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EX-31.2 - CERTIFICATION OF CFO PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 - J CREW GROUP INCd427724dex312.htm
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

 

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

For the quarterly period ended October 27, 2012

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)

 

 

770 Broadway

New York, New York 10003

Telephone: (212) 209-2500

 

 

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  x

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

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

 

Large Accelerated Filer   ¨    Accelerated Filer   ¨
Non-Accelerated Filer   x    Smaller Reporting Company   ¨

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

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 November 23, 2012

Common Stock, $.01 par value per share   1,000 shares

 

 

 


Table of Contents

J.CREW GROUP, INC.

TABLE OF CONTENTS – FORM 10-Q

 

     Page
Number
 

PART I. FINANCIAL INFORMATION

  

Item 1.

 

Condensed Consolidated Financial Statements (unaudited):

  
 

Condensed Consolidated Balance Sheets at October 27, 2012 and January 28, 2012

     3   
 

Condensed Consolidated Statements of Operations and Comprehensive Income for the thirteen weeks ended October 27, 2012 and October 29, 2011

     4   
 

Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the thirty-nine weeks ended October 27, 2012 (Successor) and for the periods March 8, 2011 to October 29, 2011 (Successor) and January 30, 2011 to March 7, 2011 (Predecessor)

     5   
 

Condensed Consolidated Statements of Changes in Stockholders’ Equity for the thirty-nine weeks ended October 27, 2012 and the period March 8, 2011 to January 28, 2012

     6   
 

Condensed Consolidated Statements of Cash Flows for the thirty-nine weeks ended October 27, 2012 (Successor) and for the periods March 8, 2011 to October 29, 2011 (Successor) and January 30, 2011 to March 7, 2011 (Predecessor)

     7   
 

Notes to Unaudited Condensed Consolidated Financial Statements

     8   

Item 2.

 

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

     16   

Item 3.

 

Quantitative and Qualitative Disclosure About Market Risk

     28   

Item 4.

 

Controls and Procedures

     28   

PART II. OTHER INFORMATION

  

Item 1.

 

Legal Proceedings

     29   

Item 1A.

 

Risk Factors

     29   

Item 6.

 

Exhibits

     29   

 

2


Table of Contents

PART I – FINANCIAL INFORMATION

 

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

J.CREW GROUP, INC.

Condensed Consolidated Balance Sheets

(unaudited)

(in thousands, except share data)

 

     October 27,
2012
    January 28,
2012
 
ASSETS     

Current assets:

    

Cash and cash equivalents

   $ 195,675      $ 221,852   

Merchandise inventories

     348,601        242,659   

Prepaid expenses and other current assets

     61,646        58,023   

Prepaid income taxes

     7,012        4,087   
  

 

 

   

 

 

 

Total current assets

     612,934        526,621   
  

 

 

   

 

 

 

Property and equipment, net

     321,797        264,572   

Favorable lease commitments, net

     38,070        48,930   

Deferred financing costs, net

     52,178        58,729   

Intangible assets, net

     977,968        985,322   

Goodwill

     1,686,915        1,686,915   

Other assets

     1,784        2,433   
  

 

 

   

 

 

 

Total assets

   $ 3,691,646      $ 3,573,522   
  

 

 

   

 

 

 
LIABILITIES AND STOCKHOLDERS’ EQUITY     

Current liabilities:

    

Accounts payable

   $ 161,523      $ 158,116   

Other current liabilities

     154,680        116,339   

Interest payable

     12,983        26,735   

Current portion of long-term debt

     15,000        15,000   
  

 

 

   

 

 

 

Total current liabilities

     344,186        316,190   
  

 

 

   

 

 

 

Long-term debt

     1,570,000        1,579,000   

Unfavorable lease commitments and deferred credits, net

     65,840        53,700   

Deferred income taxes, net

     409,787        410,515   

Other liabilities

     37,896        37,065   
  

 

 

   

 

 

 

Total liabilities

     2,427,709        2,396,470   
  

 

 

   

 

 

 

Stockholders’ equity:

    

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

     —          —     

Additional paid-in capital

     1,186,301        1,183,606   

Accumulated other comprehensive loss

     (20,655     (18,963

Retained earnings

     98,291        12,409   
  

 

 

   

 

 

 

Total stockholders’ equity

     1,263,937        1,177,052   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 3,691,646      $ 3,573,522   
  

 

 

   

 

 

 

See notes to unaudited condensed consolidated financial statements.

 

3


Table of Contents

J.CREW GROUP, INC.

Condensed Consolidated Statements of Operations and Comprehensive Income

(unaudited)

(in thousands)

 

     Thirteen Weeks Ended
October 27, 2012
    Thirteen Weeks Ended
October 29, 2011
 

Revenues:

    

Net sales

   $ 548,506      $ 473,027   

Other

     7,302        6,548   
  

 

 

   

 

 

 

Total revenues

     555,808        479,575   

Cost of goods sold, including buying and occupancy costs

     292,738        277,806   
  

 

 

   

 

 

 

Gross profit

     263,070        201,769   

Selling, general and administrative expenses

     188,569        143,876   
  

 

 

   

 

 

 

Income from operations

     74,501        57,893   

Interest expense, net of interest income

     24,089        25,349   
  

 

 

   

 

 

 

Income before income taxes

     50,412        32,544   

Provision for income taxes

     17,233        10,944   
  

 

 

   

 

 

 

Net income

   $ 33,179      $ 21,600   
  

 

 

   

 

 

 

Other comprehensive income:

    

Unrealized loss on cash flow hedge, net of tax

     (436     (3,581
  

 

 

   

 

 

 

Comprehensive income

   $ 32,743      $ 18,019   
  

 

 

   

 

 

 

See notes to unaudited condensed consolidated financial statements.

 

4


Table of Contents

J.CREW GROUP, INC.

Condensed Consolidated Statements of Operations and Comprehensive Income (Loss)

(unaudited)

(in thousands)

 

     Thirty-nine Weeks Ended
October 27, 2012
    For the Period  
     March 8, 2011 to
October 29, 2011
            January 30, 2011 to
March 7, 2011
 
   (Successor)     (Successor)          (Predecessor)  

Revenues:

             

Net sales

   $ 1,563,936      $ 1,171,450             $ 130,116   

Other

     20,882        19,358               3,122   
  

 

 

   

 

 

          

 

 

 

Total revenues

     1,584,818        1,190,808               133,238   

Cost of goods sold, including buying and occupancy costs

     845,223        712,066               70,284   
  

 

 

   

 

 

          

 

 

 

Gross profit

     739,595        478,742               62,954   

Selling, general and administrative expenses

     527,357        415,748               79,736   
  

 

 

   

 

 

          

 

 

 

Income (loss) from operations

     212,238        62,994               (16,782

Interest expense, net of interest income

     74,860        66,588               1,166   
  

 

 

   

 

 

          

 

 

 

Income (loss) before income taxes

     137,378        (3,594            (17,948

Provision (benefit) for income taxes

     51,496        (856            (1,798
  

 

 

   

 

 

          

 

 

 

Net income (loss)

   $ 85,882      $ (2,738          $ (16,150
  

 

 

   

 

 

          

 

 

 

Other comprehensive income (loss):

             

Unrealized loss on cash flow hedge, net of tax

     (1,692     (15,231            —     
  

 

 

   

 

 

          

 

 

 

Comprehensive income (loss)

   $ 84,190      $ (17,969          $ (16,150
  

 

 

   

 

 

          

 

 

 

See notes to unaudited condensed consolidated financial statements.

 

5


Table of Contents

J.CREW GROUP, INC.

Condensed Consolidated Statements of Changes in Stockholders’ Equity

(unaudited)

(in thousands, except shares)

 

     Common Stock      Additional
paid-in
    Retained      Accumulated
other
comprehensive
    Total
stockholders’
 
     Shares      Amount      capital     earnings      loss     equity  

Balance at March 8, 2011

     —         $ —         $ —        $ —         $ —        $ —     
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Issuance of 1,000 shares of common stock

     1,000         —           1,170,693        —           —          1,170,693   

Share-based compensation

     —           —           12,913        —           —          12,913   

Net income

     —           —           —          12,409         —          12,409   

Unrealized loss on cash flow hedges, net of tax

     —           —           —          —           (18,963     (18,963
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Balance at January 28, 2012

     1,000       $ —         $ 1,183,606      $ 12,409       $ (18,963   $ 1,177,052   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Share-based compensation

     —           —           3,213        —           —          3,213   

Contribution to Parent

     —           —           (518     —           —          (518

Net income

     —           —           —          85,882         —          85,882   

Unrealized loss on cash flow hedges, net of tax

     —           —           —          —           (1,692     (1,692
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Balance at October 27, 2012

     1,000       $ —         $ 1,186,301      $ 98,291       $ (20,655   $ 1,263,937   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

See notes to unaudited condensed consolidated financial statements.

 

6


Table of Contents

J.CREW GROUP, INC.

Condensed Consolidated Statements of Cash Flows

(unaudited)

(in thousands)

 

    Thirty-nine Weeks Ended
October 27, 2012
    For the Period  
    March 8, 2011  to
October 29, 2011
            January 30, 2011 to
March 7, 2011
 
  (Successor)     (Successor)          (Predecessor)  

CASH FLOWS FROM OPERATING ACTIVITIES:

            

Net income (loss)

  $ 85,882      $ (2,738          $ (16,150

Adjustments to reconcile to cash flows from operating activities:

            

Depreciation of property and equipment

    52,363        41,795               3,929   

Share-based compensation

    3,213        47,015               1,080   

Non-cash charge related to step-up in carrying value of inventory

    —          30,833               —     

Amortization of favorable lease commitments

    10,860        8,739               —     

Amortization of intangible assets

    7,354        6,537               —     

Amortization of deferred financing costs

    7,201        6,401               970   

Excess tax benefits from share-based awards

    —          —                 (74,495

Changes in operating assets and liabilities:

            

Merchandise inventories

    (105,942     (55,435            (20,204

Prepaid expenses and other current assets

    (3,623     (17,332            3,178   

Other assets

    649        921               (825

Accounts payable and other liabilities

    40,136        30,904               (2,440

Federal and state income taxes

    (4,514     39,418               3,847   
 

 

 

   

 

 

          

 

 

 

Net cash provided by (used in) operating activities

    93,579        137,058               (101,110
 

 

 

   

 

 

          

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

            

Acquisition of J.Crew Group, Inc.

    —          (2,981,415            —     

Capital expenditures

    (109,588     (69,351            (2,644
 

 

 

   

 

 

          

 

 

 

Net cash used in investing activities

    (109,588     (3,050,766            (2,644
 

 

 

   

 

 

          

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

            

Proceeds from debt

    —          1,600,000               —     

Proceeds from equity contributions

    —          1,173,741               —     

Excess tax benefit from share-based awards

    —          —                 74,495   

Payment of debt issuance costs

    —          (67,530            —     

Proceeds from share-based compensation plans

    —          —                 1,130   

Repayment of debt

    (9,000     (3,000            —     

Costs incurred in refinancing debt

    (650     —                 —     

Repurchases of common stock

    —          —                 (20

Contribution to Parent

    (518     —                 —     
 

 

 

   

 

 

          

 

 

 

Net cash provided by (used in) financing activities

    (10,168     2,703,211               75,605   
 

 

 

   

 

 

          

 

 

 

Decrease in cash and cash equivalents

    (26,177     (210,497            (28,149

Beginning balance

    221,852        353,211               381,360   
 

 

 

   

 

 

          

 

 

 

Ending balance

  $ 195,675      $ 142,714             $ 353,211   
 

 

 

   

 

 

          

 

 

 

Supplemental cash flow information:

            

Income taxes paid

  $ 56,179      $ 18,082             $ —     
 

 

 

   

 

 

          

 

 

 

Interest paid

  $ 81,351      $ 48,351             $ 35   
 

 

 

   

 

 

          

 

 

 

Non-cash equity contribution from management shareholders

  $ —        $ 102,483             $ —     
 

 

 

   

 

 

          

 

 

 

See notes to unaudited condensed consolidated financial statements.

 

7


Table of Contents

J.CREW GROUP, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the thirteen and thirty-nine weeks ended October 27, 2012 (Successor), and the periods March 8, 2011 to

October 29, 2011 (Successor), and January 30, 2011 to March 7, 2011 (Predecessor)

(Dollars in thousands, unless otherwise indicated)

1. Basis of Presentation

J.Crew Group, Inc. and its wholly owned subsidiaries (the “Company” or “Group”) was 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, co-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.

Although the Company continued as the same legal entity after the Acquisition, the accompanying unaudited condensed consolidated statements of operations and comprehensive income (loss), stockholders’ equity and cash flows are presented for two periods: Predecessor and Successor, which relate to the period before and after the Acquisition. The Acquisition and the allocation of the purchase price were recorded as of March 7, 2011.

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 January 28, 2012.

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 and the disclosure of loss contingencies 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. The Transactions

As discussed in note 1, the Acquisition was completed on March 7, 2011 and was financed with:

 

   

Senior Credit Facilities of $1,450 million consisting of: (i) a $250 million, 5-year asset-based revolving credit facility (the “ABL Facility”), which was undrawn at closing, and (ii) a $1,200 million, 7-year term loan credit facility (the “Term Loan”);

 

   

Senior unsecured 8.125% notes due 2019 (the “Notes”) of $400 million; and

 

   

Equity investments of approximately $1.2 billion from Parent funded by the Sponsors, co-investors and management.

The Acquisition occurred simultaneously with:

 

   

The closing of the financing transactions and equity investments described above; and

 

   

The termination of the Company’s previous $200 million asset-based revolving credit facility.

These transactions, the Acquisition and payment of any costs related to these transactions are collectively herein referred to as the “Transactions.”

 

8


Table of Contents

3. Purchase Accounting

The Acquisition was accounted for as a purchase business combination in accordance with ASC 805, Business Combinations, whereby the purchase price paid to effect the Acquisition was allocated to recognize the acquired assets and liabilities at fair value. The sources and uses of funds in connection with the Transactions are summarized below:

 

Sources:

  

Proceeds from Term Loan

   $ 1,200,000   

Proceeds from Notes

     400,000   

Proceeds from equity contributions

     1,225,911   

Cash on hand

     307,150   
  

 

 

 

Total sources

   $ 3,133,061   
  

 

 

 

Uses:

  

Equity purchase price

   $ 2,981,415   

Transaction costs

     151,646   
  

 

 

 

Total uses

   $ 3,133,061   
  

 

 

 

In connection with the purchase price allocation, fair values of long-lived and intangible assets were determined based upon assumptions related to the future cash flows, discount rates and asset lives utilizing currently available information, and in some cases, valuation results from independent valuation specialists. The purchase price was allocated as follows:

 

Purchase price

   $ 2,981,415   

Less: net assets acquired

     (571,644

Less: after-tax cost of post-combination share-based awards

     (21,425
  

 

 

 

Excess of purchase price over book value of net assets acquired

   $ 2,388,346   
  

 

 

 

Write up of tangible assets:

  

Property and equipment

   $ 35,334   

Merchandise inventories

     32,500   

Fair market value of favorable leases

     61,010   

Acquisition-related intangible assets:

  

J.Crew brand name (indefinite lived)

     885,300   

Madewell brand name (20 year life)

     82,000   

Loyalty program and customer lists (5 year life)

     27,010   

Less: historical intangible assets

     (4,351
  

 

 

 

Acquisition-related intangibles

     989,959   
  

 

 

 

Write down/(up) of liabilities:

  

Gift card liability revaluation

     7,737   

Deferred rent and lease incentive revaluation

     66,880   

Fair market value of unfavorable leases

     (40,920

Deferred income taxes:

  

Long-term deferred tax asset

     (20,171

Short-term deferred tax liability

     (5,678

Long-term deferred tax liability

     (425,220

Residual goodwill(1)

     1,686,915   
  

 

 

 

Total allocated excess purchase price

   $ 2,388,346   
  

 

 

 

 

(1) Residual goodwill consists primarily of intangible assets related to the knowhow, design and merchandising of the Company’s brands that do not qualify for separate recognition in accordance with ASC 805.

 

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Pro forma financial information

The following unaudited pro forma results of operations gives effect to the Transactions as if they had occurred on the first day of fiscal 2011 (January 30, 2011). The pro forma results of operations reflects adjustments (i) to record amortization and depreciation resulting from purchase accounting, (ii) to record Sponsor monitoring fees, and (iii) to eliminate non-recurring charges that were incurred in connection with the Transactions, including acquisition-related share-based compensation, transaction costs, transaction-related litigation costs and recoveries and amortization of the step-up in the carrying value of inventories. This unaudited pro forma financial information should not be relied upon as necessarily being indicative of the historical results that would have been obtained if the Transactions had actually occurred on that date, nor the results of operations in the future.

 

(Dollars in thousands)

   For the Period
January 30, 2011 to
October 29, 2011
 
   As reported     Pro forma  

Total revenues

   $ 1,324,046      $ 1,324,046   
  

 

 

   

 

 

 

Net income (loss)

   $ (18,888   $ 46,464   
  

 

 

   

 

 

 

4. Transactions with Sponsors

In connection with the Transactions, the Company entered into a management services agreement with the Sponsors pursuant to which they received on the closing date an aggregate transaction fee of $35 million. In addition, pursuant to such agreement, and in exchange for on-going consulting and management advisory services, the Sponsors receive an aggregate annual monitoring fee prepaid quarterly equal to the greater of (i) 40 basis points of consolidated annual revenues or (ii) $8 million. The Sponsors also receive reimbursement for out-of-pocket expenses incurred in connection with services provided pursuant to the agreement. The Company recorded an expense of $6.8 million, in the first nine months of fiscal 2012, for monitoring fees and out-of-pocket expenses, included in selling, general and administrative expenses in the statements of operations and comprehensive income (loss).

5. Goodwill and Intangible Assets

The significant components of our intangible assets and goodwill are as follows:

 

     Loyalty Program
and Customer Lists
    Favorable Lease
Commitments
    Madewell
Brand Name
    J.Crew
Brand Name
     Goodwill  

Balance at January 28, 2012

   $ 21,780      $ 48,930      $ 78,242      $ 885,300       $ 1,686,915   

Amortization expense

     (1,426     (3,341     (1,025     —           —     
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Balance at April 28, 2012

   $ 20,354      $ 45,589      $ 77,217      $ 885,300       $ 1,686,915   

Amortization expense

     (1,426     (3,494     (1,025     —           —     
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Balance at July 28, 2012

   $ 18,928      $ 42,095      $ 76,192      $ 885,300       $ 1,686,915   

Amortization expense

     (1,426     (4,025     (1,025     —           —     
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Balance at October 27, 2012

   $ 17,502      $ 38,070      $ 75,167      $ 885,300       $ 1,686,915   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Total accumulated amortization at October 27, 2012

   $ (9,508   $ (22,940   $ (6,833     
  

 

 

   

 

 

   

 

 

      

6. Share-Based Compensation

Chinos Holdings, Inc. 2011 Equity Incentive Plan

During the first nine months of fiscal 2012, the Parent issued 4,218,000 options to certain members of management, including (i) 1,524,000 options with an exercise price of $1.00 that become exercisable over a period of up to seven years and (ii) 2,694,000 options with an exercise price of $1.00 that only become exercisable when certain owners of the Parent receive a specified level of cash proceeds, as defined in the equity incentive plan, from the sale of their initial investment. The options have terms of up to ten years.

The weighted average grant-date fair value of the time-based awards was $0.47 per share. For the first nine months of fiscal 2012, the Company recorded an expense of $3.2 million for the time-based awards. Expense associated with the options exercisable when certain owners of the Parent receive a specified level of cash proceeds will not be recognized until that event occurs.

 

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During the first nine months of fiscal 2012, the Parent issued 40,000 shares of restricted stock to a new member of the board of directors. The shares vest over two years and have a weighted average grant-date fair value of $2.17.

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

 

    For the Period
January 29, 2012 to
October 27, 2012
    For the Period
March 8, 2011 to
October 29, 2011
            For the Period
January 30, 2011 to

March 7, 2011
 
  (Successor)     (Successor)          (Predecessor)  

Share-based compensation

  $ 3,213      $ 47,015             $ 1,080   
 

 

 

   

 

 

          

 

 

 

A summary of shares available for grant as stock options or other share-based awards is as follows:

 

     Shares  

Available for grant at January 28, 2012

     26,572,908   

Granted

     (4,258,000

Forfeited and available for reissuance

     1,571,000   
  

 

 

 

Available for grant at October 27, 2012

     23,885,908   
  

 

 

 

7. Long-Term Debt and Credit Agreements

Long-term debt consisted of the following:

 

     October 27,
2012
    January 28,
2012
 

Term Loan

   $ 1,185,000      $ 1,194,000   

Notes

     400,000        400,000   

ABL Facility

     —          —     

Less current portion of Term Loan

     (15,000     (15,000
  

 

 

   

 

 

 

Long-term debt

   $ 1,570,000      $ 1,579,000   
  

 

 

   

 

 

 

On October 11, 2012, the Company entered into an amendment to the ABL Facility (the “First Amendment”) that extended the scheduled maturity date to October 11, 2017. The First Amendment reduces the pricing on loans, letters of credit and fees paid on the unutilized commitments. The First Amendment also modifies certain conditions regarding financial and negative covenants. Unamortized deferred financing costs of $5.0 million at the effective date of the First Amendment will be amortized over the new five-year term.

There were no short-term borrowings under the ABL Facility during the first nine months of fiscal 2012. Outstanding standby letters of credit were $9.2 million and excess availability, as defined, was $240.8 million at October 27, 2012. Additionally, the Company has an unsecured, demand letter of credit facility with HSBC which provides for the issuance of up to $35 million of documentary letters of credit on a no fee basis. Outstanding letters of credit under this facility were $14.3 million and availability was $20.7 million at October 27, 2012.

The significant components of interest expense are as follows:

 

    For the Thirty-nine
Weeks Ended
    For the Period  
  January 29, 2012 to
October 27, 2012
    March 8, 2011 to
October 29, 2011
            January 30, 2011 to
March 7, 2011
 
  (Successor)     (Successor)          (Predecessor)  

Term Loan

  $ 42,796      $ 37,488             $ —     

Notes

    24,375        21,458               —     

Amortization of deferred financing costs

    7,201        6,401               970   

Other, net of interest income

    488        1,241               196   
 

 

 

   

 

 

          

 

 

 

Interest expense, net

  $ 74,860      $ 66,588             $ 1,166   
 

 

 

   

 

 

          

 

 

 

 

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8. Derivative Financial Instruments

Interest Rate Caps

In April 2011, the Company entered into interest rate cap agreements for an aggregate notional amount of $600 million in order to hedge the variability of cash flows related to a portion of the Company’s floating rate indebtedness. These cap agreements, effective in March 2012, hedge a portion of contractual floating rate interest commitments through the expiration of the agreements in March 2013. Pursuant to the agreements, the Company has capped LIBOR at 3.5% with respect to the aggregate notional amount of $600 million. In the event LIBOR exceeds 3.5% the Company will pay interest at the capped rate. In the event LIBOR is less than 3.5%, the Company will pay interest at the prevailing LIBOR. In the first nine months of fiscal 2012 the Company paid interest under the Term Loan at the prevailing LIBOR.

Interest Rate Swaps

In April 2011, the Company entered into floating-to-fixed interest rate swap agreements for an initial aggregate notional amount of $600 million to limit exposure to interest rate increases related to a portion of the Company’s floating rate indebtedness once the Company’s interest rate cap agreements expire. These swap agreements, effective March 2013, hedge a portion of contractual floating rate interest commitments through the expiration of the agreements in March 2016. As a result of the agreements, the Company’s effective fixed interest rate on the notional amount of floating rate indebtedness will be 3.56% plus the then applicable margin.

Fair Value

As of the effective date, the Company designated the interest rate cap and 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 interest rate cap and interest rate swap agreements are highly correlated to the changes in interest rates to which the Company is exposed. Unrealized gains and losses on these instruments are designated as effective or ineffective. The effective portion of such gains or losses is recorded as a component of accumulated other comprehensive income or loss, while the ineffective portion of such gains or losses will be recorded as a component of interest expense. Future realized gains and losses in connection with each required interest payment will be reclassified from accumulated other comprehensive income or loss to interest expense.

The fair values of the interest rate cap and 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 amounts included in the condensed consolidated balance sheet is as follows:

 

     October 27,
2012
    January 28,
2012
 

Interest rate caps (included in other assets)

   $ —        $ 6   
  

 

 

   

 

 

 

Interest rate swaps (included in other liabilities)

   $ 33,125      $ 30,358   
  

 

 

   

 

 

 

Accumulated other comprehensive loss, net of tax (included in stockholders’ equity)

   $ (20,655   $ (18,963
  

 

 

   

 

 

 

9. 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.

Financial assets and liabilities

The fair value of the Company’s debt is estimated to be $1,608 million and $1,542 million at October 27, 2012 and January 28, 2012 based on quoted market prices of the debt (level 1 inputs).

 

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In April 2011, the Company entered into interest rate cap and swap agreements in order to hedge the variability of cash flows related to a portion of the Company’s floating rate indebtedness, which are measured in the financial statements at fair value on a recurring basis. See note 8 for more information regarding the fair value of these financial assets and liabilities.

The carrying amounts reported in the 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

Except for certain leasehold improvements, the Company does not have any non-financial assets or liabilities as of October 27, 2012 or January 28, 2012 that are measured in the financial statements at fair value.

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 (e.g. leasehold improvements). 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 Thirty-nine
Weeks Ended
    For the Period  
    January 29, 2012 to
October 27, 2012
    March 8, 2011 to
October 29, 2011
           January 30, 2011 to
March 7, 2011
 
    (Successor)     (Successor)            (Predecessor)  

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

  $ 160      $ 395           $ —     
 

 

 

   

 

 

        

 

 

 

Impairment charge

  $ 160      $ 395           $ —     
 

 

 

   

 

 

        

 

 

 

10. Income Taxes

Group files a consolidated federal income tax return, which includes all of its wholly owned subsidiaries. Each subsidiary files separate, or combined where required, state or local tax returns in required jurisdictions. Effective for the tax year ended January 2012, the Company filed as a member of the consolidated group of Parent.

Tax returns for periods ended January 2010 through January 2012 are subject to examination by the Internal Revenue Service. The tax returns for the periods ended January 2011 and March 7, 2011 are currently under examination. Various state and local jurisdiction tax authorities are in the process of examining income tax returns or hearing appeals for certain tax years ranging from 2008 to 2010. The results of these audits and appeals are not expected to have a significant effect on the results of operations or financial position.

The difference between the U.S. statutory income tax rate of 35% and the effective tax rate for the thirty-nine weeks ended October 27, 2012 (Successor) of 37.5% is driven by state and local income taxes, partially offset by a reduction in uncertain tax positions. The difference between the U.S. statutory income tax rate of 35% and the effective tax rate the period March 8, 2011 to October 29, 2011 (Successor) and January 30, 2011 to March 7, 2011 (Predecessor) of 23.8% and 10.0%, respectively, is primarily driven by (i) the tax deductibility of certain Transaction costs and (ii) state and local income taxes, net of federal benefit.

As of October 27, 2012, the Company has $4.8 million in liabilities associated with uncertain tax positions (including interest and penalties of $1.1 million) reflected in other liabilities. The amount, if recognized, that would affect the effective tax rate is $2.4 million. During the third quarter of fiscal 2012, the Company reduced its liability for uncertain tax positions by $2.2 million due to the expiration of statute of limitations. While the Company expects the amount of unrecognized tax benefits to change in the next twelve months, the change is not expected to have a significant effect on the estimated effective annual tax rate, the results of operations or financial position. However, the outcome of tax matters is uncertain and unforeseen results can occur.

11. 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 adverse effect on the Company’s financial position, results of operations or cash flows.

 

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12. Recent Accounting Pronouncements

Recently Adopted Accounting Pronouncements

In May 2011, a pronouncement was issued providing consistent definitions and disclosure requirements of fair value with respect to U.S. GAAP and International Financial Reporting Standards. The pronouncement changed certain fair value measurement principles and enhanced the disclosure requirements, particularly for Level 3 measurements. The changes were effective prospectively for interim and annual periods beginning after December 15, 2011. The Company adopted this pronouncement on January 29, 2012. The adoption of this guidance did not have a significant impact on the Company’s condensed consolidated financial statements.

In June 2011, a pronouncement was issued that amended the guidance relating to the presentation of comprehensive income and its components. The pronouncement eliminates the option to present the components of other comprehensive income as part of the statement of equity and requires an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The Company adopted this pronouncement on January 29, 2012. The adoption of this guidance required changes in presentation only and therefore did not have a significant impact on the Company’s condensed consolidated financial statements.

In September 2011, a pronouncement was issued that amended the guidance for goodwill impairment testing. The pronouncement allows the entity to perform an initial qualitative assessment to determine whether it is “more likely than not” that the fair value of the reporting unit is less than its carrying amount. This assessment is used as a basis for determining whether it is necessary to perform the two step goodwill impairment test. The methodology for how goodwill is calculated, assigned to reporting units, and the application of the two step goodwill impairment test have not been revised. The pronouncement is effective for fiscal years beginning after December 15, 2011. The Company adopted this pronouncement in the fourth quarter of fiscal 2011. The adoption did not have a significant impact on the Company’s condensed consolidated financial statements.

Recently Issued Accounting Pronouncements

In December 2011, a pronouncement was issued that amended the guidance related to the disclosure of recognized financial instruments and derivative instruments that are either offset on the balance sheet or subject to an enforceable master netting arrangement or similar agreement. The amended provisions are effective for fiscal years beginning on or after January 1, 2013, and are required to be applied retrospectively for all prior periods presented. As this pronouncement relates to disclosure only, the adoption of this amendment will not have a significant impact on the Company’s condensed consolidated financial statements.

13. Subsequent Event

Superstorm Sandy struck the East Coast on October 29, 2012, resulting in (i) personal property damage in three stores, one of which will remain closed indefinitely and (ii) temporary closures of 131 additional stores for periods of one to fourteen days.

 

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Forward-Looking Statements

This report contains “forward-looking statements,” which include information concerning our plans, objectives, goals, strategies, future events, future revenues or performance, capital expenditures, financing needs and other information that is not historical information, including statements regarding our estimated impact on revenues as a result of Superstorm Sandy. When used in this report, the words “estimate,” “expect,” “anticipate,” “project,” “plan,” “intend,” “believe” and variations of such words or similar expressions are intended to identify forward-looking statements. All forward-looking statements, including, without limitation, our examination of operating trends, are based upon our current expectations and various assumptions. We believe there is a reasonable basis for our expectations and beliefs, but there can be no assurance that we will realize our expectations or that our beliefs will prove correct.

There are a number of risks and uncertainties that could cause our actual results to differ materially from the forward-looking statements contained in this report. Important factors that could cause our actual results to differ include, but are not limited to, our substantial indebtedness and lease obligations, the strength of the global economy, declines in consumer spending or changes in seasonal consumer spending patterns, competitive market conditions, our ability to anticipate and timely respond to changes in trends and consumer preferences, our ability to successfully develop, launch and grow our newer concepts and execute on strategic initiatives, products offerings, sales channels and businesses, material disruption to our information systems, our ability to implement our real estate strategy, our ability to attract and retain key personnel, interruptions in our foreign sourcing operations, and other factors which are set forth in the section entitled “Risk Factors” and elsewhere in our Annual Report on Form 10-K for the fiscal year ended January 28, 2012 filed with the SEC. There may be other factors of which we are currently unaware or deem immaterial that may cause our actual results to differ materially from the forward-looking statements.

All forward-looking statements attributable to us or persons acting on our behalf apply only as of the date they are made and are expressly qualified in their entirety by the cautionary statements included in this report. Except as may be required by law, we undertake no obligation to publicly update or revise any forward-looking statement to reflect events or circumstances occurring after the date they were made or to reflect the occurrence of unanticipated events.

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This document should be read in conjunction with the Management’s Discussion and Analysis section of our Annual Report on Form 10-K for the fiscal year ended January 28, 2012 filed with the SEC. When used herein, the terms “J.Crew,” “Group,” “Company,” “we,” “us” and “our” refer to J.Crew Group, Inc., including its wholly-owned consolidated subsidiaries.

Executive Overview

J.Crew is a nationally recognized apparel and accessories retailer that differentiates itself through high standards of quality, style, design and fabrics with consistent fits and authentic details. We are an integrated multi-channel, multi-brand specialty retailer that operates stores and websites to consistently communicate with our customers. We design, market and sell our products, including those under the J.Crew®, crewcuts® and Madewell® brands, offering complete assortments of women’s, men’s and children’s apparel and accessories. We believe our customer base consists primarily of affluent, college-educated, professional and fashion-conscious women and men.

We conduct our business through two primary sales channels: (1) Stores, which consists of our retail, factory and Madewell stores, and (2) Direct, which consists of our websites and catalogs. As of October 27, 2012, we operated 290 retail stores (including eight crewcuts and 43 Madewell stores), 102 factory stores (including four crewcuts factory stores), and three clearance stores, throughout the United States and Canada; compared to 266 retail stores (including 10 crewcuts and 31 Madewell stores), 94 factory stores (including three crewcuts factory stores), and three clearance stores as of October 29, 2011.

On March 7, 2011, the Company was acquired by Chinos Holdings, Inc., a company formed by investment funds affiliated with TPG and LGP (the “Acquistion”). Although the Company continued as the same legal entity after the Acquisition, we have prepared separate discussion and analysis of our consolidated operating results, financial condition and liquidity for: (i) the thirteen and thirty-nine weeks ended October 27, 2012 (Successor), (ii) the period March 8, 2011 to October 29, 2011 (Successor), and (iii) the period January 30, 2011 to March 7, 2011 (Predecessor). Additionally, we have prepared supplemental discussion and analysis of the combined periods last year before and after the Acquisition, on a pro forma basis, which we refer to as “pro forma first nine months of fiscal 2011.” The pro forma results give effect to the Acquisition as if it occurred on the first day of the fiscal year. We compare the first nine months of fiscal 2012 to the pro forma first nine months of fiscal 2011.

In connection with the Acquisition, the Company incurred significant indebtedness and became more leveraged. The purchase price paid in connection with the Acquisition has been allocated to recognize the acquired assets and liabilities at fair value. Purchase accounting adjustments have been recorded to: (i) increase the carrying value of our property and equipment, and inventory, (ii) establish intangible assets for our trade names, loyalty program, customer lists and favorable lease commitments, and (iii) revalue gift card and lease-related liabilities. Subsequent to the Acquisition, interest expense and non-cash depreciation and amortization charges have significantly increased. As a result, our Successor financial statements are not comparable to our Predecessor financial statements.

The following is a summary of our revenues for the third quarter of fiscal 2012 compared to third quarter of fiscal 2011:

 

(Dollars in millions)

   Thirteen
Weeks Ended
October 27, 2012
     Thirteen
Weeks Ended
October 29, 2011
 

Stores

   $ 391.7       $ 334.5   

Direct

     156.8         138.5   
  

 

 

    

 

 

 

Net sales

     548.5         473.0   

Other, primarily shipping and handling fees

     7.3         6.6   
  

 

 

    

 

 

 

Total revenues

   $ 555.8       $ 479.6   
  

 

 

    

 

 

 

Highlights of third quarter of fiscal 2012 versus third quarter of fiscal 2011:

 

   

Revenues increased 15.9% to $555.8 million.

 

   

Comparable company sales increased 10.4%.

 

   

Direct net sales increased 13.2% to $156.8 million.

 

   

Income from operations increased $16.6 million to $74.5 million.

 

   

We opened seven J.Crew retail stores, five J.Crew factory stores, and four Madewell stores.

 

   

We launched a new website dedicated to our J.Crew factory direct business.

 

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The following is a summary of our revenues for the first nine months of fiscal 2012 compared to first nine months of fiscal 2011:

 

(Dollars in millions)

   Thirty-nine
Weeks Ended
October 27, 2012
     Thirty-nine
Weeks Ended
October 29, 2011
 

Stores

   $ 1,129.8       $ 926.7   

Direct

     434.1         374.8   
  

 

 

    

 

 

 

Net sales

     1,563.9         1,301.5   

Other, primarily shipping and handling fees

     20.9         22.5   
  

 

 

    

 

 

 

Total revenues

   $ 1,584.8       $ 1,324.0   
  

 

 

    

 

 

 

Highlights of first nine months of fiscal 2012 versus pro forma first nine months of fiscal 2011:

 

   

Revenues increased 19.7% to $1,584.8 million.

 

   

Comparable company sales increased 13.2%.

 

   

Direct net sales increased 15.8% to $434.1 million.

 

   

Income from operations increased $166.0 million to $212.2 million.

 

   

We opened 14 J.Crew retail stores, six J.Crew factory stores, and 12 Madewell stores. We closed one crewcuts store and one Madewell store.

 

   

We launched a new website dedicated to our J.Crew factory direct business.

Subsequent Event

Superstorm Sandy struck the East Coast on October 29, 2012, resulting in (i) personal property damage in three of our stores, one of which will remain closed indefinitely and (ii) temporary closures of 131 additional stores for periods of one to fourteen days. We believe the impact on revenues will not be material to the results of the fourth quarter.

How We Assess the Performance of Our Business

In assessing the performance of our business, we consider a variety of performance and financial measures. A key measure used in our evaluation is comparable company sales, which includes (i) net sales from stores that have been open for at least twelve months, (ii) direct net sales, and (iii) shipping and handling fees.

A complete description of the measures we use to assess the performance of our business appears in the Management’s Discussion and Analysis section of our Annual Report on Form 10-K for the fiscal year ended January 28, 2012 filed with the SEC.

Results of Operations – Third Quarter of Fiscal 2012 compared to Third Quarter of Fiscal 2011

 

     Thirteen Weeks Ended
October 27, 2012
    Thirteen Weeks Ended
October 29, 2011
    Variance
Increase / (Decrease)
 

(Dollars in millions)

   Amount      Percent of
Revenues
    Amount      Percent of
Revenues
    Dollars     Percentage  

Revenues

   $ 555.8         100.0   $ 479.6         100.0   $ 76.2        15.9

Gross profit

     263.1         47.3        201.8         42.1        61.3        30.4   

Selling, general and administrative expenses

     188.6         33.9        143.9         30.0        44.7        31.1   

Income from operations

     74.5         13.4        57.9         12.1        16.6        28.7   

Interest expense, net

     24.1         4.3        25.3         5.3        (1.2     (5.0

Provision for income taxes

     17.2         3.1        10.9         2.3        6.3        57.5   

Net income

   $ 33.2         6.0   $ 21.6         4.5   $ 11.6        53.6

Revenues

Revenues increased $76.2 million, or 15.9%, to $555.8 million in the third quarter of fiscal 2012 from $479.6 million in the third quarter last year, driven primarily by an increase in sales of women’s apparel, specifically sweaters, knits, and pants. Comparable company sales increased 10.4% in the third quarter of fiscal 2012. Comparable company sales increased 5.4% in the third quarter of fiscal 2011.

 

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Stores sales increased $57.2 million, or 17.1%, to $391.7 million in the third quarter of fiscal 2012 from $334.5 million in the third quarter last year. Stores sales increased 10.3% in the third quarter of fiscal 2011. Sales from stores that have been open for less than twelve months were $43.1 million in the third quarter of fiscal 2012.

Direct sales increased $18.2 million, or 13.2%, to $156.8 million in the third quarter of fiscal 2012 from $138.5 million in the third quarter last year. Direct sales increased $20.6 million, or 17.5%, in the third quarter of fiscal 2011.

The approximate percentage of our sales by product category, based on our internal merchandising system, is as follows:

 

     Thirteen
Weeks Ended
October 27, 2012
    Thirteen
Weeks Ended
October 29, 2011
 

Apparel:

    

Women’s

     58     60

Men’s

     22        21   

Children’s

     7        7   

Accessories

     13        12   
  

 

 

   

 

 

 
     100     100
  

 

 

   

 

 

 

Other revenues increased $0.8 million to $7.3 million in the third quarter of fiscal 2012 from $6.6 million in the third quarter last year.

Gross Profit

Gross profit increased $61.3 million to $263.1 million in the third quarter of fiscal 2012 from $201.8 million in the third quarter last year. This increase resulted from the following factors:

 

     Increase/(decrease)  

(Dollars in millions)

   Before Purchase
Accounting
Impact
    Last Year
Purchase
Accounting
Impact(1)
     As Reported  

Increase in revenues

   $ 41.3      $ —         $ 41.3   

Increase in merchandise margin

     17.3        5.8         23.1   

Increase in buying and occupancy costs

     (3.1     —           (3.1
  

 

 

   

 

 

    

 

 

 

Increase in gross profit

   $ 55.5      $ 5.8       $ 61.3   
  

 

 

   

 

 

    

 

 

 

 

(1) Reflects non-cash charges related to step-up in carrying value of acquired inventories.

Gross margin increased to 47.3% in the third quarter of fiscal 2012 from 42.1% in the third quarter last year. The increase in gross margin was driven by: (i) a 300 basis point expansion in merchandise margin due to decreased markdowns, (ii) a 110 basis point increase from the purchase accounting adjustment described in the table above, and (iii) a 110 basis point decrease in buying and occupancy costs as a percentage of revenues.

 

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Table of Contents

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased $44.7 million to $188.6 million in the third quarter of fiscal 2012 from $143.9 million in the third quarter last year. This increase primarily resulted from the following:

 

     Increase/(decrease)  

(Dollars in millions)

   Before
Transaction Impact
     Last Year
Transaction
Impact
     As Reported  

Increase in operating expenses, primarily stores and payroll

   $ 19.8       $ —         $ 19.8   

Increase in share-based and incentive compensation

     8.3         —           8.3   

Increase in advertising and catalog costs

     5.2         —           5.2   

Increase in depreciation

     2.5         —           2.5   

Prior year transaction-related litigation recoveries

     —           3.6         3.6   

Other, net

     5.3         —           5.3   
  

 

 

    

 

 

    

 

 

 

Increase in selling, general and administrative expenses

   $ 41.1       $ 3.6       $ 44.7   
  

 

 

    

 

 

    

 

 

 

As a percentage of revenues, selling, general and administrative expenses increased to 33.9% in the third quarter of fiscal 2012 from 30.0% in the third quarter last year. As a percentage of revenues, selling, general and administrative expenses, without the impact of Transaction-related litigation recoveries, increased to 33.9% in the third quarter of fiscal 2012 from 30.8% in the third quarter last year.

Interest Expense, Net

Interest expense, net of interest income, decreased $1.2 million to $24.1 million in the third quarter of fiscal 2012 from $25.3 million in the third quarter last year. A summary of interest expense is as follows:

 

(Dollars in millions)

   Third Quarter
Fiscal 2012
    Third Quarter
Fiscal 2011
 

Term Loan

   $ 14.2      $ 14.3   

Notes

     8.1        8.1   

Amortization of deferred financing costs

     2.4        2.4   

Other, net of interest income

     (0.6     0.5   
  

 

 

   

 

 

 

Interest expense, net

   $ 24.1      $ 25.3   
  

 

 

   

 

 

 

Provision for Income Taxes

The effective tax rate for the third quarter of fiscal 2012 was 34.2%. The difference between the statutory rate of 35% and the effective rate was driven primarily by state and local income taxes, offset by a reduction in uncertain tax positions due to the expiration of statute of limitations.

Net Income

Net income increased $11.6 million to $33.2 million in the third quarter of fiscal 2012 compared to $21.6 million in the third quarter last year. This increase was due to: (i) an increase in gross profit of $61.3 million and (ii) a decrease in interest expense of $1.2 million, offset by (iii) an increase in selling, general and administrative expenses of $44.7 million and (iv) an increase in the provision for income taxes of $6.3 million.

 

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Table of Contents

Results of Operations – First Nine Months of Fiscal 2012 (Successor)

 

     Thirty-nine Weeks Ended
October 27, 2012
 

(Dollars in millions)

   Amount      Percent of
Revenues
 

Revenues

   $ 1,584.8         100.0

Gross profit

     739.6         46.7   

Selling, general and administrative expenses

     527.4         33.3   

Income from operations

     212.2         13.4   

Interest expense, net

     74.9         4.7   

Provision for income taxes

     51.5         3.2   

Net income

   $ 85.9         5.4

Revenues

Revenues were $1,584.8 million for the first nine months of fiscal 2012. Revenues consisted of (i) Stores sales of $1,129.8 million, or 71.3% of revenues, (ii) Direct sales of $434.1 million, or 27.4% of revenues, and (iii) other revenues (primarily shipping and handling fees) of $20.9 million, or 1.3% of revenues. Revenues reflect higher than planned Stores sales.

Gross Profit

Gross profit was $739.6 million, or 46.7% of revenues, for the first nine months of fiscal 2012. Gross profit was impacted by lower than planned markdowns.

Selling, General and Administrative Expenses

Selling, general and administrative expenses were $527.4 million, or 33.3% of revenues, for the first nine months of fiscal 2012.

Interest Expense, Net

Interest expense, net of interest income, was $74.9 million for the first nine months of fiscal 2012. Interest expense reflects debt service on borrowings resulting from the Acquisition.

Provision for Income Taxes

The effective tax rate of 37.5% for the first nine months of fiscal 2012 reflects our expected annual effective tax rate. The difference between the statutory rate of 35% and the effective rate was driven primarily by state and local income taxes, net of federal benefit.

Net Income

Net income was $85.9 million for the first nine months of fiscal 2012 driven primarily by gross profit of $739.6 million offset by selling, general and administrative expenses of $527.4 million, interest expense of $74.9 million, and income tax expense of $51.5 million.

Results of Operations – For the Period March 8, 2011 to October 29, 2011 (Successor)

 

     For the Period
March 8, 2011 to
October 29, 2011
 

(Dollars in millions)

   Amount     Percent of
Revenues
 

Revenues

   $ 1,190.8        100.0

Gross profit

     478.7        40.2   

Selling, general and administrative expenses

     415.7        34.9   

Income from operations

     63.0        5.3   

Interest expense, net

     66.6        5.6   

Benefit for income taxes

     (0.9     (0.1

Net loss

   $ (2.7     (0.2 )% 

 

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Table of Contents

Revenues

Revenues were $1,190.8 million for the period March 8, 2011 to October 29, 2011. Revenues consisted of (i) Stores sales of $840.2 million, or 70.6% of revenues, (ii) Direct sales of $331.2 million, or 27.8% of revenues, and (iii) other revenues (primarily shipping and handling fees) of $19.4 million, or 1.6% of revenues. Revenues reflect lower than planned Stores sales.

Gross Profit

Gross profit was $478.7 million, or 40.2% of revenues, for the period March 8, 2011 to October 29, 2011. Gross profit was impacted by higher than planned markdowns, and includes the impact of purchase accounting of $33.4 million.

Selling, General and Administrative Expenses

Selling, general and administrative expenses were $415.7 million, or 34.9% of revenues, for the period March 8, 2011 to October 29, 2011, and include the impact of purchase accounting and transaction costs of $67.2 million.

Interest Expense, Net

Interest expense, net of interest income, was $66.6 million for the period March 8, 2011 to October 29, 2011. Interest expense reflects debt service on borrowings resulting from the Acquisition.

Provision for Income Taxes

The effective tax rate was 23.8% for the period March 8, 2011 to October 29, 2011. The difference between the statutory rate of 35% and the effective rate was driven primarily by non-deductible transaction costs and state and local income taxes, net of federal benefit.

Net Loss

Net loss was $2.7 million for the period March 8, 2011 to October 29, 2011 driven primarily by selling, general and administrative expenses of $415.7 million (including the impact of purchase accounting and transaction costs of $67.2 million) and interest expense of $66.6 million, offset by gross profit of $478.7 million.

Results of Operations – For the Period January 30, 2011 to March 7, 2011 (Predecessor)

 

     For the Period
January 30, 2011 to
March 7, 2011
 

(Dollars in millions)

   Amount     Percent of
Revenues
 

Revenues

   $ 133.2        100.0

Gross profit

     62.9        47.2   

Selling, general and administrative expenses

     79.7        59.8   

Income from operations

     (16.8     (12.6

Interest expense, net

     1.2        0.9   

Provision for income taxes

     (1.8     (1.3

Net income

   $ (16.1     (12.1 )% 

Revenues

Revenues were $133.2 million for the period January 30, 2011 to March 7, 2011. Revenues consisted of (i) Stores sales of $86.5 million, or 64.9% of revenues, (ii) Direct sales of $43.6 million, or 32.8% of revenues, and (iii) other revenues (primarily shipping and handling fees) of $3.1 million, or 2.3% of revenues. Revenues reflect lower than planned Stores sales and shipping and handling fees.

 

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Table of Contents

Gross Profit

Gross profit was $62.9 million, or 47.2% of revenues, for the period January 30, 2011 to March 7, 2011. Gross profit was impacted by higher than planned markdowns.

Selling, General and Administrative Expenses

Selling, general and administrative expenses were $79.7 million, or 59.8% of revenues, for the period January 30, 2011 to March 7, 2011, and include transaction costs of $32.2 million.

Interest Expense, Net

Interest expense, net of interest income, was $1.2 million for the period January 30, 2011 to March 7, 2011. Interest expense reflects primarily the write off of the remaining unamortized deferred financing costs associated with the credit facility terminated in connection with the Acquisition.

Provision for Income Taxes

The effective tax rate was 10% for the period January 30, 2011 to March 7, 2011. The difference between the statutory rate of 35% and the effective rate was driven primarily by non-deductible transaction costs.

Net Loss

Net loss was $16.1 million for the period January 30, 2011 to March 7, 2011 driven primarily by selling, general and administrative expenses of $79.7 million (including transaction costs of $32.2 million), offset by gross profit of $62.9 million.

Supplemental MD&A – Results of Operations – First Nine Months Fiscal 2012 compared to Pro forma First Nine Months Fiscal 2011

 

(Dollars in millions)

  For the Period
March 8, 2011 to
October 29, 2011
            For the Period
January 30, 2011 to
March 7, 2011
    Adjustments     Pro forma
First Nine Months
Fiscal 2011
 
    (Successor)          (Predecessor)              

Revenues

  $ 1,190.8             $ 133.2      $ —        $ 1,324.0   

Gross profit

    478.7               63.0        29.3 (a)      571.0   

Selling, general and administrative expenses

    415.7               79.7        (77.0 )(a)      418.4   

Income (loss) from operations

    63.0               (16.8     106.3        152.6   

Interest expense, net

    66.6               1.2        8.6 (b)      76.4   

Provision (benefit) for income taxes

    (0.9            (1.8     32.4 (c)      29.7   

Net income (loss)

  $ (2.7          $ (16.1   $ 65.3      $ 46.5   

Notes:

(a) To give effect to the following adjustments:

 

(Dollars in millions)    Adjustments  

Amortization expense(1)

   $ 0.8   

Depreciation expense(2)

     0.9   

Sponsor monitoring fees(3)

     0.7   

Amortization of lease commitments, net(4)

     1.9   

Elimination of non-recurring charges(5)

     (110.6
  

 

 

 

Total pro forma adjustment

   $ (106.3
  

 

 

 

Pro forma adjustment:

  

Recorded in cost of goods sold

   $ (29.3

Recorded in selling, general and administrative expenses

     (77.0
  

 

 

 

Total

   $ (106.3
  

 

 

 

 

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Table of Contents
(1) To record five weeks of additional amortization expense of intangible assets for our Madewell brand name, loyalty program and customer lists amortized on a straight-line basis over their respective useful lives.
(2) To record five weeks of additional depreciation expense of the step-up of property and equipment allocated on a straight-line basis over a weighted average remaining useful life of 8.2 years.
(3) To record five weeks of additional expense (calculated as the greater of 40 basis points of consolidated annual revenues or $8 million) to be paid to the Sponsors in accordance with a management services agreement.
(4) To record five weeks of additional amortization expense of favorable and unfavorable lease commitments amortized on a straight-line basis over the remaining lease life, offset by the elimination of the amortization of historical deferred rent credits.
(5) To eliminate non-recurring charges that were incurred in connection with the Transactions, including acquisition-related share based compensation, transaction costs, transaction-related litigation costs and recoveries, and amortization of the step-up in the carrying value of inventory.

 

(b) To give effect to the following adjustments:

 

(Dollars in millions)    Adjustments  

Pro forma cash interest expense(1)

   $ 69.2   

Pro forma amortization of deferred financing costs(1)

     7.2   

Less historical interest expense, net

     (67.8
  

 

 

 

Total pro forma adjustment to interest expense, net

   $ 8.6   
  

 

 

 

 

(1) To record thirty-nine weeks of interest expense associated with borrowings under the Term Loan Facility and the Notes, and the amortization of deferred financing costs. Pro forma cash interest expense reflects a weighted-average interest rate of 5.6%. If LIBOR increases above 1.25%, a 0.125% increase would increase annual interest expense under the Term Loan Facility by $1.5 million.
(c) To reflect our expected annual effective tax rate of approximately 39%.

 

     First Nine Months
Fiscal 2012
    Pro Forma
First Nine Months
Fiscal 2011
    Variance
Increase / (Decrease)
 

(Dollars in millions)

   Amount      Percent of
Revenues
    Amount      Percent of
Revenues
    Dollars     Percentage  

Revenues

   $ 1,584.8         100.0   $ 1,324.0         100.0   $ 260.8        19.7

Gross profit

     739.6         46.7        571.0         43.1        168.6        29.5   

Selling, general and administrative expenses

     527.4         33.3        418.4         31.6        109.0        26.0   

Income from operations

     212.2         13.4        152.6         11.5        59.6        39.1   

Interest expense, net

     74.9         4.7        76.4         5.8        (1.5     (2.0

Provision for income taxes

     51.5         3.2        29.7         2.2        21.8        73.4   

Net income

   $ 85.9         5.4   $ 46.5         3.5   $ 39.4        84.8

Revenues

Revenues increased $260.8 million, or 19.7%, to $1,584.8 million in the first nine months of fiscal 2012 from $1,324.0 million in the pro forma first nine months last year, driven primarily by an increase in sales of women’s apparel, specifically sweaters, knits, and pants. Comparable company sales increased 13.2% in the first nine months of fiscal 2012. Comparable company sales increased 2.0% in the first nine months of fiscal 2011.

Stores sales increased $203.1 million, or 21.9%, to $1,129.8 million in the first nine months of fiscal 2012 from $926.7 million in the pro forma first nine months last year. Stores sales increased $38.5 million, or 4.3%, in the first nine months of fiscal 2011. Sales from stores that have been open for less than twelve months were $121.7 million in the first nine months of fiscal 2012.

Direct sales increased $59.3 million, or 15.8%, to $434.1 million in the first nine months of fiscal 2012 from $374.8 million in the pro forma first nine months last year. Direct sales increased $40.0 million, or 12.0%, in the first nine months of fiscal 2011.

 

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Table of Contents

The approximate percentage of our sales by product category, based on our internal merchandising system, is as follows:

 

     First Nine Months
Fiscal 2012
    Pro Forma
First Nine Months
Fiscal 2011
 

Apparel:

    

Women’s

     59     61

Men’s

     22        22   

Children’s

     6        6   

Accessories

     13        11   
  

 

 

   

 

 

 
     100     100
  

 

 

   

 

 

 

Other revenues, which consist primarily of shipping and handling fees, decreased $1.6 million, or 7.1%, to $20.9 million in the first nine months of fiscal 2012 from $22.5 million in the pro forma first nine months last year. This decrease resulted primarily from shipping and handling promotions, partially offset by the impact of shipping and handling income from increased Direct sales.

Gross Profit

Gross profit increased $168.6 million to $739.6 million in the first nine months of fiscal 2012 from $571.0 million in the pro forma first nine months last year. This increase resulted from the following factors:

 

(Dollars in millions)

   Increase
(decrease)
 

Increase in revenues

   $ 145.7   

Increase in merchandise margin

     36.6   

Increase in buying and occupancy costs

     (13.7
  

 

 

 

Increase in gross profit

   $ 168.6   
  

 

 

 

Gross margin increased to 46.7% in the first nine months of fiscal 2012 from 43.1% in the pro forma first nine months last year. The increase in gross margin was driven by: (i) a 230 basis point expansion in merchandise margin due to decreased markdowns and (ii) a 130 basis point decrease in buying and occupancy costs as a percentage of revenues.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased $109.0 million, or 26.0%, to $527.4 million in the first nine months of fiscal 2012 from $418.4 million in the pro forma first nine months last year. This increase primarily resulted from the following:

 

(Dollars in millions)

   Increase  

Increase in operating expenses, primarily stores and payroll

   $ 53.0   

Increase in share-based and incentive compensation

     25.0   

Increase in advertising and catalog costs

     15.1   

Increase in depreciation

     5.7   

Other, net

     10.2   
  

 

 

 

Increase in selling, general and administrative expenses

   $ 109.0   
  

 

 

 

As a percentage of revenues, selling, general and administrative expenses increased to 33.3% in the first nine months of fiscal 2012 from 31.6% in the pro forma first nine months last year.

Interest Expense, Net

Interest expense, net of interest income, decreased $1.5 million to $74.9 million in the first nine months of fiscal 2012 from $76.4 million in the pro forma first nine months last year. A summary of interest expense is as follows.

 

(Dollars in millions)

   First Nine
Months

Fiscal  2012
     Pro Forma
First Nine  Months
Fiscal 2011
 

Term Loan

   $ 42.8       $ 43.1   

Notes

     24.4         24.4   

Amortization of deferred financing costs

     7.2         7.2   

Other, net of interest income

     0.5         1.7   
  

 

 

    

 

 

 

Interest expense, net

   $ 74.9       $ 76.4   
  

 

 

    

 

 

 

 

24


Table of Contents

Income Taxes

The effective tax rate for the first nine months of fiscal 2012 was 37.5%. The difference between the statutory rate of 35% and the effective rate was driven primarily by state and local income taxes, partially offset by a reduction in uncertain tax positions due to the expiration of statute of limitations.

Net Income

Net income increased $39.4 million to $85.9 million in the first nine months of fiscal 2012 compared to $46.5 million in the pro forma first nine months last year. This increase was due to: (i) an increase in gross profit of $168.6 million and (ii) a decrease in interest expense of $1.5 million, offset by (iii) an increase in selling, general and administrative expenses of $109.0 million and (iv) an increase in the provision for income taxes of $21.8 million.

Liquidity and Capital Resources

Our primary sources of liquidity are our current balances of cash and cash equivalents, cash flows from operations and borrowings available under the ABL Facility. Our primary cash needs are capital expenditures in connection with opening new stores and remodeling our existing stores, investments in our distribution network, making information technology system enhancements, meeting debt service requirements and funding working capital requirements. The most significant components of our working capital are cash and cash equivalents, merchandise inventories, accounts payable and other current liabilities. See “—Outlook” below.

Operating Activities

 

(Dollars in millions)

  For the  Thirty-nine
Weeks ended
October 27, 2012
    For the  Period
March 8, 2011 to
October 29, 2011
            For the Period
January 30, 2011 to
March 7, 2011
 
    (Successor)     (Successor)          (Predecessor)  

Net income (loss)

  $ 85.9      $ (2.7          $ (16.1

Adjustments to reconcile to cash flows from operating activities:

            

Depreciation of property and equipment

    52.4        41.8               3.9   

Share-based compensation

    3.2        47.0               1.1   

Non-cash charge related to step-up in carrying value of inventory

    —          30.8               —     

Amortization of favorable lease commitments

    10.9        8.7               —     

Amortization of intangible assets

    7.3        6.5               —     

Amortization of deferred financing costs

    7.2        6.4               1.0   

Excess tax benefit from share-based awards

    —          —                 (74.5

Changes in operating assets and liabilities

    (73.3     (1.5            (16.5
 

 

 

   

 

 

          

 

 

 

Net cash provided by (used in) operating activities

  $ 93.6      $ 137.0             $ (101.1
 

 

 

   

 

 

          

 

 

 

Cash provided by operating activities of $93.6 million in the first nine months of fiscal 2012 (Successor) was driven by: (i) net income of $85.9 million, (ii) non-cash expenses of $81.0 million, offset by (iii) changes in operating assets and liabilities of $73.3 million due to seasonal working capital fluctuations and an increase in accrued incentive compensation.

Cash provided by operating activities of $137.0 million in the period March 8, 2011 to October 29, 2011 (Successor) was driven by: (i) non-cash expenses of $141.2 million offset by (ii) changes in operating assets and liabilities of $1.5 million and (iii) net loss of $2.7 million.

Cash used in operating activities of $101.1 million in the period January 30, 2011 to March 7, 2011 (Predecessor) resulted from: (i) net loss of $16.1 million, (ii) changes in operating assets and liabilities of $91.0 million (including the impact of excess tax benefits from share-based compensation plans) due primarily to an increase in refundable income taxes resulting from the Acquisition and seasonal working capital fluctuations, offset by (iii) non-cash expenses of $6.0 million.

 

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Table of Contents

Investing Activities

 

    For the Thirty-nine
Weeks ended

October 27, 2012
    For the Period
March 8, 2011 to
October 29,  2011
            For the Period
January 30, 2011 to
March 7, 2011
 
  (Successor)     (Successor)          (Predecessor)  

Capital expenditures:

            

New stores

  $ 43.1      $ 25.5             $ 0.6   

Information technology

    29.0        10.6               1.1   

Other(1)

    37.5        33.3               0.9   
 

 

 

   

 

 

          

 

 

 

Net cash used in investing activities

  $ 109.6      $ 69.4             $ 2.6   
 

 

 

   

 

 

          

 

 

 

 

(1) Includes capital expenditures for warehouse and corporate office expansion, store renovations and general corporate purposes.

Capital expenditures are planned at approximately $135 million for fiscal year 2012, including $55 million for new stores, $40 million for information technology enhancements, $25 million for warehouse and corporate office expansion, and the remainder for store renovations and general corporate purposes.

Financing Activities

 

    For the Thirty-nine
Weeks ended

October 27, 2012
    For the Period
March 8, 2011 to
October 29,  2011
            For the Period
January 30, 2011 to
March 7, 2011
 
  (Successor)     (Successor)          (Predecessor)  

Proceeds from debt

  $ —        $ 1,600.0             $ —     

Proceeds from equity contributions

    —          1,173.7               —     

Excess tax benefit from share-based awards

    —          —                 74.5   

Payment of debt issuance costs

    —          (67.5            —     

Proceeds from share-based compensation plans

    —          —                 1.1   

Repayment of debt

    (9.0     (3.0            —     

Costs incurred in refinancing debt

    (0.7     —                 —     

Contribution to Parent

    (0.5     —                 —     
 

 

 

   

 

 

          

 

 

 

Net cash provided by (used in) financing activities

  $ (10.2   $ 2,703.2             $ 75.6   
 

 

 

   

 

 

          

 

 

 

Cash used in financing activities was $10.2 million in the first nine months of fiscal 2012 resulting primarily from quarterly principal repayments of debt under the Term Loan.

Cash provided by financing activities was $2,703.2 million from March 8, 2011 to October 29, 2011 resulting from the proceeds from debt and equity contributions in connection with the Acquisition, offset primarily by the payment of debt issuance costs.

Cash provided by financing activities was $75.6 million from January 30, 2011 to March 7, 2011 resulting primarily from the tax benefits from share-based compensation plans.

ABL Facility

On October 11, 2012, the Company entered into an amendment to the ABL Facility (the “First Amendment”), with Bank of America, N.A., as administrative agent and the other agents and lenders party thereto, that modifies the $250 million senior-secured financing (which may be increased by up to $75 million in certain circumstances), subject to a borrowing base limitation. The borrowing base will equal the sum of: 90% of the eligible credit card receivables; plus, 85% of eligible accounts; plus, 90% (or 92.5% for the period of August 1 through December 31 of any fiscal year) of the net recovery percentage of eligible inventory multiplied by the cost of eligible inventory; plus, 85% of the net recovery percentage of eligible letters of credit inventory, multiplied by the cost of eligible letter of credit inventory; plus, 85% of the net recovery percentage of eligible in-transit inventory, multiplied by the cost of eligible in-transit inventory; plus, 100% of qualified cash; minus, all availability and inventory reserves. The ABL Facility includes borrowing capacity in the form of letters of credit up to the entire amount of the facility, and up to $25 million in U.S. dollars for borrowings on same-day notice, referred to as swingline loans, and is available in U.S. dollars, Canadian dollars and Euros. The Company did not incur loans under the ABL Facility at the closing of the Acquisition through October 27, 2012. Any amounts outstanding under the ABL Facility are due and payable in full on the fifth anniversary of the First Amendment.

 

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Borrowings under the ABL Facility bear interest at a rate per annum equal to, at Group’s option, any of the following, plus, in each case, an applicable margin: (a) in the case of borrowings in U.S. dollars, 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 adjusted for certain additional costs, plus 1.00%; (b) in the case of borrowings in U.S. dollars or in Euros, a LIBOR determined by reference to the costs of funds for deposits in the relevant currency for the interest period relevant to such borrowing adjusted for certain additional costs; (c) in the case of borrowings in Canadian dollars, the average offered rate for Canadian dollar bankers’ acceptances having an identical term of the applicable borrowing; and (d) in the case of borrowings in Canadian dollars, a fluctuating rate determined by reference to the higher of (1) the average offered rate for 30 day Canadian dollar bankers’ acceptances plus 0.50% and (2) the prime rate of Bank of America, N.A. for loans in Canadian dollars. The applicable margin for borrowings under the ABL Facility varies based on Group’s average historical excess availability from 0.50% to 1.00% with respect to base rate borrowings and borrowings in Canadian dollars bearing interest at the rate described in the immediately preceding clause (d), and from 1.50% to 2.00% with respect to LIBOR borrowings and borrowings in Canadian dollars bearing interest at the rate described in the immediately preceding clause (c).

All obligations under the ABL Facility are unconditionally guaranteed by Group’s immediate parent and certain of Group’s existing and future wholly owned domestic subsidiaries (referred to herein as the subsidiary guarantors) and are secured, subject to certain exceptions, by substantially all of Group’s assets and the assets of Group’s immediate parent and the subsidiary guarantors, including, in each case subject to customary exceptions and exclusions:

 

   

a first-priority security interest in personal property consisting of accounts receivable, inventory, cash, deposit accounts (other than any designated deposit accounts containing solely the proceeds of collateral with respect to which the obligations under the ABL Facility have only a second-priority security interest), securities accounts, commodities accounts and certain assets related to the foregoing and, in each case, proceeds thereof (such property, the “Current Asset Collateral”);

 

   

a second-priority pledge of all of Group’s capital stock directly held by Group’s immediate parent and a second priority pledge of all of the capital stock directly held by Group and any subsidiary guarantors (which pledge, in the case of the capital stock of each (a) domestic subsidiary that is directly owned by Group or by any subsidiary guarantor and that is a disregarded entity for United States Federal income tax purposes substantially all of the assets of which consist of equity interests in one or more foreign subsidiaries or (b) foreign subsidiary, is limited to 65% of the stock of such subsidiary); and

 

   

a second-priority security interest in substantially all other tangible and intangible assets, including substantially all of the Company’s owned real property and intellectual property.

The ABL Facility includes restrictions on Group’s ability and the ability of certain of its subsidiaries to, among other things, incur or guarantee additional indebtedness, pay dividends (including to the Parent) on, or redeem or repurchase, capital stock, make certain acquisitions or investments, materially change its business, incur or permit to exist certain liens, enter into transactions with affiliates or sell its assets to, or merge or consolidate with or into, another company. In addition, from the time when excess availability under the ABL Facility is less than the greater of (a) 10.0% of the lesser of (1) the commitment amount and (2) the borrowing base and (b) $20 million, until the time when Group has excess availability under the ABL Facility equal to or greater than the greater of (a) 10.0% of the lesser of (1) the commitment amount and (2) the borrowing base and (b) $20 million for 30 consecutive days, the credit agreement governing the ABL Facility requires Group to maintain a Fixed Charge Coverage Ratio (as defined in the ABL Facility) tested as of the last day of each fiscal quarter that shall not be less than 1.0.

Although Group’s immediate parent is not generally subject to the negative covenants under the ABL Facility, such parent is subject to a holding company covenant that limits its ability to engage in certain activities.

The credit agreement governing the ABL Facility additionally contains certain customary representations and warranties, affirmative covenants and provisions relating to events of default, including without limitation, a cross-default according to the terms of any indebtedness with an aggregate principal amount of $35 million or more. If an event of default occurs under the ABL Facility, the lenders may declare all amounts outstanding under the ABL Facility immediately due and payable. In such event, the lenders may exercise any rights and remedies they may have by law or agreement, including the ability to cause all or any part of the collateral securing the ABL Facility to be sold.

There were no short-term borrowings during the first nine months of fiscal 2012. Outstanding standby letters of credit were $9.2 million and excess availability, as defined, was $240.8 million at October 27, 2012.

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 $35 million of documentary letters of credit on a no fee basis. Outstanding letters of credit were $14.3 million and availability was $20.7 million at October 27, 2012.

 

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Outlook

Our short-term and long-term liquidity needs arise primarily from (i) capital expenditures, (ii) debt service requirements, including quarterly principal payments and repayments based on annual excess cash flows as defined, and (iii) working capital needs. Management anticipates that capital expenditures will be approximately $135 million for fiscal 2012, including approximately $55 million for new stores, approximately $40 million for information technology enhancements, approximately $25 million for warehouse and corporate office expansion, and the remainder for store renovations and general corporate purposes. Management believes that our current balances of cash and cash equivalents, cash flow from operations and availability under the ABL Facility will be adequate to finance debt service requirements, planned capital expenditures and working capital needs for the next twelve months. Our ability to make planned capital expenditures, to fund our debt service requirements and to remain in compliance with the financial covenants, and to fund our operations depends on our future operating performance, which in turn, may be impacted by prevailing economic conditions and other financial and business factors, some of which are beyond our control.

Off Balance Sheet Arrangements

We enter into documentary letters of credit to facilitate the international purchase of merchandise. We also enter into standby letters of credit to secure reimbursement obligations under certain insurance and trade programs. As of October 27, 2012, we had the following obligations under letters of credit in future periods:

 

     Total      Within
1 Year
     2-3
Years
     4-5
Years
     After 5
Years
 
     (amounts in millions)  

Letters of Credit

              

Standby

   $ 9.2       $ 9.2       $ —         $ —         $ —     

Documentary

     14.3         14.3         —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 23.5       $ 23.5       $ —         $ —         $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Cyclicality and Seasonality

The industry in which we operate is cyclical, and consequently our revenues are affected by general economic conditions. Purchases of apparel and accessories are 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.

Our business is seasonal. As a result, our revenues fluctuate from quarter to quarter. We have four distinct selling seasons that align with our four fiscal quarters. Revenues are usually higher in our fourth fiscal quarter, particularly December, as customers make holiday purchases. Our working capital requirements also fluctuate throughout the year, increasing substantially in September and October in anticipation of holiday season inventory requirements.

Critical Accounting Policies

A summary of our critical accounting policies is included in the Management’s Discussion and Analysis section of our Annual Report on Form 10-K for the fiscal year ended January 28, 2012 filed with the SEC.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

Borrowings under the Senior Credit Facilities are at variable rates of interest and expose us to interest rate risk. If interest rates increase, our debt service obligations on our variable rate indebtedness will increase even though the amount borrowed would remain the same, and our net income and cash flow, including cash available for servicing our indebtedness, will correspondingly decrease. If LIBOR increases above 1.25%, a 0.125% increase in the floating rate applicable to the $1,185 million outstanding under the Term Loan Facility would result in a $1.5 million increase in our annual interest expense. Assuming all revolving loans are drawn under the $250 million ABL Facility, a 0.125% change in the floating rate would result in a $0.3 million change in our annual interest expense. We have entered into interest rate swaps and caps in order to hedge the volatility of cash flows related to a portion of the Company’s floating rate indebtedness (see note 8 to the unaudited condensed consolidated financial statements). These hedges may not fully mitigate our interest rate risk, or may not be effective.

 

ITEM 4. CONTROLS AND PROCEDURES

Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms.

There were no changes in internal control over financial reporting that occurred during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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Table of Contents

PART II – OTHER INFORMATION

 

ITEM 1. 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 adverse effect on the Company’s financial position, results of operations or cash flows.

 

ITEM 1A. RISK FACTORS

The Company’s Annual Report on Form 10-K for the fiscal year ended January 28, 2012 includes a detailed discussion of certain risks that could materially adversely affect our business, our operating results, or our financial condition. There have been no material changes to the risk factors previously disclosed.

 

ITEM 6. EXHIBITS

Articles of Incorporation and Bylaws

 

Exhibit
No.

 

Document

3.1   Amended and Restated Certificate of Incorporation of J.Crew Group, Inc., adopted March 7, 2011. Incorporated by reference to Exhibit 3.1 to the Form 8-K filed on March 10, 2011.
3.2   Amended and Restated By-laws of J.Crew Group, Inc., adopted March 7, 2011. Incorporated by reference to Exhibit 3.2 to the Form 8-K filed on March 10, 2011.

Material Contracts

 

Exhibit
No.

 

Document

10.1   First Amendment to Credit Agreement, dated as of October 11, 2012, by and among J. Crew Group, Inc., Chinos Intermediate Holdings B, Inc., Bank of America, N.A., as administrative agent and as collateral agent, and each lender party thereto. Incorporated by reference to Exhibit 10.1 to the Form 8-K filed on October 15, 2012.

Certifications

 

Exhibit
No.

 

Document

31.1   Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
31.2   Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
32.1   Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.**

Interactive Data Files

 

Exhibit
No.

 

Document

101   Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Condensed Consolidated Balance Sheets at October 27, 2012 and January 28, 2012, (ii) the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the thirteen weeks ended October 27, 2012 and October 29, 2011, (iii) the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the thirty-nine weeks ended October 27, 2012 and for the periods March 8, 2011 to October 29, 2011 and January 30, 2011 to March 7, 2011, (iv) the Condensed Consolidated Statements of Changes in Stockholders’ Equity for the thirty-nine weeks ended October 27, 2012 and for the period March 8, 2011 to January 28, 2012, (v) the Condensed Consolidated Statements of Cash Flows for the thirty-nine weeks ended October 27, 2012 and for the periods March 8, 2011 to October 29, 2011 and January 30, 2011 to March 7, 2011, and (vi) the Notes to Unaudited Condensed Consolidated Financial Statements.**

 

* Filed herewith.
** Furnished herewith.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

  J.CREW GROUP, INC.
  (Registrant)

Date: November 28, 2012

  By:  

/s/    MILLARD DREXLER

    Millard Drexler
    Chairman of the Board and Chief Executive Officer
Date: November 28, 2012   By:  

/s/    STUART C. HASELDEN

    Stuart C. Haselden
    Chief Financial Officer

 

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EXHIBIT INDEX

Articles of Incorporation and Bylaws

 

Exhibit
No.

  

Document

3.1    Amended and Restated Certificate of Incorporation of J.Crew Group, Inc., adopted March 7, 2011. Incorporated by reference to Exhibit 3.1 to the Form 8-K filed on March 10, 2011.
3.2    Amended and Restated By-laws of J.Crew Group, Inc., adopted March 7, 2011. Incorporated by reference to Exhibit 3.2 to the Form 8-K filed on March 10, 2011.

Material Contracts

 

Exhibit
No.

  

Document

10.1    First Amendment to Credit Agreement, dated as of October 11, 2012, by and among J. Crew Group, Inc., Chinos Intermediate Holdings B, Inc., Bank of America, N.A., as administrative agent and as collateral agent, and each lender party thereto. Incorporated by reference to Exhibit 10.1 to the Form 8-K filed on October 15, 2012.

Certifications

 

Exhibit
No.

  

Document

31.1    Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
31.2    Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
32.1    Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.**

Interactive Data Files

 

Exhibit
No.

  

Document

101    Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Condensed Consolidated Balance Sheets at October 27, 2012 and January 28, 2012, (ii) the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the thirteen weeks ended October 27, 2012 and October 29, 2011, (iii) the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the thirty-nine weeks ended October 27, 2012 and for the periods March 8, 2011 to October 29, 2011 and January 30, 2011 to March 7, 2011, (iv) the Condensed Consolidated Statements of Changes in Stockholders’ Equity for the thirty-nine weeks ended October 27, 2012 and for the period March 8, 2011 to January 28, 2012, (v) the Condensed Consolidated Statements of Cash Flows for the thirty-nine weeks ended October 27, 2012 and for the periods March 8, 2011 to October 29, 2011 and January 30, 2011 to March 7, 2011, and (vi) the Notes to Unaudited Condensed Consolidated Financial Statements.**

 

* Filed herewith.
** Furnished herewith.

 

31