are usually higher in the spring season. Approximately 31% of annual net sales in fiscal 2003 occurred in the fourth quarter. Our working capital requirements also fluctuate throughout the year, increasing substantially in September and October in anticipation of the holiday season inventory requirements.

 

Recent Accounting Pronouncements

 

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” This statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities.” The provisions of this statement are effective for contracts entered into or modified after June 30, 2003 and hedging relationships designated after June 30, 2003. The provisions of the statement related to Statement 133 Implementation Issues that have been effective for fiscal quarters that began prior to June 15, 2003 should continue to be applied in accordance with their respective effective dates. The adoption of SFAS No. 149 did not have a significant effect on our financial statements.

 

16

 

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity. The provisions of this statement were effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS No. 150 resulted in a reclassification of the liquidation value and accumulated and unpaid dividends of the Series B preferred stock and the accumulated and unpaid dividends related to the Series A preferred stock to liabilities, which totaled $211.7 million as of January 31, 2004. After such reclassification, the dividends related to the Series B preferred stock and the accreted dividends of the Series A Preferred Stock will be treated as interest expense.

 

In December 2003, the FASB revised and reissued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities.” FIN No. 46 requires unconsolidated variable interest entities to be consolidated by their primary beneficiaries if the entities do not effectively dispense the risks and rewards of ownership among their owners and other parties involved. The provisions of FIN No. 46 must be applied no later than as of the end of the first reporting period ending after March 15, 2004. The adoption of FASB Interpretation No. 46 will not have a significant effect on our financial statements.

 

Critical Accounting Policies

 

Management’s discussion and analysis of financial condition and results of operations is based upon the consolidated financial statements which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these 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 and evaluate 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 and judgments used in the preparation of our consolidated financial statements. We do not believe that changes in these assumptions and estimates 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 inventories based on estimated future sales. Excess inventories may be disposed of through factory, clearance catalogs, internet clearance sales and other liquidations. Based on historical results experienced through various methods of disposition, we write down the carrying value of inventories that 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 capitalized and amortized over the expected future revenue stream of the catalog mailings, which approximates four months. The expected future revenue stream is determined based on historical revenue trends developed over an extended period of time. If the current revenue streams were to diverge from the expected trend, 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 our long-lived assets are store fixtures, equipment and leasehold improvements. The impairment of unamortized costs is measured at the store level 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 book value.

 

Sales Returns

 

We must make estimates of future sales returns related to current period sales. Management analyzes historical returns, current economic trends and changes in customer acceptance of 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 deductible temporary differences, which will reduce taxable income in future periods. Statement of Financial Accounting Standards (“SFAS”) No. 109, “Accounting for Income Taxes” states that a valuation allowance is required when it is more likely than not that all or a portion of a deferred tax asset will not be realized. A review of all available positive and negative evidence needs to be considered, including a company’s current and past performance, the market environment in which a company operates, length of carryback and carryforward periods, existing contracts or sales backlog that will result in future profits, etc. Forming a conclusion that a valuation allowance is not needed is difficult when there is negative evidence such as cumulative losses in recent years. Cumulative losses weigh heavily in the overall assessment. As a result of our assessments, we established a valuation allowance to reduce our net deferred tax assets to their estimated realizable value of $5.0 million at February 1, 2003 and we provided an

 

17

 

additional allowance at January 31, 2004 to fully reserve our net deferred tax assets. We do not expect 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 net income or net assets. Our variable rate debt consists of borrowings under the Congress Credit Facility. The interest rates are a function of the bank prime rate or LIBOR. A one percentage point increase in the base interest rate would result in approximately $100,000 change in income before taxes for each $10 million of borrowings.

 

We have a licensing agreement in Japan which provides for royalty payments based on sales of J. Crew merchandise as denominated in yen. We have entered into forward foreign exchange contracts from time to time in order to minimize this risk. At January 31, 2004, there were no forward foreign exchange contracts outstanding.

 

We enter into letters of credit to facilitate the international purchase of merchandise. The letters of credit are primarily denominated in U.S. dollars. Outstanding letters of credit at January 31, 2004 were $39.5 million, including $3.5 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

 

(a)   Evaluation of Disclosure Controls and Procedures.   When the original Form 10-K was filed, we concluded that our disclosure controls and procedures as of the end of the period covered by the report were effective. Subsequent to the original Form 10-K filing, in September 2004 our new Chief Financial Officer identified an error in the company's accounting for samples in the course of reviewing the company's accounts upon joining the Company. As a result, we concluded that our previously reported financial statements for the fiscal year ended January 31, 2004 and for the first quarter ended May 1, 2004 should be restated to reflect the write-off of certain prepaid samples incurred during those periods which should have been expensed as incurred. See Note 2 to our consolidated financial statements for a description of the restatement. We believe that the deficiencies in our disclosure controls and procedures that led to this error related to a lack of adequate resources to review our accounting policies as appropriate. We now have such adequate resources and we believe that the deficiencies have been remediated. We continue to monitor the effectiveness of our disclosure controls and procedures on an ongoing basis.

 

(b)   Changes in Internal Controls.   There were no significant changes in our internal controls over financial reporting during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

 

18